Tobacco and Vape Tax Automation

Does this sound familiar? Every day, your company’s sales transactions are processed through an intricate system to determine the latest tax liabilities. It’s a labyrinth of spreadsheets, reporting mechanisms, and custom integrations — one that’s been developed gradually over time. Add to that a maze of tax compliance filing and the latest Prevent All Cigarette Trafficking (PACT Act) reporting. With each new tax or regulatory ruling comes another change, and with every tax law change another tweak to the process.

With the growing complexity of federal, state, county, city, and other local taxes, and regulations continuing to expand — can your business keep up? It’s a tough scenario many companies are facing.

Consider the trajectory other tobacco products (OTP) have taken. Once upon a time, just a handful of states collected excise tax on electronic cigarettes and vapor. Then the FDA finalized a rule to regulate all tobacco products, and the level of excise calculation and compliance complexity began to increase tenfold. This is just one example among a sea of many more that makes tobacco tax determination and compliance a highly complicated, highly involved responsibility.

Thankfully, it’s not just IT consultants and tobacco tax teams that are tracking and automating these liabilities. Tax industry specialists are too, and they’re supporting comprehensive automation solutions that have already been shown to save tremendous resources and reduce audit risks in many industries, including tobacco.

In this paper, we’ll explore:

• Tobacco and vape industry growth and change
• Tobacco and vape tax challenges
• PACT Act compliance updates
• The current state of tax compliance
• What tobacco can learn from other industries
• Outsourcing tobacco tax automation

In 2017, Bloomberg published an in-depth report. The headline: Big Tobacco Has Caught Startup Fever. The takeaway: Consumer demands are shifting further from cigarettes, and tobacco companies are at the helm of innovations. Bloomberg reported, “It’s no longer such a stretch to imagine … a nicotine-delivery gadget capable of doing to cigarettes what Uber did to taxicabs or Napster did to the compact disc.” As of 2019, there were nearly 14 million e-cigarette users in North America. By 2020, the global e-cigarette and vape market had swelled to $15.04 billion.

With the excitement of innovation around new product types — e-cigarettes, snuff, heat-not-burn, and more — comes an underbelly of ever-evolving tax rules, rates, and regulations. Tobacco is no longer measured in sticks, cartons, and packs alone, but also in milliliters, cartridges, and ounces. At the same time, new distribution channels have opened the door for manufacturers and wholesalers to sell directly to consumers, and for retailers to act as wholesalers.

These trends toward new types of tobacco products, and new methods for getting them in the hands of consumers, haven’t made taxation any simpler. If anything, the opposite is true. As the tobacco industry continues to innovate, taxing agencies seek new ways to regulate.

What happens when millions of people abandon one product in favor of another? Tax authorities take note. Such is the case with tax on vaping products, cigars, and OTP. As the smoking population increasingly trades traditional cigarettes for these other products, tax dollars are diverted to newer forms of smoking or nicotine intake. In response, federal and state governments are determining not just how to regulate this multifaceted industry, but also how to enhance tax revenues from these products.

 As of early 2021, 29 states have specific vaping tax laws in place, as well as a number of large municipalities. This number has tripled since 2019 and is expected to continue to grow, leading to what’s arguably the most wildly disparate (and toughest to follow) range of compliance requirements compared with any other industry in the United States.

For example, in Minnesota, e-cigarettes are taxed at 95% of the wholesale price, while in West Virginia they’re taxed volumetrically at $0.075/ml of e-cigarette liquid. California taxes vaping products at 56.93% of the wholesale price, while New York taxes them at 20% of the retail price. In many states an entire e-cigarette starter kit package may be taxed, while in other states a starter kit (or just a pod or cartridge) may only incur sales tax while e-liquid may be taxed at the volumetric rate. In Connecticut, open system vaping products are taxed at $0.40/fluid ml, while closed system containers of e-liquid are taxed at 10% of the wholesale price. Regulators continue to struggle with appropriate taxing structure due to product nicotine content variation and packaging issues. There’s also concern over the true end goal of the tax — whether it’s growing tax revenue or redirecting use of cigarettes to something considered less harmful.

The U.S. Supreme Court’s South Dakota v. Wayfair, Inc. decision in 2018 also added a new state tax wrinkle. While the primary impact of this case was to expand sales tax nexus for online sellers, it now requires OTP sellers to collect state excise tax in addition to sales tax in nexus states. Since economic nexus thresholds vary by state, remote sellers face an additional level of complexity. Merchants need to keep close tabs on sales volumes. It’s easy to exceed thresholds, triggering new registration and tax collection requirements.

In March 2021, thousands of businesses that sell and ship vaping products suddenly became subject to new compliance rules when an amendment to the PACT Act went into effect. The amendment broadened the interpretation of the word cigarette to encompass all electronic nicotine delivery systems, including vape pens, refillable devices, e-cigarettes, hookah pens, and e-pipes, as well as vape liquids, system components, and accessories.

If you sell or advertise vaping products, you must now register with both the Bureau of Alcohol, Tobacco, Firearms and Explosives (ATF) and with the tobacco tax administrator in each state where products are shipped. This applies to both direct-to-consumer sales as well as wholesale distribution. Moreover, if your website can be seen by a consumer in a state, that’s considered advertising. Failure to register correctly can lead to a $5,000 fine per state for the first violation and $10,000 for subsequent violations, or 2% of the gross sales of cigarettes or smokeless tobacco of the delivery seller during the one-year period ending on the date of the violation.

Companies also need to file detailed shipping reports on a monthly basis in each state, and some sellers may require new business licenses. Of course, businesses are also liable for tax collecting and remitting. Changes to the PACT Act mean vaping businesses are on the hook for both sales tax and excise tax at the federal, state, and local levels.

It’s critical for online sellers, and any tobacco seller who must collect both tax types, to have a streamlined solution for compliance. This is a heavy lift for many small-to-medium sized businesses who aren’t prepared for this level of documentation. Most larger tobacco and vape companies understand that automation is key to handling any of these complexities, but few are maintaining automation solutions as efficiently as they could.

Many manufacturers, wholesalers, distributors, and retailers have compliance automation processes in place — ones that have been built over time to address the ever-mounting array of regulatory complexity, ranging from Master Settlement Agreement (MSA) and PACT Act reporting to thousands of different state, local, city, and county excise taxes.

These systems are often implemented as add-ons to legacy ERP applications or as custom spreadsheets and manual entries, and they must be updated each time an additional tax law goes into effect or reporting regulation is put in place. They require significant IT and tax resources to modify and test every time there’s a change to taxing or reporting regulations.

To make matters more complex, state taxing agencies often modify required forms and legislative mandates and introduce new reporting requirements. All the while, local, city, and county tax regulations continue to unfold. Many companies also find it challenging to secure all required business licenses, as authorities have different regulations. Tack on the burden of managing resale certificates and it’s no wonder a lot of businesses feel overwhelmed. Every one of these changes, no matter how seemingly small, requires extra effort by tobacco and vape company tax analysts to comply with additional requirements. And if a system is designed to handle only one unit of measure, it can require major changes to handle new ones.

Bottom line: The ongoing efforts required to maintain inadequate automated compliance systems can require extensive IT costs and tax analyst resources over the long haul. Due to the manual nature of custom updates and integrations, they also increase both the risk of reporting errors and the potential for noncompliance penalties. Trying to handle compliance manually can be particularly cumbersome and prone to errors.

Most businesses would rather focus on more strategic initiatives to keep them competitive, which means the time is right for tobacco and vape companies to discover the automation solutions currently embraced by other industries.

Many industries with similar tax complexity, such as motor fuel supply and distribution, have learned to successfully outsource automation for tax determination, exemption certificate management, reconciliation, and return preparation and filing. By offloading the effort required to track tax rules, rates, and reporting requirements, these companies are able to spend a fraction of the time previously required to build and maintain custom automation systems. This, in turn, allows staff to focus on more strategic work.

The time is right for tobacco manufacturers, wholesalers, distributors, and retailers to consider a similar approach to excise tax compliance automation. By trusting a third party to handle automation, especially when it’s delivered as SaaS, IT and tax teams benefit from shared resources: Tax law research, adjustments, and tests are all handled by dedicated specialists whose full-time work is devoted to fine-tuning automation solutions and ensuring the latest tax laws are reflected. The result? Greater reliability and scalability as well as savings on IT operations and hardware.

Before embarking on the next round of system upgrades required to maintain tobacco tax compliance, consider leveraging automation of sales tax and excise tax functions with the experts at Avalara.

Avalara AvaTax for Tobacco is an excise tax calculation engine, continually updated to reflect accurate rates and rules for a wide variety of transactions in thousands of jurisdictions for tobacco and vape businesses Avalara AvaTax, created specifically for sales and use tax, can also be useful for those businesses that require non-tobacco point-of-sale tax calculations, like grocery and convenience stores.

With so many additional businesses now required to maintain a business license in shipping states to comply with the PACT Act, it’s crucial not to miss this step. Avalara Business Licenses makes obtaining business licenses and registering in new states easy.

When it’s time to remit, Avalara Returns for Tobacco automates the preparation and filing of state and local tobacco returns, including electronic filing as required. Under the PACT Act, returns must be filed in all jurisdictions where you’re registered, even if no sales were made (a zero return). Avalara Returns for Tobacco also offers PACT Act compliance reporting services to help make sure that you maintain your requirements in every state — on time, every month.

Avalara CertCapture streamlines the collection, storage, and management of resale or exemption certificates that are often mandatory.

These cloud-based tax automation solutions save tremendous amounts of time while reducing compliance risks created by shifting regulations like PACT Act changes, allowing tax and financial leaders more time to focus on strategic-level projects.