Sales Tax Nightmares: Real Horror Stories from Shopify Merchants
Pujun Bhatnagar · October 29, 2024 · 10 min read
You've always wanted to start a business and decided to sell online. However, you aren't really sure where to start your e-commerce business -- BigCommerce, WooCommerce, or Shopify.
After days of contemplating, you decided to sell on Shopify. And that's a great choice because Shopify is the most popular e-commerce and shopping cart platform with merchants in over 175 countries and 2.1 active users daily, according to Hosting Pill [1].
It didn't take long for your business to take off. You indeed found a home in Shopify, and things were going great until you realized that it's tax season and you do not know a thing about it. Also, Shopify is not required to automatically collect and remit sales tax, but they can do it for you if you pay for its additional service called Shopify Tax, which only works for sales within the United States.
If you want to do it yourself, you have to learn the economic nexus and how to register and file sales taxes. That's a lot of things to take in for a new entrepreneur like you. Even those who have been in the market for years struggle when it comes to sales tax compliance.
In one Avalara survey [2], 53% of the respondents admitted that the most challenging part of sales tax compliance is the ever-changing tax rules and rates. Another 42% said managing consumer use tax obligations costs their business too much.
Whether you pay for Shopify's tax service, hire a sales tax agency or automation provider, or do it manually, if you establish economic nexus, then you must comply with the state's sales tax regulation, and you've got to take this seriously. Yes, or else you will be in serious trouble.
The Hidden Dangers of Sales Tax Non-Compliance
Failing to comply with sales tax obligations has serious repercussions for your business. And you can't use your lack of knowledge as an excuse for your non-compliance. Remember the adage, "Ignorance of the law excuses no one."
Here are some of the consequences you will face with sales tax non-compliance.
Penalties and Fines
Businesses that fail to comply with sales tax regulations are subject to penalties and fees, which vary by city and state. In Texas, the penalty for unpaid taxes between 1 to 30 days is 5% and 10% if it's over a month late.
According to the National Small Business Association [3] - 2018 Taxation Survey, 33% of small businesses were penalized for incorrect filing. So, when you do, you must do it right.
Interest Charges
Leaving your taxes unpaid could be a big problem because the interest could accumulate until the amount you owe is paid. For instance, California charges an interest rate for unpaid taxes quarterly at around 7%.
The longer you leave your taxes unpaid, the more interest charge you'll have to pay. Since the interest charges can significantly increase, the total amount you owe could strain your finances and lead to financial burdens.
Audits and Investigations
Being subjected to audits and investigations is another consequence that business owners dread. Each state has its own rules and procedures for this. However, among the common audit triggers are getting nexus or use tax wrong, outdated tax rate information, wrong jurisdiction, wrong product taxability, and missing exemptions or exempt sales issues.
In one survey by NetReflector/Potentiate [4], 14% of the participants admitted that they had experienced a sales tax audit in the past five years, and 79% of the audits took three weeks to be completed. However, in a few cases, the audits lasted for over five months.
Additionally, the audit wasn't easy and was time-consuming for some companies. Since time is money, it's safe to say they lost money during the process. Based on the survey, it took an average of 35 hours for employees to cooperate and finish the audit. However, 3% of the companies spent over 100 hours on audit.
Also, emerging small businesses (ESBs) are less likely to be audited than small and midsize businesses (SMBs). And the audits are 218% more costly for SMBs than ESBs.
Reputation Damage
Another terrifying thing you could face for not filing on time and doing your taxes right is a damaged reputation.
Consider this: Customers are surprised to see a higher total price at checkout due to incorrect sales tax. You can imagine their frustration, feeling deceived and misled.
According to a 2022 study from Baymard Institute [5], 48% of shoppers abandon their carts due to extra costs, which may include tax, shipping, and customs costs.
When you charge more tax than required, customers feel cheated, damaging their trust in your business. This goes both ways; when you don't charge them taxes when you should, they will also start to question the legitimacy of your business.
As a business owner, you must approach this cautiously because unhappy customers can share negative reviews online.
Per BrightLocal [6] 82% of consumers read reviews, and 52% avoid businesses with less than a 4-star rating.
Also, legal compliance issues could affect your business operation and lead to delays in fulfilling orders, indirectly impacting customer experience.
Business Licenses Revocation
Many states can suspend or revoke a business license or permit for tax non-compliance. For instance, New York State can suspend a business' Certificate of Authority, a requirement to conduct business, when sales taxes are not collected and remitted properly.
The worst thing that could happen to your business for failing to comply with your tax obligations is being shut down. So, you should not take chances when managing your sales tax.
Real Horror Stories from Shopify Merchants
Several Shopify merchants admit that handling sales tax is a challenging job. Among the most significant challenges is their lack of knowledge about taxes, which is understandable because tax regulations vary in different states.
One Shopify merchant who has been in business for four years initially thought Shopify collects and remits their sales tax. However, they later realized it wasn't the case when they learned they had liabilities in six states where they didn't file taxes. The merchant said they also didn't charge taxes from their customers.
"Now I've started charging my customers sales tax but the filing and registration is a nightmare. I've registered my business for a sales tax permit in 11 states and it's a nightmare!" the Shopify merchant wrote. "I use TaxJar and it's expensive as well, the auto filing costs $35 per filing (which would be like $385 per month on top of the standard plan fee)."
The merchant is asking for alternatives and wonders how other business owners manage sales tax compliance, if they file it on their own, how often they do it, and how they track it.
Another Shopify merchant admitted a similar issue -- they were "confused asf about taxes." They were confused because sales tax varies from state to state and they didn't find the Shopify help center helpful at all.
"Taxes such, I'm not sure how to handle taxes likes sales tax, because some states have it and others don't, and the Shopify help center page about US tax references wasn't the greatest," the merchant wrote. "I couldn't understand a lot of what I was reading, so I figured I'd come here and ask if anyone has experience with dealing with taxes for your store. Any help or advice would be appreciated!"
Apparently, this concern is common among Shopify merchants because others have experienced the same. They only realized they had sales tax liability when Shopify notified them and they didn't know how to proceed.
"Recently, I received a Shopify notification that we have sales tax liability in 7 states. Even though we don't have a physical presence in these states, we still have nexus due to the amount of orders. I asked our accountant what exactly this means, and unfortunately, he does not know," the merchant wrote, adding that they will replace their current accountant.
The Shopify merchant wasn't sure if they had to register their business with all seven states and wondered if Shopify had kept track of how much sales tax they had collected for each state. And the merchant sounded desperate as they pleaded for help.
"Can somebody please explain this process to me like I'm five years old? I'm not even joking, I'm very confused at the moment and I don't want to get in trouble if we don't do this properly. I understand you guys aren't accountants and such but any insight would be helpful," the merchant added.
Another Shopify merchant could relate to the sales tax "nightmare." "It's truly a battle st crazy system. The most sanity is using TaxJar, which for me was lightweight, or Avalara, who can do a lot of the work for you but at a cost,"** the merchant wrote.
As shown above, several Shopify merchants struggle with sales tax compliance because of a lack of knowledge or the assumption that Shopify has already collected and remitted their taxes. This is not an isolated issue and in the next section, you will find more reasons why many struggle with the same problem.
Common Pitfalls Leading to Sales Tax Nightmares
Shopify merchants struggle with sales tax compliance for several reasons, and it's understandable, given the complex process. It's actually more than just the lack of knowledge -- the real struggle is keeping up with the ever-changing tax laws that vary from state to state, understanding nexus, and more.
In the next section, we will deal with the various reasons many failed with sales tax compliance.
Misunderstanding economic nexus
Economic nexus is the threshold that establishes when a business can collect and remit sales tax within a jurisdiction. This varies by state, and failing to recognize whether your company has established nexus may lead to uncollected tax and penalties.
You must monitor economic nexus thresholds because they can change. Failing to track sales thresholds may result in unexpected compliance failures.
Failing to register the business
Business owners need to register for a sales tax permit in states where they have tax obligations. Failure to do so can lead to compliance problems.
Not updated with tax law changes
Sales tax laws change frequently at state and local levels. Failure to keep yourself up to date with these changes can lead to non-compliance and liabilities. This is one of the reasons why it's best to leave tax to the experts.
Applying incorrect tax rates
It is very important that you determine the right tax rate in your jurisdiction before applying it because failure to do so could lead to collecting an incorrect tax rate and may result in you paying potential fines.
Another possible reason merchants apply incorrect taxes is misclassifying products or services, which can lead to underpayment or overpayment.
Finally, do not forget sales tax holidays as failure to do so could also lead to collecting incorrect tax rates.
Failing to collect taxes
One of the common issues among Shopify merchants is the wrong assumption that the platform has already collected and remitted their sales tax, which results in them failing to do so. This can result in back taxes owed and the seller having to pay penalties and interest.
Erroneous sales tax returns
When filing sales tax returns, it is very important that you do it accurately. Make sure that all details are accurate, and that there are no incorrect figures, missing information, incorrect tax calculations, misspelled names, and missed deductions. Also, make sure to mention and include tax exemptions and certificates.
Mistakes in sales tax returns could trigger audits and penalties, so make sure to do it right.
Inadequate record keeping
It is essential to record everything in business. In fact, it is a good habit to practice because poor record-keeping will be a huge problem when you are subjected to audits and may lead to compliance issues.
Not filing returns on time
Filing returns is important, and it should be done on time. Late filing can result in penalties and interest charges. This may also increase your tax liability and strain your cash flow.
Errors in manual process
Another pitfall in sales tax compliance is an overreliance on manual processes. The drawback is that doing sales tax manually increases the risk of human error, which can result in inaccuracies and non-compliance.
How to Avoid Your Own Sales Tax Horror Story
You do not have to experience the same horror sales tax stories because you can avoid this nightmare. The best you can do is turn to sales tax automation, which several providers like Avalara, TaxJar, and Kintsugi offer.
Sales tax automation is the best way to manage sales tax compliance because the automated systems provide instant updates to tax rates and rules in real-time for enhanced accuracy, they offer comprehensive reporting and audit trail and allow seamless integration so you can integrate our existing e-commerce platforms, ERP systems or accounting software to streamline your operations. They also offer 24/7 customer support.
Overall, sales tax automation saves you time and money, and more importantly, it reduces your audit risks. Kintsugi can put your sales tax on autopilot in 3 minutes.
So, book a demo now or sign up for free.
Sources
[1] Hosting Pill. **** https://hostingpill.com/statistics/shopify-statistics/
[2] Avalara survey. https://newsroom.avalara.com/2024-03-26-Avalara-Survey-Finds-Businesses-Are-Turning-to-Automation-to-Manage-Tax-on-Purchases
[3] National Small Business Association. https://www.nsbaadvocate.org/_files/ugd/fec11a_98f01c7c33604f57a73e6420dfc6d7b6.pdf
[4] NetReflector/Potentiate. https://www.avalara.com/blog/en/north-america/2021/10/can-your-business-spend-less-on-sales-tax-compliance.html
[5] Baymard Institute. https://baymard.com/lists/cart-abandonment-rate
[6] Bright Local. https://www.sentiment.io/why-negative-feedback-on-social-media-can-be-a-positive-for-your-business/
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