What is a tax holiday? And how do they affect small businesses?

A tax holiday is a temporary removal of a tax imposed by the state or federal government on specific goods or products. Tax holidays have benefits and drawbacks that small business owners should understand.

Types of tax holidays

Twenty states have had or will have tax holidays in 2022, and they cover a wide variety of products and situations:

• Back to school: Many states implement a tax holiday in August to help parents purchase clothing, shoes, and school supplies to prepare for the beginning of the school year.
• Disaster preparedness: Common in southern states, this holiday lifts the sales tax on items like generators, radios, flashlights, coolers, and tarps in anticipation of hurricane season.
• Energy Star: Appliances and products that are Energy Star-rated have no tax during this event. Some states also include products designed to conserve water or reduce water usage.
• Grocery and food: State tax on groceries and food is suspended during this event.
• Clothing: Not linked to the back-to-school season, this tax holiday eliminates the tax on all clothing or sometimes just children's clothing.
• National Guard Members: No tax is applied on purchases by National Guard members. Nevada is the only state with this particular provision.
• Gas: New York and Florida have implemented a gas tax holiday for specific months in 2022.
• Guns and Ammunition: Mississippi and Tennessee lift sales tax on guns for a specified period.

Florida is the state with the most tax holidays—it has 10 types of tax holidays scheduled in 2022. Unique tax holidays offered in Florida include suspension of tax on tools, windows, and doors and a Freedom Week (around the Fourth of July) with no tax on entertainment such as movies, museums, and parks.

Tax holidays shift spending

Tax holidays sound like they should provide significant savings for consumers and increase sales by small businesses. But a study by the Federal Reserve found that tax holidays don't necessarily increase consumer spending but rather just shift when people spend. This does not increase small business revenue.

Increased costs due to tax holidays

Janelle Fritts, a policy analyst at the Tax Foundation in Washington, D.C., says that sales tax holidays hurt small businesses and "are political gimmicks that distract from real and lasting tax reform."

She explains that businesses may have to hire temporary employees or pay for overtime to handle the shifted sales, which reduces profits. She says that this year states are using tax holidays in response to inflation but that "if tax holidays did actually increase demand, they would be mildly inflationary and contribute to the problem."

Accounting challenges

Tax holidays also place accounting burdens on small businesses. Lucy Dadayan, a senior research associate at the Tax Policy Center in Washington, D.C., points out that online sellers must comply with tax holidays in all jurisdictions, creating accounting difficulties.

No matter the implications of tax holidays, if your state has one, you want to do everything you can to reap whatever benefits are possible.

"It is likely that many small businesses might not be able to afford the automated sales tax software and solutions," she says. "And those businesses that manage sales taxes manually will need to spend enormous amounts of time and work in figuring out all the details of the sales tax holidays and will need to map the inventory to tax codes created for a specific sales tax holiday." She said she believes tax holidays cost small businesses money and offer little or no return on investment.

How to maximize sales tax benefits

No matter the implications of tax holidays, if your state has one, you want to do everything you can to reap whatever benefits are possible. Consider these tips to maximize your sales during tax holidays:

• Adjust prices down to respond to caps. Most sales tax holidays place a cap on the price of items that qualify for the sales. For example, states often place a $100 cap on back-to-school clothing purchases or a $1,000 cap on generator sales during tax holidays. If you sell a generator priced at $1,100 or a pair of shoes priced at $105, consider temporarily reducing the prices so those items qualify for the tax holiday and will be more likely to sell.
• Adjust prices up to compensate for no sales tax. Some businesses find they can temporarily increase the prices of some products to capture a portion of what customers would have spent on tax. If the sales tax that has been suspended is seven percent, a price increase of three percent means you will increase revenue and customers will still save.
• Offer incentives to return. "New people might be in your store solely for the tax holiday. What are you doing to get them back in?" asks Chris Jones, chair of the Accounting Department at the University of Wisconsin-Oshkosh. Take steps to encourage them to return to your business.

Tips for managing tax holidays

While tax holidays may bring you a temporary upturn in sales, there are some important tips for small business owners to keep in mind, suggests Jones.

• Research and understand exactly which items the sales tax holiday applies to and train staff so that the rules are applied correctly.
• Understand the state's rules for layaway, shipping, returns, exchanges, and online orders for the sales tax holiday.
• Learn if the county or municipal sales taxes have also been lifted in your area during the holiday and apply those rules as well.
• Explore whether your state allows you to opt out of the holiday and consider this option.
• Keep the purchase price cap in mind. Be sure you and your staff understand this and implement it according to the law.
• Determine your state rules for advertising. Some states do not permit retailers to advertise the tax holiday, while others do.
• Keep accurate books. You could face a sales tax audit in the future and will need to document how you implemented and applied the sales tax holiday. "A CPA can help immensely—they're far more likely to have a grasp on all the rules," explains Jones.

Sales tax holidays can create added complications for small businesses, but with planning and attention to detail, you can get the most benefit possible.