The Good, the Bad, and the Ugly of State Sales Tax Systems

Note that this is the newest in my series of "real-world" small business issues.  Other posts in this series include Buying a Small Business and Working with the Department of Labor

One of the things I did not mention in my series on buying a small business was the notion of complexity.  Our business manages over 175 sites with 500 seasonal employees in 10 states.  I have friends who own businesses that have the same sales, and more profit, from working alone from their home.  As I often tell people, I love what I do, working in recreation and spending most of my time in National and State Parks, but it is overly complex for the money we make.

The one advantage of this is that, despite being a small business, I get to observe business practices in many parts of the country.  And one business-related practice that varies tremendously from state to state is sales taxes.  (By the way, before I bought this business, I was a strong Federalist.  Putting most regulatory power in the states slows government encroachment.  It also limits anti-business regulation, because states know that such unilateral regulation will just chase employment across state lines, as California has found out.  However, having to deal with 10 different tax and regulatory regimes every day is causing me to revisit Federalism a bit).

Anyway, based on this experience, I will dedicate the rest of this post to my observations of the good and bad of state sales tax systems.

Background

Unless you live in Alaska, Delaware, Montana, New Hampshire, or Oregon, you are probably used to paying sales taxes on most retail transactions (those five states have no general sales tax).  Sales tax is generally a percentage, typically between 6% and 9%, that is added at the register to most sales.  Unlike VAT taxes in Europe, sales taxes are only applied to the final sale to the consumer -- items sold as inputs to a manufacturing process or to be resold at retail are not taxed).

In addition to state taxes, many counties and/or cities have their own sales taxes that are added on as well.  Also, special additional sales taxes are added for things like lodging or rental cars.  (Tourism related special sales taxes are very popular, in part because proceeds are sometimes used for local tourism promotion, but more so because locals like having a tax that is mostly paid by visitors and non-residents).  Depending on the state, certain items are generally exempt from sales taxes, such as groceries.  Some states have coy alternate names for sales tax, like "transaction privilege tax", but its all basically the same. 

Businesses who collect the tax are responsible for keeping track both of sales and sales taxes collected, and to report these monthly or quarterly (depending on the state and their sales volume).  Businesses, not consumers, are accountable for making sure the right tax is collected and paid.  So, if a business forgets to charge sales tax on a taxable transaction, the state department of revenue will come after the seller, not the buyer.

The one exception to this is the use tax, the one "innovation" in sales taxation that has occurred over the last couple of years.  Irritated that they have been constitutionally limited from collecting taxes on mail order and Internet sales made across state lines, states have invented the use tax.  Basically, it is just a sales tax the buyer must pay on interstate retail purchases where no sales tax was paid.  Suffice it to say that the paperwork to pay this tax correctly is a nightmare and I would bet that 99.9% of companies out there are not in compliance.  Is anyone in your company filing use tax reports on that last Dell you bought?

Near the Ideal

For small businesses that only have one location, sales taxes are probably not a hassle.  My wife runs a purse business, with just one sales location, and her returns are no problem.  However, once you cross the line to having multiple locations, and as soon as these locations start crossing county or state lines, sales tax returns are going to start to be a hassle.

From a business person's point of view, the ideal sales tax system is one that does not care what part of the state those sales occurred in, and applies one and only one rate to all purchases in all parts of the state.  The sales tax return would then be very simple, with a box for "sales" and a box for "tax owed".  The return could fit on a 3x5 card.

Of the states in which we do business, Kentucky and Minnesota come closest to this ideal.  Both have one statewide rate for all locations, don't differentiate between types of retail sales, and have very short and simple returns.  Each, however, being government entities, have to do some small things, though, to make sure they fall short of perfect. 

Kentucky, for example, insists that you use the pre-printed form they send you - you can't download a blank off the Internet.  That means that, since you have to use ink to fill it out, if you make a mistake, it becomes a big scratched out mess.  Minnesota has a very simple return, but does not allow paper returns - you have to use the Internet.  I assume this is irritating for businesses that have difficulty with Internet access.  I am comfortable with an Internet form (except for this) but of course, since their is absolutely no alternative, their online site has a terrible uptime.  I once had one of the phone representatives piously tell me that I was still liable for all late penalties even if the reason I could not file was that their site was down for nearly a week.

Way too many rates

We haven't operated in every state, but I can't imagine that there is any state with more special local rates than Washington State.  I don't know if this is a function of not having an income tax, or just the general socialist slant of most of the state's government (at least west of the cascades), but it is a real mess.  Many states have rates that vary by county, but in Washington state, there may be as many as 15 or 20 different rates in a single county.  As you might imagine, you have to stare at an online map pretty closely to make sure you have the right rate.  Plus there are sales-based occupancy taxes that vary by type of business and there are lodging taxes that vary by geography and number of rooms (or campsites) in the establishment.  There are convention taxes, rapid transit taxes, and stadium taxes that all have their own boundaries that don't necessarily match any county lines.

The result is a sales tax return 8 pages long, even longer than the ridiculously complicated California return.  Each time we add a campground in the state, we spend literally hours pouring over maps and rules trying to figure out what taxes we owe.  And, even then, we sometimes get notified that we missed something or find out later that we have been collecting a tax we were not supposed to collect.

Way too Arcane

For all of its complexity of rates, the Washington return is actually laid out in a clear manner and is pretty easy to understand.  On the opposite end of the scale is California, which has a return that is ridiculously difficult to understand.  Even having filled out this return for two years now, I still have to pull out an old return every time to figure out how to fill in the form.

Way too Many Registrations

Most states only require one registered account per state.  If you have multiple locations, the state generally requires you to register each location and get a certificate to put on the wall of the establishment, but all the locations can be registered under one master account. 

Except for Florida.  Florida requires a company to obtain a different sales tax number for every location in the state.  In fact, for a few of our campgrounds that also had a store, we had to obtain a separate sales tax number for the store and the campground.  As a result, despite having fairly modest operations in Florida, we have about 10 sales tax numbers.  In the beginning, Florida tried to get us to file a separate return for each location, but after a lot of back and forth with various customer service agents (see below) we were able to settle on filing 2 consolidated statement, one for each county that we are in.

Bad Customer Service

One of the nearly universal features of state departments of revenue is bad customer service.  This can take the form of really long processing times (it took Wisconsin 6 months to process my original filing for a tax ID) or long phone hold and wait times (in nearly every state).  Or, in the case of Florida, the state can feature all of the above, plus what I call "magic 8 ball" customer service.  Every time I call Florida on a particular issue, I get a different answer to my question, sometimes from the same person. 

Asking for Useless Information

One of the toughest things as a manager is to fight against the tendency to ask managers to report too many things every month.  I am constantly getting requests from my staff to build "X" data request into the monthly or weekly report.  I try to be pretty ruthless with these requests, limiting what managers have to report to just what we really need to know in HQ.

Unfortunately, state departments of revenue have the same pressures, and sometimes they are not very good at resisting this pressure.  For example, in Arizona, the state made a modification to the sales tax reports recently requiring us to break down all of our deductions by location, by type of sale and by type of deduction.  This is far more detail than any other state asks for, and one wonders why they need it, or if it just gets filed away unused.  Since this is a three-dimensional matrix, the number of line items can get very long (in our business, we have about 9 locations times up to 3 sales types times up to 4 deduction types).

Egregiously High Rates

Every once in a while, we run into a community that adds a ridiculously high rate to a particular type of retail sale.  More often than not, this occurs with lodging taxes.  Take the example of Mono County, California (on the east side of the Sierras in the Owens Valley).  Mono County adds on a 12% lodging tax, in addition to all other taxes.  Now, I can understand a high tourism community where infrastructure impacts from visitors drive higher taxes, but even tourist overwhelmed Sedona, Arizona (most beautiful spot in America, by the way) only adds 6% to lodging taxes.  The best I can guess is that Mono County, whose tourists are mostly from Los Angeles, are still angry at LA's taking all their water and are now getting revenge.

Conclusion

In starting your own business, sales tax registration and research should be a key item on your checklist.  As your business grows, be ready for substantial increases in your tax filing complexity.

  • I found this Blog to be very informative. Thank you for sharing your insights into this topic.

  • Scott

    Warren - I don't like tooting my own horn but I work for a sales tax software company. If you need something to help automate your process (Arizona in particular is a little tricky) send me an email. And to be clear, I'm not a salesman. : )

  • Richard Brown

    Mono county certinly doesn't need to raise citizens of the countys taxes. They have a bunch of hjgway bandits taking down out of state cars, then if you want a hearing you first have to come back for an arrainment hearing, then get a court date and come back again. Now of course the court knows few will go to all the trouble,sooo the county gets a freebe tax. The answer stay out of Mono County I will