Unique complexities raise audit risk for direct sellers
By: Brian Brown, Sr.
Risk is ever-present. It lives and breathes in relation to your people, product, and processes. Regardless of your time and effort to dismiss it away, it will survive. The objective reality isn’t to eliminate risk, it’s to mitigate it.
That’s nothing new for 2022. Every sound business leader is constantly running the numbers. They’re taking calculated risks, making moves to best navigate a challenging array of opportunities and threats.
When it comes to mitigating risk in sales tax compliance, all bets are off on the rates and processes remaining the same everywhere, for everything. It’s just not going to happen. Something somewhere is always being revised. The cards are stacked against direct selling organizations that have to navigate a particularly challenging environment of thousands of jurisdictions, unique product taxability, and W9 and 1099 document management, among the dozens of other compliance complexities.
Time and Money
“Playing the percentages” in the vast majority of emerging small businesses (ESB), three or fewer employees with a mean hourly wage of $83 typically work on sales tax. Each month these employees devote a combined 131 hours to compliance activities, so ESBs generally spend $11,968 per month on sales and use tax compliance.
Small and midsized businesses (SMB) generally have two to five employees working on sales tax, with a mean hourly wage of $98. Since they spend a combined 163 hours on sales
tax compliance, SMBs typically spend $17,672 monthly on sales tax management.
SMBs tend to put their money where their mouth is and hire more staff to help with tax compliance when compared to their smaller (EMB) counterparts. They’re also more likely to employ external service providers.
The Luck of the Draw on Audits
Beyond the hard costs of managing tax compliance yourself is the luck of the draw on audits. ESBs were less likely to be audited than SMBs (9 percent versus 19 percent). When ESBs were audited, they spent considerably less on overseeing the audit than their larger counterparts spent: $1,471 versus $4,679. In other words, audits were 218 percent more costly for SMBs than ESBs. To hit the jackpot would mean never being audited, but to play your cards right would mean having an audit protection guarantee through an automated service provider.
Being audited doesn’t necessarily mean you’ve even done anything wrong. So what triggers the audit penalties? Reasons include everything from late filings to consumer use tax liabilities and failure to register in a state when required. Yet sales tax rate or rule errors and missing exemption certificates were the top two reasons.
These top two are especially relevant to direct selling organizations that have nexus throughout the United States because of the independent contractor relationships. Managing those rules and rates across the thousands of jurisdictions only amplifies the potential for a mistake. Depending on whether your direct selling business has fully embraced e-commerce or is operating within a more traditional buy and resell/wholesale distribution model, the necessity of managing exemption certificates becomes more cumbersome.
It’s worth noting that only 21 percent of the businesses surveyed said they kept money aside to respond to audits. Among those that did, the amount of the reserve budget varied considerably by size. The mean reserve budget for ESBs was $9,790; the mean reserve budget for SMBs was $457,638.
Again, the survey cautions that the reasons for audit penalties came from “extremely small base sizes.”
Risks and Rewards
To play to your advantage would be to invest in a cloud solution that sweetens the pot with a clear understanding of the nuances of direct selling. Remaining with a manual standard operating procedure is upping the ante on the exposure your business has to incorrect tax assessments, let alone an audit.
Properly managing sales tax avoids the constant raising of the stakes that many direct selling organizations expose themselves to as they hit rocket ship growth. The scrutiny of direct sellers is already high on income and product claims, so avoid raising the stakes any more than it already is.
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