There are a few different reasons why a business might fail to pay sales taxes. For small businesses, new businesses, or those that aren’t appropriately managed, confusion or ignorance can cause them to neglect their tax obligations, unintentionally. Some businesses might deliberately avoid paying taxes by underreporting their sales or falsifying records.

Failing to pay taxes for any reason can lead to serious legal trouble, including large fines and possibly criminal charges. Evading sales tax can also skew competition and shortchange community services funded by these taxes. Regulatory authorities are constantly changing their tactics to catch and correct tax discrepancies, often with the help of advanced tracking and auditing tools.

Below, we’ll explain what happens when a business doesn’t pay the correct sales taxes and what to do if you find out you’ve been underpaying.

What’s in this article?

• Common mistakes businesses make with sales tax
  
• What happens when businesses don’t file taxes?
  
• How to catch up on unpaid sales tax
  

Common mistakes businesses make with sales tax

Here are some common mistakes that might lead businesses to unintentionally underpay sales taxes:

• Overlooking economic nexus: Nexus determines whether your business has a tax obligation in a state. While nexus was previously defined only by a physical presence, new laws increasingly account for economic nexus, which is based on sales revenue or transaction volume. Overlooking these newer criteria can cause businesses to fail to register in states where they owe taxes.

• Applying incorrect tax rates: Sales tax rates vary by state, city, and county, and applying incorrect tax rates can lead companies to under- or overcharge customers. Regularly updating your tax rate database and using reliable tax calculation software can help prevent this issue.

• Mismanaging exemptions: Improper handling of tax-exempt sales can occur if a business doesn’t obtain the proper exemption certificates from customers or fails to renew them periodically. Businesses must accurately track and store exemption certificates and verify their validity to avoid this issue.

• Misunderstanding taxability: Businesses sometimes assume taxability is uniform across states, when in fact it varies widely. Different states have different rules for what constitutes a taxable product or service, and businesses must understand and apply the correct rules for each state in which they operate.

• Failing to track use tax: Many businesses neglect use tax, which applies when they buy taxable goods or services out of state for use in their home states without paying sales tax. This often happens with online purchases. Businesses must keep track of these transactions and remit use tax appropriately.

• Filing late or inaccurately: Businesses sometimes overlook deadlines or make errors in their tax filings. Implementing a strict calendar system and regular audits of sales tax filings can mitigate these risks.

• Not maintaining proper documentation: Businesses should keep meticulous records of all sales transactions, exemption certificates, tax filings, and any correspondence with tax authorities. Inadequate documentation can cause issues with tax compliance and during audits.

• Neglecting local taxes: Local jurisdictions often have their own sales taxes beyond state taxes. Businesses sometimes fail to account for these and inadequately collect taxes as a result.

• Ignoring industry-specific rules: Different industries have different sales tax rules. For example, construction, manufacturing, and software industries each have unique tax considerations. Businesses in these sectors can make mistakes by failing to fully understand their industry-specific sales tax obligations.

What happens when businesses don’t file taxes?

For businesses, failing to file taxes can result in several consequences, from financial penalties to legal issues. The longer taxes go unpaid, the more severe the consequences can become. Here’s what happens when businesses don’t file taxes.

Penalties and interest

Penalties and interest charges are typically incurred for each month that businesses fail to file or pay taxes. Common penalties include the following:

• Failure-to-file penalty: A percentage of the unpaid taxes, accruing monthly until the return is filed

• Failure-to-pay penalty: A percentage of the unpaid taxes, also accruing monthly until the taxes are paid

• Interest on unpaid taxes: Interest charges on unpaid taxes, accruing daily from the due date until the tax is paid in full

• Negligence penalty: A percentage of the underpaid tax due for negligent failure to pay

• Fraud penalty: A percentage of the underpaid tax due for fraud

Sample policy

In New York, the state penalties for failing to file sales tax are as follows:

• Late filing: The penalty is $50 for the first month plus 10% of the tax due for the first month, followed by 1% for each additional month up to a maximum of 30%.

• Late payment: The penalty is 10% of the tax due for the first month, followed by 1% for each additional month up to a maximum of 30%.

• Failure to pay the tax collected: Willfully failing to remit the state and local taxes collected might result in fines and a jail sentence.

Increased audit risk

Businesses that avoid paying sales tax are more likely to be audited. Audits are time-consuming, resource-intensive, and can disrupt business operations. Tax authorities might also extend the period subject to audit, exposing the business to scrutiny over several years, and an audit can result in additional penalties if discrepancies or unpaid taxes are found.

Collection actions

If taxes remain unpaid, tax authorities have the power to take collection actions, such as the following:

• Lien: A legal claim against your property to secure payment of the tax debt

• Levy: Seizure of your business’s assets, including bank accounts and property, to satisfy the debt

• Garnishment: Interception of a portion of your wages or other income to pay the debt

Loss of business licenses

In some jurisdictions, failing to file or pay taxes can lead to the suspension or revocation of business licenses and permits. This can effectively shut down your business operations until the taxes are filed and paid.

Damage to credit rating

Tax liens and other collection actions can severely impact your business’s credit rating. This can make it difficult to secure loans, lines of credit, or favorable terms with suppliers and lenders, limiting your ability to grow or sustain operations.

Personal liability

In certain situations, business owners can be held personally liable for unpaid taxes, especially if the business is structured as a sole proprietorship or partnership. Even in corporations or limited liability companies (LLCs), if it’s determined that the failure to file was due to willful neglect, the personal assets of directors and executives could be at risk.

Legal consequences

Persistent noncompliance can lead to civil penalties such as lawsuits initiated by tax authorities, as well as criminal charges such as tax evasion and fraud. While rare, these cases can result in substantial fines and even imprisonment. The severity of the consequences often depends on the amount of tax owed and the perceived intent behind the failure to file.

Damage to business reputation

Tax evasion can damage a business’s reputation with customers, suppliers, and investors. This loss of goodwill can have long-term impacts on your business relationships and market position. Investors might lose confidence in the business, affecting future funding and growth prospects and complicating any sale or transfer.

Operational disruptions

Unfiled taxes take substantial administrative effort to resolve and can involve prolonged negotiations or legal proceedings. Tax authorities have the power to seize business assets, including bank accounts and property, to satisfy unpaid taxes, and they can garnish ongoing revenue to pay off the tax debt. The ongoing stress of tax issues can also affect the morale and productivity of owners and employees. All of these factors put a strain on business resources and productivity.

Loss of competitive edge

Accumulated penalties and interest can divert funds from other business investments and cause a business to lose its competitive edge. Legal troubles and financial instability can weaken the business’s market position relative to competitors.

How to catch up on unpaid sales tax

Both businesses and individuals can fall behind in paying taxes, including sales tax. Many states have voluntary disclosure programs for businesses, which proactively address unpaid taxes and often reduce or waive penalties and interest. Outside of these programs, here’s how to catch up on unpaid sales tax:

• Assess your situation: Start by understanding the extent of your unpaid sales tax obligations. Identify the tax periods for which you haven’t filed or paid sales tax and estimate the total amount of unpaid taxes, including penalties and interest.

• Gather documentation: Collect all relevant financial documents including sales records, invoices, and receipts. Ensure you have valid exemption certificates for any tax-exempt sales and compile copies of any previously filed tax returns for reference.

• Review state regulations: Sales tax regulations vary by state so review the specific requirements and penalties in your state. Confirm your tax obligations based on physical or economic presence and verify the applicable tax rates for each period and jurisdiction.

• Consult a tax professional: A tax professional can help you assess your situation and develop a strategy for compliance, as well as assist in negotiating with tax authorities for reduced penalties or installment plans.

• Prepare and file overdue tax returns: Prepare and file the delinquent tax returns. Ensure all sales and tax amounts are accurately reported and use electronic filing systems if they’re available, as they can speed up processing.

• Calculate and pay penalties and interest: Calculate the penalties and interest due on your unpaid taxes. Use state-provided calculators or consult your tax professional and include interest charges up to the date of payment.

• Submit payment or arrange a payment plan: Submit payment for the taxes, penalties, and interest. Pay the full amount if possible to avoid additional interest. If this is not possible, arrange a payment plan with the tax authorities. Many states offer installment agreements.