Tax Compliance for Manufacturers is More Complex Than Ever

Tax compliance in manufacturing is complex. If you sell your products in multiple states, you know complying with each state’s rules and regulations is cumbersome. Audits from state tax authorities are always a concern. OpMentors understands these difficulties. We deploy specialized solutions using Salesforce, FinancialForce, and tools such as Avalara to help your business meet its unique objectives, goals, and challenges. Explore our services to learn how we can help you transform your business.

Tax compliance in manufacturing is more complex than ever

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 e-commerce — are changing some fundamental assumptions that manufacturers have always operated under.

Remembering the before times

In the old days — say, five years ago — many manufacturers hardly worried 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. 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 and 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 e-commerce platforms, which made it hard to create consistent internal processes for applying the certificates, which sometimes led to annoyed customers.
But while it wasn’t simple, exemption certificate management was, for the most part, 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 with 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 should collect and remit taxes on their nonexempt sales. For 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 the 13th sale to a new customer in that state, 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 significant errors and fines. Like everyone else, auditors like to get more bang for their buck.

Pandemic problems

As if the 2018 court ruling wasn’t enough, 2020 brought us the COVID-19 pandemic, which created a 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 people working from home, it was difficult for finance teams to track and manage paper exemption certificates stuffed into file cabinets and boxes back in locked-down offices.

Remote work itself caused some companies problems. Suppose 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 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. E-commerce exploded, and retail customers began using e-commerce platforms to seek products directly from the manufacturer. But drop-shipping products to customers can quickly create an economic nexus that you never had before, and thus a new sales 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, your best finance people will likely have opportunities to work elsewhere. 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

FinancialForce and Avalara have resources to help manufacturers (and businesses throughout various industries) figure out their tax compliance challenges.

One 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 can also contact the OpMentors team, who can talk you through the automated tax compliance solutions available through our partnership with Avalara.

Working together, we can solve your tax compliance challenges and other business needs.

Robert Haukenberry and Kevin Hughes