Check transaction taxability

The major risk that companies have is not paying use tax on their untaxed purchases. And we discuss this problem in the seminars. BUT, it's also important to NOT pay taxes when you don't have to. For example, I had a participant from Illinois recently tell me this story.

They bought services from a company that was also in Illinois. Because the vendor didn't charge sales tax, the AP department self-assessed use tax. Apparently, nobody asked whether or not this service was taxable (in many states it is). But in Illinois this service isn't taxable. If the AP department had simply asked the vendor why they weren't charging tax, they might have avoided paying taxes they didn't need to pay.

But nobody asked. And they self assessed use tax on these purchases for years.

Finally, someone asked a question about the invoice and a purchasing agent, who had been in my seminar, happened to notice that they were self-assessing use tax. She emailed me asking whether or not I thought this invoice was taxable. I replied that I couldn't imagine how it could be. She researched it further and discovered that they had OVERPAID the state of Illinois by almost $19,000!

The morals of the story:
1. Check the taxability of every transaction, particularly large or continuing ones;
2. When you have an in-state vendor who isn't charging tax, they might know why. Before you go self-assessing, ask them.
3. One of the reasons this mistake may have been made is because the person deciding on taxability may have been most familiar with another state and just assumed Illinois would be the same. Make sure your staff knows that the state rules vary from state to state. Assume nothing is the same.

The Sales Tax Guy

Issue: Product Testing - Exempt?

I had a call today from a seminar participant and as we were talking, I realized her issue would be a perfect puzzle to present to you.

The company makes engines. The engines are taken out of finished goods inventory and placed in a testing area. Are the testing equipment and supplies taxable or exempt under the manufacturing equipment exemption? In most states, inline testing of manufactured products would be exempt as part of the manufacturing process. But in this state, the manufacturing process stops once the product has been put in finished goods inventory (in most states, the process stops at the last machine).

So testing the engine, after it's been placed in inventory, would be outside the scope of manufacturing and therefore taxable. But here's the fun part: if they had intercepted the engines before being placed in the warehouse, then the testing would have fallen within the scope of manufacturing and would therefore be exempt. Stupid, huh?

In my conversation with the taxpayer, I suggested she contact a local expert. While a strict reading of the laws is all I can go with, a local consultant (CPA, lawyer, etc.) will be familiar with enforcement practices in that state. I can foresee an undocumented position of, "well, yeah, we know this is really inline quality control testing; it's just getting placed in the warehouse for convenience and you haven't made the journal entry moving it to FG inventory, so we'll let this one slide." It isn't documented (as near as I can tell), but it may be the informal position the state takes.

There are three lessons here:

1. understand the rules for the exemptions that your company takes advantage of;
2. interpret the rules very strictly;
3. engage a local expert to identify any undocumented positions that will help you.

The Sales Tax Guy