Sales and use tax can be a considerable burden for any company. These taxes can be imposed on nearly every transaction and the cost to comply with the myriad of rules can be significant. Add to this fact, that in recent years state taxing authorities have become increasingly more aggressive in both legislative changes and audit enforcement efforts. The likelihood of being audited has increased so businesses need to be prepared for challenges. Let’s face it, you are a revenue collector for the state, your objective is to collect as much as you can, as soon as you can.
Will you be ready when the sales tax auditor comes knocking at your door? There are several steps you can take to ensure you are. Generally, the following sales and use tax compliance issues are applicable to all businesses:
- Maintaining adequate records
- Adequate records means that every book and record is in place that is needed to trace a transaction from its inception to inclusion on a tax return. In other words, there is a discernible “audit trail”. All states’ sales and use tax laws require that adequate records be maintained. When they are not, auditors are permitted to use alternative audit methods to determine the accuracy of returns under audit. It is then up to the taxpayer to prove that the auditor’s methods were unreasonable and resulted in an incorrect tax due.
- Lack of exemption certificates
- Generally when a taxable product or service is sold and sales tax is not charged the vendor must obtain a properly completed exemption certificate. The key is not only to obtain the certificate, but it must be properly completed and you must maintain it in your files. Auditors may disallow non-taxable sales that are not supported by properly completed exemption certificates. This results in sales tax imposed on a non- taxable sale.
- Test periods
- Most state sales and use tax laws allow for the use of a test period in lieu of a detailed review of all sales and/or purchase transactions. A test period is a review of a specific time frame within the audit period. The result of the test period is then projected (applied) throughout the entire audit period. Test periods work well and save time when the period chosen is representative. Therefore, it is imperative that a test period contain the same type of transactions that occur throughout the entire audit period. Selection of a non-representative test period could result in a significant over assessment of sales and use tax.
- Responsible person liability
- Sales and use tax is a trustee tax, therefore sales and use tax laws include provisions that allow a state to hold individuals who are deemed to be “responsible persons” personally liable for sales and use tax due. Generally, a responsible person is anyone who is under a duty to act for the business.
- Use tax
- Use tax is the complement of sales tax and is due when sales tax is not paid at the time of a purchase. Generally, everything subject to sales tax is subject to use tax. Everyone, including individuals, are subject to use tax and are required to voluntarily pay such upon the filing of their sales tax returns (if a registered vendor), or a use tax report. In the case of an individual use tax may be due upon the filing of a personal income tax return.
- Filing requirements
- Generally, if you sell tangible personal property you must be registered for sales and use tax and comply accordingly. Most states require sales and use tax returns be e-filed either monthly, quarterly or annually depending upon sales and sales tax volume.
- Lack of adequate sales/use tax policies
- Many companies do not have formal sales and use tax policies or procedures to capture the information needed to meet their sales and use tax responsibilities. This often leads to inadequate and lost records which can cause misstatement of tax due. Failures here often lead to outsized assessments on audit.
Businesses in specialized industries are often subject to additional scrutiny:
- Issues include Nexus determinations, affiliate nexus issues and click-through nexus issues; taxability of hardware/software and related services; taxability of printed promotional materials; proper inclusions and exclusions in taxable selling price and determination of sales tax rates; inaccurate product and service tax matrix; lack of trained sales and use tax personnel; not properly structuring transactions up front to minimize taxes; and failure to properly manage sales and use tax audits.
- Issues are generally the same as above but one must also consider the impact the Marketplace Fairness Act (“Act” or “MFA”) will have on their business if enacted. The Act will allow states to require remote sellers to collect their sales and use tax, regardless of whether the seller has a physical presence in the state. The Act does not negate existing nexus rules; rather it will add an additional layer of rules which must be reviewed if you are a remote seller. Don’t be fooled, the Act will apply to any business which sells remotely, i.e. telephone solicitation, catalog sales, TV shopping channels, etc. not just businesses that sell over the Internet.
- Issues include construction costs associated with building improvements; taxability of production machinery, equipment, parts and supplies; taxability of hardware and software and related services; installation of production equipment; nexus determination; overpayment of sales tax on exempt transactions; drop shipment rules and exemption certificate management;
- Issues include product and service taxability; nexus determination; invoice preparation to minimize tax consequences; cloud computing, ASP, and SaaS; and taxability of purchases.
- Issues include capital improvements vs. taxable repairs; taxability of building material purchases; use tax responsibilities; overpayment of sales tax on materials purchased for use in exempt organization jobs, taxable jobs, or where installed out-of-state; contractor or retailer determination, i.e. self-use of manufactured products; nexus determination; failure to properly claim refund/credit for tax overpaid on exempt purchases or paid on materials installed in taxable jobs; taxability of materials consumed by contractor vs. transferred to customers; and government contractor rules.
Action steps you can take now to prepare for what may be the inevitable:
- Be proactive
- Don’t wait until the auditor comes knocking to determine your sales and use tax responsibilities. Sales tax should always be on your radar so you can properly comply. Once a state contacts you, your options are greatly reduced, you are relegated to playing defense.
- Conduct a review of your sales activity in each state and determine where you have established nexus. States have aggressive nexus teams who identify businesses conducting business in their state, but yet aren’t properly complying with the state’s sales and use tax rules. When returns are not filed there is no statute of limitations this allows states to go back to the very first day you conducted business in their state. The resulting tax assessment can easily impact a business’s cash flow, in some cases may even cause a business to close.
- Understand the rules
- Once you know where you have nexus, know how sales and use tax applies to your activities in those states. Register and comply accordingly. Sales tax is a consumer tax which you collect and remit. Don’t let it become your expense.
- Sales tax automation
- Using automated processes increases accuracy, saves time, mitigates errors, creates a trail and can increase profitability.
- Understand now how the MFA may affect you
- As noted, should the MFA become law, it will grant states authority to require remote sellers to collect their state sales and use tax. Will you be caught in this new nexus net? Don’t wait until the last minute to find out.
- Implement formal sales & use tax policies
- Personnel must be properly trained. Every company should have formal sales and use tax policies and procedures in place. Only then can staff understand and follow the processes established to insure compliance.
- Learn from past mistakes
- If you were audited in the past and it resulted in a large liability or refund you must improve your sales and use tax function by implementing changes that will prevent the same mistakes from happening again.
- Self-audit on a regular basis
- You should review both sales and purchase transactions on a regular basis to ensure that sales and tax is being handled correctly and that proper books and records are maintained. A self-audit will also identify refund opportunities that may exist.
- Voluntary disclosures
- If you realize after following some of the recommendations above that you have sales and use tax exposure in a particular state consider participating in that state’s voluntary disclosure program. Most programs will limit the look-back period, waive penalties and impose minimum interest. These programs encourage non-filers and filers with problems to come forward voluntarily and become current. Significant penalty and interest savings are possible.
Sales and use tax laws change constantly, posing complex and distinct challenges. It affects all of us- from individual consumers to the largest businesses, regardless of the applicable jurisdictions or types of transaction at issue. Through skillful planning, and analysis, you should prepare yourself for what may someday be inevitable - a sales and use tax audit. Don’t wait, put sales and use tax on your radar now. Avoid surprises, make sure your staff and processes are in order and you have minimized your audit exposure before the sales tax auditor comes looking for you.
Whether you are ready to implement some or all of the recommendations above we can help. The first step is to contact us. We welcome your questions and can work with you to design an action plan to resolve your sales and use tax issues.
If you would like additional information, have questions, or want to discuss your situation, call us at (631) 414-4558.