Manufacturers have always faced a unique set of rules when it comes to tax compliance. However, two forces — the COVID-19 pandemic and the rise of ecommerce — are changing some of the fundamental assumptions that manufacturers have always operated under.
Remembering the before times
Back in the old days — say, five years ago — many manufacturers hardly worried at all about sales tax compliance. That, in large part, was because most of their sales were tax exempt, often because they were producing components that would go into another company’s product, and taxes wouldn’t be collected until the final product was sold to the end user.
All a manufacturer had to do to satisfy the authorities was produce an exemption certificate — proving specific transactions were exempt from tax. (You can learn more by downloading The Ultimate Guide to Sales Tax Exemption Certificates from our partners at Avalara.)
That wasn’t always painless. Many companies stored paper certificates in filing cabinets — even boxes. This required accounting team members to physically rifle through stacks of paper to search for the correct document, and it didn’t provide an easy way to track whether the certificates were valid or had expired. The paper systems were disconnected from manufacturers’ ERP and ecommerce platforms, which made it hard to create consistent internal processes for applying the certificates — and that
sometimes led to annoyed customers.
But while it wasn’t simple, for the most part, exemption certificate management was a known process. Then came 2018.
The Wayfair decision affected manufacturing too
The U.S. Supreme Court’s 2018 decision in South Dakota v. Wayfair, Inc. upended the previous legal standard that said a state could only apply sales tax to companies that had a physical nexus within its boundaries. (This typically meant a brick-and-mortar location like a factory, store, or warehouse, but there were other examples too.)
After the Wayfair decision, states were allowed to levy sales taxes on companies based on whether they were making a specified level of sales with a state. As part of that — and here’s what trips up manufacturers — many states require companies to register and report sales, even when those sales are tax exempt. This creates a reporting requirement, and failure to comply with it can lead to fines.
Further, some states count tax-exempt sales when calculating whether a company has an obligation to collect and remit taxes on their nonexempt sales. As an example, your manufacturing business has a customer in a state that requires companies to start collecting and remitting sales tax once they record more than $200,000 in total sales. You deliver 12 tax-exempt shipsets worth $20,000 each to this customer — you’re over the $200,000 threshold, but all the sales are tax exempt, so while you’re required to register and report, you pay no tax.
But then you pick up a 13th sale in that state to a new customer, and it’s not tax exempt. And since you’ve already gone over the $200,000 threshold with your exempt sales, you need to collect and remit that tax — and you’d better have already registered to do so.
That brings up another issue: Manufacturers are among the most common targets of state tax auditors. That’s because so many manufacturers fail to manage their exemption certificates properly, leading to large errors and fines, and — like everyone else — auditors like to get more bang for their buck.
As if the 2018 court ruling wasn’t enough, 2019 brought us the COVID-19 pandemic, which created a whole new set of operating and tax compliance challenges for the manufacturing industry.
First, the pandemic has forced many back offices to close for extended periods over the past two years. With so many working from home, it was difficult for finance teams to track and manage paper exemption certificates that were stuffed into file cabinets and boxes back in locked-down offices.
Remote work itself caused some companies problems. If your senior accountant decided to ride out the pandemic by telecommuting from their family’s lake cabin one state over, that could have created a new physical nexus problem for your company, meaning you might have a new tax registration compliance issue.
In addition, supply chains were tangled. That prompted some companies to seek out new vendors and shippers to keep materials coming in and finished products going out. If your Chicago, Illinois, company contracted with a new warehouse and trucking company in nearby Gary, Indiana, you might also have created a new tax obligation.
The pandemic also created opportunities for manufacturers. Ecommerce exploded, and retail customers began using ecommerce platforms to seek out products direct from the manufacturer. But drop-shipping products to customers can easily create an economic nexus that you never had before, and thus a new sale tax compliance problem for your remote-working finance team to figure out.
The scrambled supply chains also meant Tier 1 manufacturers were looking for new vendors. You may have captured new buyers for your products, but if they were in a new state, that gives you a whole new exemption certificate regime to learn and comply with.
Finally, the pandemic also ushered in the era of the Great Resignation. With labor in short supply worldwide, it’s likely that your best finance people have opportunities to work somewhere else. If someone goes, you lose institutional knowledge around exemption certificate management, leaving your business in a bind as you scramble to find someone to manage this paper-based process.
Partnering for success
Our partners at Avalara have resources to help manufacturers figure out their tax compliance challenges.
One of them is the Avalara Tax Changes 2022 report, which includes a section specifically about new tax issues facing manufacturers. Avalara also offers the Free Sales Tax Risk Assessment, which can help manufacturers identify whether they’ve got economic nexus in states they didn’t know about.
You also can contact your account representative here, who can talk you through the automated tax compliance solutions available to you through our partnership with Avalara.
Working together, we can solve your tax compliance challenges, and your other business needs.