In this edition of the Connected Enterprise we speak with Scott Peterson from Avalara on how the Pandemic accelerated e-commerce adoption means for Business Tax.
Carl Lewis: Welcome to the Connected Enterprise Podcast. I’m Carl Lewis, your host from Vision33, and my guest is Scott Peterson from Avalara. Scott, welcome to the podcast. Tell us about yourself, your background, and Avalara.
Scott Peterson: Thanks for inviting me, Carl. I’m Scott Peterson, and my title is long: Vice President of US Tax Policy and Government Relations. Basically, my job is relationships. I build and maintain relationships with state and local governments so Avalara has someone to interact with when things don't go perfectly.
Avalara helps businesses eliminate the compliance burden governments impose on them for tax compliance. We help people with sales, alcoholic beverage, lodging, tobacco, motor fuel, insurance premium, and value-added taxes. And probably some I'm forgetting! We have contracts with businesses and help them with automation or outsourcing, so they don’t have to deal with the government.
Carl Lewis: Were taxes your plan in life?
Scott Peterson: Heck no! I went to graduate school to become the city manager of Los Angeles. I graduated during a nasty recession and couldn't find a job. I got an offer from the South Dakota legislature – where I lived – to be an analyst, and I figured it was better than being unemployed.
They had hired three people; we all started the same day. The boss introduced us to the employees, and everybody was topic structured. The boss asked if they wanted to change their specialties and when they all said no, he told me, "You're our tax guy."
Carl Lewis: Scott, what’s happening with ecommerce today, from Avalara’s perspective? We know it's taken off like a rocket because of the pandemic, but where's it going from here?
Scott Peterson: We didn't imagine it would be where it is today. Even before the pandemic, which radically accelerated it, ecommerce was growing at 25% to 30% a year. Total retailing was growing 2% or 3%, but online was going 25% or 30%. The pandemic shifted everything. I've always worked from home, so the pandemic didn't change where I work, but it changed what I do. Same with shopping – the pandemic didn’t stop people from shopping; it just changed where and how they shop.
That accelerated ecommerce growth much further than most people thought possible. And it won’t slow down. What will change is what little in-person commerce we do. I’ll always buy my clothes in person. My wife will always have her shoes delivered. But eventually, we’ll fly, travel, and eat in restaurants again. We’ll do the things that are literally impossible to do remotely. That’s where I see commerce changing. I think ecommerce will continue to grow at a double-digit rate forever.
Carl Lewis: I agree. I don’t buy clothes without seeing them first, but a downside of buying more online is returning more things. I read that returns for ecommerce companies are 30%. Does that complicate things from a tax perspective?
Scott Peterson: No. Returns are standard. People have always bought things, changed their minds, and returned them. Retailers built returns into their accounting systems long ago. And their sales tax is part of their accounting system, so returns are only an issue when they cross tax periods.
For sales tax in the United States, the tax period is a month. If you buy something on March 30th and return it on April 4th, you've crossed tax periods. During a tax period, retailers must account for their sales. They’ll account for the return when they file for April. You always credit the taxes you collect during the month you give the return. State websites are set up to deal with returned goods.
What's odd with return goods now is that businesses are occasionally telling people, "Don't bother returning it. We’ll send you the right thing. Keep the wrong things because it costs too much to ship it back and return it to inventory – it’s cheaper for us to give it to you."
Carl Lewis: I see that happening with so-called commodity items. It depends on the item’s original cost, but it's a curious growth. Some people say five or six years of ecommerce progress was crammed into the last year.
Scott Peterson: Yes, and we see it in sales. People who weren’t traditionally online are doing this for the first time. They know nothing about selling online. They don't want to think about shopping carts. The concept of collecting sales tax from someone 1,500 miles away is beyond their knowledge. People know what they know, and in the sales tax collection world, what you know is often a danger. In 2018’s South Dakota versus Wayfair trial, the Supreme Court allowed states to make everybody collect sales tax everywhere. That exposed many people to something they didn’t even realize existed. If you're thinking about collecting sales tax in an ecommerce world, remember this: everything is taxable somewhere. Someone, somewhere, taxes everything, and you must be prepared.
Carl Lewis: Interesting. With this ecommerce growth, will the number of audits increase?
Scott Peterson: Yes. First, states had a dismal record of audit compliance. The best state – and best means largest – does no more than 3% of their total businesses every year.
Carl Lewis: Wow.
Scott Peterson: It's impossible to be in business your entire life and never be audited. Big companies get audited all the time. There's an auditor in nearly every big store right now, and as soon as they leave, the next state auditor will stop in. Large retailers and manufacturers have office space and employees dedicated solely to state audits.
If small retailers file returns that look like they know what they’re doing, they never get audited. At least, in the old world. Wayfair radically increased the number of licenses people must deal with. So, the best was doing 3%; now they’ll be lucky to do 1.5% – maybe 1.8% – because there are so many more licensed businesses to deal with. They must get back up to where they were before, which means hiring people.
Carl Lewis: Wow. You would assume everyone gets audited because everyone seems to have a horror story.
Scott Peterson: States are better at advertising that they audit than they are at auditing.
Carl Lewis: I've heard we've always had exempt goods and services, but some states are now taxing them. How does that affect sellers and buyers?
Scott Peterson: Much of this is relatively new because of the internet and the digitization of the formerly tangible. You went to a bookstore for a book. You went to a music store for music. You got a book or CD, which were taxable not because they were books or music but because they were tangible. In every state, the sales tax law is that all tangible, personal property is subject to sales tax unless specifically exempt. It made no difference what it was – if you're the world's greatest entrepreneur and invent something, the state sales tax picks it up automatically if it's tangible.
State laws didn't cover intangible/digital products. So, in the last 10 years, states have changed their laws to apply to things delivered or accessed electronically. If you download a Kindle book, the states that tax electronically accessed items would pick up sales tax on that. If you're the Kindle manufacturer, you must figure out how to collect sales tax on your customers' digital books.
That’s mostly what we’ve seen in the last 10 years in taxation: things that were exempt not necessarily by design but by an act of God (basically).
Now we see other things. There's always an effort by states to exempt groceries. Everyone thinks taxable groceries affect the disadvantaged too much. There’s little movement in that movement, though, because it’s expensive. Groceries make up a significant portion of the tax base where they’re taxable, so there’s been lots of legislation but little progress.
We've seen activity in social areas. Many states are introducing legislation to exempt gun safety equipment like locks and safes to make gun ownership less hazardous in homes. There's a movement to exempt diapers. Last year, it was introduced in 10ish states, 15 states the year before, a dozen this year. And feminine hygiene products. I don't want to call it a social movement, but an organized effort by folks to get those things exempt from sales tax is something new.
The buyer benefits, but sometimes the seller doesn't because it makes their life more complicated. I must know what a gun safety device is. Which items constitute gun safety devices? Is it children, adolescent, or adult diapers that are exempt? Often, that’s an audit trap. If you're not careful, if the state isn't black and white in how they define these things, and if you don’t build your system perfectly, you’ll get caught on it.
Carl Lewis: It seems like they're trying to motivate how we live. I know states have tried to make groceries taxable, but it hasn't worked out yet.
Scott Peterson: That's a political loser. Unless you live in a state where sales tax is the only tax. For those who want to continue to tax groceries, 100% of their argument isn't the effect on the poor – it's, "We can exempt groceries, and it'll help the poor and the rich." The only way we’ll get that money back is to have an income tax.
Carl Lewis: Exactly. Before Wayfair, the nexus used to be simple to evaluate. But now, every state has a different take on how much did you sell, did you reach X limit, etc. What will happen with the nexus and the fact that it's different for every state? Will there ever be any commonality that makes it easier for businesses?
Scott Peterson: I don't think there will ever be commonality. The only way would be if a state loses a lawsuit or Congress steps in. Congress can pass a law under the commerce clause and say, "You can do this, but these are the rules. We're going to regulate interstate commerce." Interstate commerce is people engaged in business across state lines – so it’s all interstate commerce. If Congress set a national parameter, most states wouldn't be too offended, depending on where they set it.
The alternative is that states win or lose. Every state has a threshold, and they're all slightly different, so it's complicated to deal with because you must understand the difference between the states that use gross sales and those that use taxable sales. You must understand which states tax services and which don't. You must understand if the state wants you to include your marketplace sales inside the threshold or not. Some states have a higher threshold. Some include both a dollar threshold and a transaction threshold. Some have only a dollar threshold. And Kansas has no threshold.
If you’re the controller or VP of tax trying to keep track of this, you have a spreadsheet, and all those things have a column, plus your sales, etc. Most of us thought it would be simple, but it’s not.
In 2018, when the Supreme Court ruled on the South Dakota versus Wayfair lawsuit, they gave states the ability to make everybody collect sales tax everywhere. But none of us expected South Dakota to win. That’s probably why we're all so disappointed about how complicated it is. Had we known South Dakota would win, we'd have put more effort into making sure the Supreme Court said, "We liked South Dakota's law; if you want to do what South Dakota did, you need South Dakota's law." That would have made it easy. But that isn't what they did. They only got rid of what we created in 1967 – which was wrong then and now – which scared many people. Then they replaced it with, "We like South Dakota's law because it does this, this, and this." They didn't say, "This is the law," which was the mistake they made in 1967. They created a standard. Since that day, they've been trying to get rid of that standard.
Carl Lewis: You mentioned marketplace sellers. For our listeners, those are people who only sell on marketplaces like Amazon and hundreds of other marketplaces that essentially manage that whole side of the business for them. What's different about their taxes?
Scott Peterson: Sometimes, they sell on five marketplaces, have their own website, and have three stores. It’s always been complicated, but Wayfair – and the marketplace laws states have adopted since then – made life even more complicated for multi-channel businesses. Ideally, if you're someone who sells only on the marketplace, you’re relieved from the tax collection and probably audit obligations a state can impose on you – assuming the marketplace collected the taxes, which is almost everywhere now. In theory, if you sell only in marketplaces that collect sales tax, your life is probably good.
You may need a sales tax license in a few states, where they ask you to include the sales you run through the marketplace. South Dakota's like that, so if you sell into South Dakota – even through a marketplace that collects taxes – and your sales are $100,000+, you need a license. You’ll file one return a year, and you’ll say, "All my sales go through marketplace. I owe you nothing." But you still have to file one return every year. If you're on multiple marketplaces and have a website and stores, you must track those things separately.
Say you sell $110,000 in South Dakota, and $109,000 of that is on a marketplace that collects tax. South Dakota says, "You exceeded the $100,000, so you need a license. You also need to collect tax on the other $1,000." The marketplace will file a tax that includes the sales you made through them, and you’ll file a return with the tax you collected on the $1,000. That plays out throughout the country because every state's rules are different. You must ask, "Does the state include marketplace sales? Do I need a license? Do I make sales outside the marketplace?" Life for a marketplace seller is only simple if their business is simple, and that's the way sales tax has always been. One store selling one thing in one state is easy.
Carl Lewis: I don't know if I've met anyone in the last 10 years who only wants to do business in their own state.
Scott Peterson: Right. I don't know how you do business without at least attempting to sell across state lines.
Carl Lewis: Even restaurants sell stuff on websites. So, no one is choosing simple anymore. Scott, what is consumer use tax, and how is it affecting businesses?
Scott Peterson: People or businesses purchasing things are consumers (aka buyers), and the consumer use tax is legally imposed on buyers. Sales tax is imposed on sellers. So, the difference between sales tax and use tax is on who pays it. The consumer use tax is imposed because we have a long history of buying things from people who weren’t legally required to collect sales tax. A Florida retailer selling to someone in Connecticut didn't have to collect Connecticut sales tax – until Wayfair.
Connecticut says, "I can't make the Florida retailer collect sales tax, but I can make the Connecticut consumer pay use tax." There are very few places where the consumer use tax isn’t identical to the sales tax. As consumers, we’re supposed to tally up the things we purchased without sales tax, but 1) most people don't keep records to do that, and 2) most people can't look at an invoice and know if they've paid sales tax. Then we're supposed to fill out the state’s use tax return on their website – every state has one – and send the state a check.
No one does that. And departments of revenue only audit businesses, so it affects consumers very little but businesses tremendously. The overwhelming majority of tax that gets collected in a sales and use tax audit is the use tax. The first thing an auditor does is look at purchase invoices to see everything they’ve bought for the last four years. Then it's, "Did you charge sales tax? Was it the right state sales tax?” If yes, they’re done. If they didn’t charge sales tax, it’s, “Was the thing taxable or not taxable?” If it was taxable, they’ll add everything up and tell the business they owe X dollars in use tax for the thing you bought but didn’t pay sales tax.
That tax will never be repealed. It will always be a burden on businesses. The only way auditors will ever give it up is if it disappears. In theory, if every retailer in the country collected sales tax on every transaction – correctly – the consumer use tax would disappear.
Carl Lewis: Interesting. I didn't realize there are so many folks not charging sales tax at the time of purchase.
Scott Peterson: Many people don't realize they're selling taxable items into a state. I tell accountants and lawyers about it because most don't know three states apply sales tax to legal and accounting services. When a lawyer gets a new client in Hawaii, New Mexico, or South Dakota, they must decide whether to bill that person more than $100,000 because if they do, they become a taxpayer in that state.
In the old days, they didn't care. If everything the attorney did occurred outside that state, it was their client’s problem. But when I ran the sales tax in South Dakota, our auditors loved to look for businesses that used out-of-state attorneys and accountants. It’s easy money for auditors.
Carl Lewis: Interesting. Do you see any changes on the horizon?
Scott Peterson: Tax policy is never revolutionary, only evolutionary, and there will always be little nibbles around the edges of tax policy. There will be new exemptions. States will exempt feminine hygiene products, which is the right thing to do. There are legitimate reasons to exempt gun safety equipment. Several states think they can build the world's greatest economy by exempting things businesses buy and move into the state. If you run a business in the state for 35 years, you get nothing, but when your out-of-state competitor moves in, they get everything.
There will always be new sales tax-related economic developments. Mississippi and West Virginia’s governors believe people don't live in their state because they have an income tax. So, they want to increase their sales tax to raise enough money to repeal their income taxes. We're talking probably a 50% increase in their sales tax rate to get that done.
Carl Lewis: Wow.
Scott Peterson: A governor who actually wants this would phase it in over nine or ten years, but governors only think in four-year periods. They're only thinking to the next election, so they’ll never start a ten-year evolutionary change in their taxes because they can't manage it. It could only finish when they're gone, and no politician wants someone else to get credit for their idea.
Carl Lewis: I think we’ll see climate change taxes, such as increases on the sales tax from gasoline and maybe tax incentives on other things.
Scott Peterson: I see some of that. There's legislation like that pending in several states, but most of the gas tax increases this year aren't because of that – they’re because they want to spend more money, like for fixing potholes.
Carbon taxes are coming back into favor, which surprises me. They're not a sales tax – they're a convoluted excise tax. Three or four states have bag taxes, which is an environmental issue. Three or four states have sugar taxes.
Several states are exempting electric car charging stations. I don't have an electric car, but some require 220 volts and a special adapter in your house. Some states are considering offering a sales tax exemption to purchase and install things like that.
Carl Lewis: Electric cars will charge with 110 volts, but it'll take a week or two. If you own an older home like I do, you don't have enough power coming to the house to charge an electric car.
Scott Peterson: I have the same house.
Carl Lewis: You’d need to spend a lot of money to modify your whole electrical system to do that. So yeah, spend the money, but don’t get taxed tax.
Scott Peterson: If you want to put an addition on your house and have to redo the electrical, you pay tax on that. But not if you get an electric car.
Carl Lewis: So, if I want to get rid of the tax for that new electric system upgrade, I need to buy an electric car first?
Scott Peterson: That's right! Seems expensive, but yes.
Carl Lewis: Somehow, that doesn’t seem like a winning formula. Well, Scott, thank you. This is critical stuff if you’re in business, and Avalara put out a great report we’ll make available to our listeners. I hope our chat will be helpful too. Thanks again for being here.
Scott Peterson: You're very welcome, Carl. I enjoyed it.
Carl Lewis: And for everyone else, we'll see you next time. Until then, stay connected.