Welcome to Tax Matters, a Vertex podcast! I’m Tricia Schafer-Petrecz, External Communications Lead at Vertex.
In this episode, Vertex Vice President of Tax Content and Chief Tax Officer Michael Bernard shares his insights on U.S. sales tax trends.
Mike kicks off the discussion by highlighting key takeaways from the Vertex final 2021 end of year sales tax rates and rules report.
Next, he delves into notable 2022 sales tax trends and challenges. These topics include potential regulatory changes at the state level, the growing adoption of digital sales taxes and auditing activity.
Now, I’ll turn it over to Mike and Eric…
Eric Krell Mike, it’s good to reconnect with you on Tax Matters. Vertex has made available the 2021 end of year sales tax rules and rate change report. Before we discuss some 2022 trends, let’s take a quick look back. What strikes you as the most notable finding from the final 2021 report?
Michael Bernard: I think the most notable one -- and again, it’s good to be with you today -- is the fact that with sub-state jurisdictions, we had almost a record number of them impose a transaction tax…. This is not at the state level, where there were no changes. No states actually added or even increased their sales taxes. These are sub-jurisdictions in those states. Mainly, they consist of police districts, fire districts, utility districts, etc. -- and a record number of them actually imposed new taxes. Obviously, there are some jurisdictions that need additional funding, as they don’t get it through any kind of revenue-sharing with the states or the Feds for that matter. You saw kind of a high watermark on that over the last 10 years.
The other thing that you saw was that a number of cities increased their taxes, and new cities actually imposed taxes. So, even though there was a lot of relief that came out of the federal bill that was passed in March of 2021 (which gave almost $350 billion to state and locals) there’s still a lot of locals out there that feel like they needed additional funding. And, Eric, that’s in addition to already having probably cut personnel and cut services. I would say for 2022, you’re going see a similar that you saw in 2021, related to these jurisdictions.
Eric Krell: What about the combined average rate? How does that look in 2021? What was occurring there?
Michael Bernard: Obviously, you saw higher rates moving up by either a quarter percent, or maybe a half a percent, in a lot of jurisdictions. Consumers need to get used to that. You’re going to see -- as we’ve said in the past -- that sales tax and any kind of transaction taxes are an easy tax to impose. They’re normally very easy to audit by jurisdictions, and they’re collectable every month, so they generates great cash flow. As I said, they’re easy to administer and easy to audit. I think you’re going to see a continued trend there, particularly in light of the fact that the only two other funding mechanisms that a lot of states have is basically an increase to the income tax, or an increase to property taxes. Transaction taxes normally are much more favored by governments.
Eric Krell: Final question about last year: Which states, cities, and/or districts earned the distinction of having the highest sales tax rates in 2021?
Michael Bernard: Well, Louisiana was one. So, Ouachita Parish in Louisiana had a combined rate of almost 13% -- so, 12.95%. That’s pretty high. In terms of some other places, we had high state tax rates in both Indiana and Mississippi, as well as in Rhode Island and Tennessee -- all at about 7%. And then you look at some places like Kodiak, Alaska; Wrangell, Arkansas; and Park, Colorado, which took the highest city sales tax rate from almost 7%…Obviously, it just depends how much of the funding that a lot of these local jurisdictions want to rely on from sales tax. Those that do rely on it heavily [on sales tax] are actually going to have very, very high rates relative to other jurisdictions, which may be relying on other forms of taxation.
Eric Krell: Let me shift your attention to the current year. Vertex, of course, continually tracks sales tax rules and rate changes. As you look out to 2022, what factor or factors are you thinking are going to drive sales tax changes?
Michael Bernard: Well, I think it’s going to continue … what we saw in 2021 in the sense that if local jurisdictions need additional taxes, they’re going to increase those taxes or impose new taxes. Like I said, all of the personnel cuts have been made. Probably all of the service cuts have been made. And now we’re probably down to the fact that they will have to increase taxes or impose new taxes to meet their budgets. I’d also like to say something, Eric, about the ballot box. I don’t think voters are going to be very receptive to increasing taxes on themselves at the ballot box this year. So, what I think you’re going to see more of is jurisdictions or city boards or whatever -- they are going to actually impose or increase sales taxes, which don’t require a vote of the people. That’s a very easy mechanism to increase funding…
The other thing is that there are probably a lot of jurisdictions out there that have reached their debt limits, so they can’t take on more debt, Obviously, transaction taxes are going to be a driver for them to meet some of their operational needs. In some cases, they may be increasing sales taxes just to service their debt or to act as a supplement to capital funding -- using current funds for capital projects. There are just a number of unknown factors out there. I think that, given all of that activity, you’re just going to continue to see an increase in transaction tax activities.
Eric Krell: A couple of weeks ago, you participated in a webcast on regulatory and audit trends, and we’ll post a link to that presentation from the landing page of this podcast. What are some regulatory issues to monitor this year?
Michael Bernard: I think there a couple of things related to regulatory. One thing is in the economic nexus area. As you know … Wayfair brought in this new rule of economic nexus -- the fact that if you reached a certain level of sales activity within a state or jurisdiction, then you were required to collect or remit sales tax. I think states have become increasingly aware that they cannot impose a very low-activity economic activity standard on taxpayers and survive a constitutional challenge around imposing a sales tax on those sellers. If you go back and you look at the original Wayfair litigation, the [threshold] was $100,000 or 200 transactions or some combination of those. What we’ve increasingly seen, particularly over the last couple of years, is that roughly 15 to 17 states have actually eliminated the [transaction-volume threshold]. The reason they’ve done so is because you can have low-dollar transactions and yet trigger nexus. And the whole idea behind the nexus standards is not so much to do that.
[Those changes] are done more to protect smaller sellers. Increasingly, states moving away from transaction-count thresholds to revenue amounts, or dollar amounts, and they’re actually pegging them to their market. South Dakota might have $100,000 worth of sales for a year as the trigger where you have to start filing, whereas California might have a $500,000 threshold. That makes sense because they’re two very differently sized markets. They’re pegging their economic activity to the actual size of their state.
The second thing is what we continually tell sellers is: Whatever you do as it relates to the nexus standards, don’t start remitting and collecting and reporting sales tax on sales until you actually hit those economic thresholds. What I would say to the folks on the podcast is: You need to constantly review how much economic activity you have during particular calendar year in a state. If your amounts drop below what the nexus standard is then you have to start thinking about de-registering and not collecting. Keep your eye on that.
Eric Krell: I know you also keep tabs on digital tax developments. What digital tax challenges should U.S. tax groups be aware of and maybe even be prepared to address?
Michael Bernard: When I think of digital tax, there are three distinct revenue streams. First of all, I think of the sale of audio or video content, or educational learning, things that look and act like tangible personal property. Anything along those lines, states are increasingly picking up those revenue streams as taxable. And there’s no constitutional challenge other than economic nexus that taxpayers can make in terms of collecting or remitting on those [taxes]… That’s the first thing.
Eric Krell: Mike, so I understand -- I have a favorite music streaming service. I live in Texas, and I think for the first time this past year, I was informed that price would go up because sales tax would be attached to that. Is that an example of what you’re talking about?
Mike: Perfect example, exactly. There are states -- maybe somewhere around 15 to 18 to 20 states -- which impose a digital sales tax on what you were just referring to. And more and more states are coming on board.
Eric Krell: And I took you off track -- what are the other two categories that you want to hit upon?
Michael Bernard: The second one, Eric, would be that there is a lot of data generated by customers being on platforms and searching for certain goods or services. There are analytics behind all of that, whether you’re on a private-company website or you’re on a marketplace or wherever. A lot of that information is sold to marketing organizations... A lot of states are now starting to tax those reports which are sold as a services tax, so that information is actually being taxed as well…What it really relates to is an expansion of services being taxed. As you know, Eric, most states do not tax services, ten or fewer actually do so. But states are starting to realize that the analytics that come out of e-commerce business are very, very valuable to marketers, and a lot of these websites are selling that to them. That sale of information is becoming more and more subject to a sales tax. That’s a second stream.
And the third is, as you’re well aware of, Eric, what’s going on in Maryland, where they are attempting to tax digital advertising….The battle here is more of a Constitutional issue – whether states have the right to tax digital advertising for sales tax purposes on websites vs. in some instances, not taxing the same type of advertising in print media, on the radio or on television. There’s kind of an equal protection argument that digital advertisers are being discriminated against relative to other types of media in their same class. While that case is moving along in the Maryland courts and it’s moving along in the federal courts, I would tell people, that’s not going to be decided probably for some time – probably the latter part of 2022. But if you are an advertiser or you use these services and your advertising budget is going to go up, or you have to collect or remit because you’re a supplier of digital advertising, you have to keep your eyes on that as well.
Eric Krell: Last question, Mike: What audit and enforcement trends are unfolding right now?
Michael Bernard: So, what we’ve seen from our customers and we -- obviously, I always have close contact with them and I talk to them quite often -- most of our customers today have said that the audit activity by governments is back to pre-pandemic levels. During the pandemic, things were kind of shut down. The governments did the same thing as most private employers do -- they actually had to work in place, they had to get their networks connected because people were remote. All of that [IT] work has now been achieved. The auditors are back, but they’re not working from the office or at a company site, where they might traditionally have gone, but now they’re working off-site and they have the tools to actually [perform] audit activity.
Auditing activity by governments, both on the pay side and on the sell side… are back in play….I know a lot of you who’ve done a great job on your sales side, on documenting your sales taxes end ensuring that you’re properly collecting or remitting. But, don’t forget about the purchasing side. To the extent that you are purchasing goods or services and you’re paying use tax on all those items, please make sure that you have proper exemption certificates in place, both for the sales and the purchase side… My advice, Eric, is to pay attention to both sides, what you’re selling and what you’re purchasing.
Eric Krell: It sounds like an exciting year ahead, Mike. Thank you very much, it’s always great to connect to you and I look forward to doing so again very soon.
Tricia Schafer-Petrecz: Thank you for listening to Tax Matters, a Vertex podcast…Check back here for more episodes soon.
Note: This transcript has been edited for clarity.