Navigating the Complexities of State and Local Sales Tax

Getting into the vending and micro-market space can be a lucrative and rewarding business for aspiring entrepreneurs.  A small amount of capital, a willingness to build relationships, coupled with a commitment to do the work necessary to keep clients happy, you can open a business fairly easily.  But like any business, there are challenges and obstacles that will present themselves, and if not managed properly, can derail even the best laid out plans for success.  

One of the biggest challenges owners face is understanding the complexities of sales tax compliance, especially when operating across multiple cities, counties, and states which have very different tax rules. For example, there have been close to 2,000 tax rate changes annually in the last few years along with numerous tax law changes.  

Most small business CPAs are not well versed in sales tax requirements, especially with products sold through a vending machine.   Due to these complexities and the limitations of their accountants, many operators are miscalculating their sales tax obligations, resulting in over payments of sales tax, or subjecting themselves to potential costly audits and penalties.  In either scenario, it means less money in your pocket and potential legal liability.

This article attempts to answer key questions about sales tax and demystify some of the beliefs and practices within the vending industry.
Many vending machine owners think of sales tax only in terms of the tax you pay to a retailer when purchasing products.  But the sales tax requirements associated with vending machines are much different than those of ordinary retail transactions.  Unlike a retail transaction where the sales tax is charged on top of the sales price, vending machine sales have the sales tax embedded in the price, and it is the vending machine operators’ responsibility to remit the sales tax.
In addition to registering to collect sales tax, most states require vending machine owners to obtain a license, or permit, to operate  their machines.  The owner of a micro market (“unattended retail”) is also considered to be a retailer and required to register with the applicable taxing authorities for the collection of sales tax.
Once registered, the vending machine owner is required to calculate sales tax on all vending transactions.The sales tax amount is typically included in the selling price. The owner determines the sales tax amount by applying a state specific calculation formula. The usual method is to calculate the sales tax from the embedded sales price using the method prescribed by the jurisdiction.
Generally, all products sold through a vending machine are taxable, even food in many states.  A number of states have specific regulations related to which products sold through a vending machine are subject to sales tax, based on the type of product that is sold (i.e., soda, juice, snacks, candy, gum, salad, sandwich, etc.) and the taxability of these products can vary by state depending upon the ingredients.  For example, juice that contains less than 10% natural juice is taxable in many states, but can vary based on the actual concentration.  Unfortunately, the tax law changes across the US numerous times throughout the year with little warning.  
Considering the complexities of sales tax regulations, how does an owner determine what products are subject to sales tax? The most accurate method is to review the state sales tax laws published on the taxing authority’s websites.  However, this can be a very difficult task and is highly inaccurate and often does not reflect specific taxing authority rules. Many owners will seek advice from a local CPA firm, but most of these firms do not have the requisite sales tax experience.
After determining the taxability of the products to be sold in the vending machines, the next requirement is to calculate the amount of sales tax owed to the taxing authority. It is important to understand the specific tax calculation formulas for the state in which you own and operate a vending machine. Some state laws define some products sold through vending machines as a “meal,”  which has a different tax treatment.  For example, a ready to eat salad is defined as a meal in Massachusetts and is subject to the state sales tax rate as well as the local meal tax rates.  There are also a few states that apply only the local sales tax rate to food items.  Other states have specific tax calculation formulas based on the type of product, like “food and non-food,” and based on the location of the machine.
The complexities of the tax calculation often transfer to the preparation of the sales tax returns. Each state has its own format regarding how gross sales, taxable amount, exempt amounts, and the tax collected needs to be reported. States with local tax rates tend to be much more complex.  For example, in approximately 60% of the states, sales taxes need to be properly reported to the local taxing authorities in addition to the state.
The frequency of fillings also varies by state and depends upon the amount of sales tax collected during the year. The first year owner’s filling will generally be annual, because the state does not have any history of sales tax collected by the newly registered Taxpayer, but the frequency of filling often changes after the initial year of operation.  The amount of sales tax collected may move the Taxpayer to a different category, requiring the reporting frequency to change to either quarterly or even  monthly. 
Most VMS software unfortunately does not provide features to reduce the burden of calculating and reporting sales tax.  Some VMS applications have the ability to store sales tax rates in their systems, however, it is the owners responsibility to supply and maintain the correct sales tax rate.  Although a few VMS solutions include a feature to store tax jurisdiction information, such as the location of a machine and a sales tax rate based on that specific location, none of the solutions provide sales tax rates.  There are no VMS systems that include either the sales tax calculation rules, or the sales tax filing requirements, or the ability to define the taxability of individual products sold in a vending machine.  Therefore, the burden is on the owner to make all of these adjustments before filing and remitting sales tax.
In summary, sales tax rates and taxability of products is extremely complex within the United States and there are very few tools or software applications that support the calculation and reporting of state and local sales tax. A majority of the CPA firms do not have the knowledge or tools to accurately or effectively calculate sales tax and prepare the applicable tax returns. 
So what is the cost of not calculating sales tax correctly?
●    Reduction of profits by paying too much in sales tax;
●    Tax and legal exposures by underpaying, leading to expensive audits and fines; and
●    Spending limited staff time on supporting these sales tax requirements.
The calculation, collection, and reporting of sales tax is quite complex. Therefore, it is important to either understand the tax laws or find a reliable tax compliance resource.

About the Authors:

Daniel O’Rourke, JD/CPA, is the Chief Operating Officer & SVP of Compliance for TACS, LLC.  Dan has 30 plus years’ experience in the application of sales tax and tax technology, along with a deep level of expertise in state and local tax legislation, as well managing global indirect tax within enterprise level ERP’s.

Scott Walters is the Co-Founder and CEO of TACS, LLC.  Scott has  worked for over 30 years with a focus on sales and use tax, and has extensive experience in the  implementation of tax technology to simplify the accounting process.  Scott’s background includes multiple roles at leading tax technology companies as well as a director at the Tier 1 accounting & consulting firm PWC.