Golden Rule: Use

Half of what this blog is about is called "use tax." What do we mean by "use?"

The meaning varies from state to state. This is most inclusive one that I've found. So it may be overkill depending on the state involved. Remember, there's an exception to everything!

"Use," in a use tax sense, means that the item is under the control of the "user."

The obvious example is the laptop on which I'm writing this masterpiece. I'm using the computer, therefore, I'd owe use tax (assuming I haven't already paid the tax).

The best example is when I store something on a shelf in my office, without even opening the box. I've used it as far as the state is concerned. I controlled it, even if I didn't get any value out of it. Therefore, I'd owe use tax (assuming I haven't already paid the tax).

Let's say that I buy a GPS unit from Amazon.com to give to my old buddy George, who works with me. I happen to be out of the office on the day the package arrives. I know George is going on vacation, and that he could really use the GPS unit (he gets lost a lot). So I call him and tell him that the package is on my desk and to please take it (I ordered it gift wrapped - I'm such a nice guy). Amazon didn't charge me tax because they don't have nexus in my state. So the responsibility falls to me to pay the use tax. While I never even touched the box, let alone the GPS unit itself, I had control over it. And, in addition, I used it by giving it to George.

Note that you don't have to own it to owe use tax. If you rent some tangible personal property and the vendor didn't charge you tax, then (depending on the state), you'll owe use tax on it. You don't own it, but you have control over it.

There are situations where contractors, who use building materials to construct a building, will have to pay use tax on the materials, even if they were purchased tax-free by the tax-exempt organization. That's because, while the organization may be exempt, the contractor isn't. And he used those materials.

This doesn't have to be hands on either. It can be by remote control.

Bottom line? You use by having control. That's all it takes.



Sales Tax Guy

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Quick Tip: Get Rid of Your auditors

You should be nice to auditors, but not too nice. Keep them away from the rest of your staff would be a good first step.

Sales Tax Guy

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Quick Tip: Use Local Experts

If you've got problems, you need to use a sales and use tax expert who is up to his or her elbows in local issues. More here. And we have many related articles here.

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Essentials Actions

Here are a few essential things that every organization and business must make sure they have under control.

Pay sales and use taxes that you collect from your customers. This is probably the worst offense possible, and can mean the loss of your business and possibly even orange jumpsuits. Don't screw this up.

Get exemption certificates from your customers and watch expiration dates.

Document things as if the audit will be two or three years from now. Because that is when the audit will happen. You're not going to remember what happened yesterday.

Be sure about your exposure to other states' taxes. Not just your own.

Make sure your services aren't taxable. In other states, too.

Make sure you get good advice from knowledgeable sources. Because you're probably not.

Pay your use taxes.

Don't overpay your taxes.

Check to make sure your business is taking advantage of every possible sales tax exemption.

Be nice to the auditor.

Watch your timings!

These were the things you really must do. And then there are a whole bunch of things you should be doing.



Sales Tax Guy

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Link: Sales tax holidays are gimmicks

Tax Foundation slams sales tax holidays as gimmicks.

Retailers can get in trouble when absorbing the tax

This is the fourth and final article in my current "absorption" series.

First of all, keep in mind that absorption, in most states, is illegal. In fact, it’s often defined as a misdemeanor. However, I’ve never heard of anyone going to jail on this. Often the attitude is, "Hey, the state got their money. What's the big deal?" As we've seen previously, there are problems. But the problem for today is that the seller isn’t actually remitting enough taxes to the state on the sale.

Let’s assume the sales tax rate is 7%. Joe sells a machine to Tony for $100,000. He absorbed the tax because Tony keeps whining about how Frank from Montana doesn’t charge him tax so maybe he’ll buy from Frank instead.

Joe’s not an idiot, so he reports sales to the state of $93,458 and $6,542 in taxes (it comes out to the $100,000 that he actually got from Tony). In other words, Joe absorbed the sales tax into the sale.

But what was the real gross sale to Tony? The invoice (which doesn’t show tax) shows a sale of $100,000. Joe’s records, including the journal entry to back out the tax, show a gross sale of $100,000 and an expense of $6,542.

One of the things auditors do is compare the sales on your books, with your invoices, with the sales you report on your sales and use tax return. The gross sale was $100,000. Which means the tax that should have been reported was $7,000 instead of $6,542. Joe under-reported his sales taxes by $458.

Joe can solve the problem by charging the taxes separately. Then it’s clear what the gross sales were, assuming you are doing the proper accounting on the back end.

Of course, then Tony will buy from Frank. That’s OK, Joe didn’t want his business anyway.

Sales Tax Guy

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Sales and Use Tax Links

In Nebraska, you'll pay SUT on the cash for clunkers program. Here and here
This brings up the question of "basis" and how rebates are handled.

You'll pay more in sales taxes at Chicago O'Hare airport than anywhere else! Here and here
Yay for the home team!

Why don't states enforce absorption laws?

Part of a series on essential actions you need to take and this is the third article in my current "absorption" series.

Normally, you don't see absorption laws being enforced too often. I'm guessing that this is largely a function of the state figuring:

1. The seller is dealing with individuals as customers, and as long as the seller remits the tax to the state, the state is OK with it. Since the odds are long that the individual is going to pay the use tax anyway, the buyers don't need the receipt that is one of the purposes of absorption laws. Or,

2. The state gets the tax from both the seller and the buyer. Incorrectly I might add. Why? Because the seller builds the tax into the price (absorbing the tax). The buyer, not even realizing this is a possibility, sees no tax on the invoice and goes ahead and pays the use tax. The state gets the money twice. Pretty cool, huh? Buyers can avoid this by contacting the vendor.

A variation occurs when this issue comes up during an audit. The buyer gets audited and the auditor pulls a taxable invoice where no tax was charged. Obviously, the buyer will be assessed use tax. Even if the auditor realized that the taxes may have been absorbed by the seller, he or she isn't going to mention it. And when was the last time you heard of a buyer, during an audit, going back to a seller, and complaining about why they didn't charge sales tax?

By the way, it's a good bet that the auditor will put the seller on the list of companies to audit. He'll be hoping to get the sales tax from the seller since it wasn't apparently charged. He'll be disappointed when the seller shows that she did pay the tax. But she didn't pay enough. And that will be the subject of my last article (for a while) on this subject.

Sales Tax Guy

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Sales and Use Tax News Links

PA thinking about taxing legal services

The big news is the Texas SUT holiday, and lots of articles about Arizona's budget battles which involve sales tax discussions.

Sales and Use Tax News Links

This article from Vertex regarding the food definition changes in the Land of Lincoln

Louisiana announces a gun sales tax holiday.
Now LA and SC are the only states that have this interesting little twist

Big weekend coming up in Texas and here
Their sales tax holiday includes more stuff this year.

Variations on Absorption Rules

This is the second article in my current "absorption" series.

Not all states have absorption laws. As we discussed in this article, some states may not put the burden on the buyer and leave it on the seller. So those states won't have the typical absorption rules. And some states are strict, and some not-so-strict. Here are the variations:

1. Some states don't have rules about this at all. If the seller wants to not charge the buyer the tax, no problem. These are usually states where the burden of the tax is intended to be imposed on the seller, not the buyer. And these states usually say that the buyer has no use tax responsibility if they purchased from an in-state seller.

2. States often provide an exemption when separately charging sale tax would be really inconvenient - bars, food vendors at sporting events, vending machines, etc. There may be requirement that a sign be posted saying that the price includes the sales tax.

3. There are a few states that say that if the invoice says "tax included", that's good enough.

4. Some states have no problem with the seller saying that they'll refund the sales tax, even though they have to charge the tax.

5. Many states are OK if the seller says something like "the state makes us charge you tax, but we'll give you a rebate of 6%." As long as the seller is not saying that they're refunding the tax itself.

Often times, the state doesn't really care too much about absorption for sales to individuals. Since the person won't pay their use taxes anyway, their having a receipt showing the tax isn't too important. See item 1 in this article. Although this kind of sign in the window may tick off even the laziest of revenuers.

Please remember that these rules are highly variable from state to state. You need to research the way it works in whatever states you are selling in.

More, on this fascinating topic, to come.



Sales Tax Guy

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News Links

Sabrix Study Finds That 95 Percent of Companies Surveyed Underestimate Their Sales Tax Liability
The "study" is based on nexus issues. They've figured out that most people don't know where they have nexus and aren't registered where they are supposed to be registered. Based on what I hear in seminars, I could have told them that.

News Links

It's "felony watch" day. Two stories about businesses accused of not paying taxes they collected from their customers. Tsk tsk

Seattle contract gets nailed for not remitting his sales tax

Hat store in NY seized by revenuers

Absorption

This is the first article in my current "absorption" series.

Most states have a law on the books that says something like this:

Thou shalt not tell thy customers ....

[sorry - just watched "The Ten Commandments" - I'm starting over now.]

The seller must separately show the sales or use tax on the invoice. The seller cannot bury the tax in the price of the goods, nor can they offer to "refund the tax." Not separately showing the tax on the invoice is generally called absorption. The seller is absorbing the tax into the price of the goods.

Why do states have this rule? It sounds like no big deal. If the seller wants to eat the tax, let 'em. See the link to the news article on absorption here to see why it's a good idea to make legislators stuff socks in their mouths.

These are the reasons I've learned, without doing any serious research on the subject. And if anyone can think of any more, please let me know.

1. If the buyer gets an invoice showing that no taxes were charged, what are they going to have to do when the auditor comes to visit? So the invoice, with the taxes shown separately, provides the taxpayer with a receipt showing that they've paid the tax. But if the seller absorbed the tax, there's no receipt and the buyer gets taxed a second time. Hooray for the auditor!

Note that this is why I told you in this article, to not simply accrue taxes when certain sellers don't charge you tax. If they absorbed the tax, then you'd simply be paying a second time.

2. States that have this rule intend for the sales and use tax to be imposed on the final consumer, not on the seller. Why? Because the state has other taxes they may want to impose on the seller's sales, like gross receipt taxes, franchise taxes, income taxes, etc. If they did not make it clear that the tax was on the final consumer, then those other taxes might be a problem because you then would really and truly have double taxation.

I'm not a tax theorist (although I play one on TV), but I'd guess that if the state passed a law that says that there's a 6% tax on your sales, and then next year passed another law saying that there was an occupation tax of 7% of your sales, you'd probably have a winning case of the same thing being taxed in the same way two different times. I'm guessing that something that bald-faced won't work. Otherwise the states would do it. They have to be a little sneakier than that.

But if the state insists that sales tax is imposed on the ultimate consumer, and that the seller is merely the collector of the tax, then the state can get away with imposing that 7% occupation tax.

So the state passes a law that says the seller must pass the tax on to the buyer. Therefore the buyer is clearly carrying the burden of the tax. Absorption laws make this clear.

3. Having laws stating that the tax must be separately stated give the seller an excuse for charging tax. Rather than getting into a dickering match with someone about the 6% sales tax they have to charge, the seller can merely say that they're required by law to charge tax.

4. Tied in with number 3, if the seller does build the tax into his price, what happens when there's a rate or rule change? Do they now have to go through and reprice everything? It's probably a minor point but requiring them to add the tax to the invoice seems to solve that problem and, in the long run, be more efficient.

5. This one sticks to me from my first sales tax audit, over 30 years ago. I was chatting with the sales tax auditor. He was a very nice guy, an old timer who was counting the days to his retirement. He really stuck it to us (we deserved it), but he was nice about it. During one meeting, I asked him about the reason for absorption laws. He said that they don't want citizens to get the idea that sales tax is an optional thing, that it's up to the seller to decide if they get taxed or not. Which ties in with item 3 as well. The state wants people to expect sales tax.

So this article covers the absorption law and most of the reasons for its existence. In future articles, I'll talk about the variations on this law and how the seller can really get in trouble on this.

Sales Tax Guy

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Picture note - It's a sponge. And I'm talking about absorption. Get it? ;-)

News Links

WV Energy Star Holiday

CT ST holiday

Absorption in MA
Since the sales tax holiday went away, retailers are offering to pay the sales tax. They've found that there's a law against it (absorption). Interesting to see the legislators scramble to try to fix the "problem."

Selling animals means sales tax
No matter how much we may think of little Muffin as part of the family, pets are considered tangible personal property and therefore taxable.

The Four Loopholes (Loophole Number 4)

There are four loopholes which created the need for use tax. Over a short period of time after inventing sales tax, the states started discovering that there were some situations where they weren't able to get the sales tax revenue they were expecting. We'll use this series of posts to discuss each one.

The state can't "reach" the seller - they have no jurisdiction over the seller

In other words, the state can't get the seller to collect the sales tax from the buyer, so they invented use tax to get it from the buyer instead.

The most common example of this is our good friend Amazon.com or, for that matter, any other mail order or online retailer.

If you're in most states, when you buy from Amazon.com, they don't have to charge you tax. The short answer is that they aren't in your state. There are no stores, warehouses, offices, facilities, delivery trucks, representatives, etc. In order for a state to impose their laws on a potential taxpayer, that taxpayer must have nexus in the state - a physical presence.

Amazon.com doesn't have a physical presence or nexus in most states. According to this page on Amazon.com's web site, they do have nexus in these states (WA, ND, KS, and KY) and charge tax. They also charge tax in NY, but that's a weird situation. Someday, I'll write an article about it, but don't hold your breath.

So Amazon.com doesn't have to obey most state laws and doesn't have to charge their buyers tax. So what is, say, Alabama supposed to do? They want that tax revenue. Mail order and online sales are a big part of the economy, and they can't simply write off that segment.

Alabama and all of the other states therefore close the loophole by imposing a use tax on the buyer. That use tax doesn't get paid very often, particularly by individuals. But for businesses, this is the primary objective of the audit that will hit you at some point. They will want to see if you've been paying your use taxes. Hopefully, regular readers of this blog are.

Another related way this loophole works are sales by the Federal government. States generally can't make the Feds collect sales tax on their sales. But many states will say that, if the buyer gets something from the Federal government, and it wasn't taxed, the buyer owes use tax. This is about the only other example of a situation where the state can't "reach" the seller.

The fourth loophole for why states have a use tax is to plug situations where they can't make the seller collect the tax.

Sales Tax Guy

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Pet Store Shut Down (PAY YOUR TAXES!)

Part of a series on essential actions you need to take

This article would have just gone out on my new Twitter feed, but as I read this news article I got more and more ticked off and decided it required the full Sales Tax Guy treatment.

In case the article disappears, the essential facts are below.

There have been several stories recently about Rhode Island suddenly closing over 1000 businesses because they haven't paid their sales and use taxes.

That's the first thing to be ticked off about. Why do they pick the depths of the recession to close businesses and increase unemployment? Sounds like the RI revenuers need a reality check. Maybe some targeted state layoffs would do the trick.

But, it's not all entirely the state's fault either. As I read the article about this pet shop owner, I really can't feel sorry for him either. Now, I am assuming the article is correct which is a big assumption. So if I'm wrong here, I've seen other situations where the facts were pretty close to as described. So, at least we'll considered it a teaching opportunity.

1. Business hasn't been good for the pet shop for a while.
2. The owner quit remitting his sales taxes and started keeping the money to run his business, figuring he'd pay it back someday when business got better. The quote in the article is “I used that money to stay in business." [my emphasis]
3. He apparently hasn't been filing returns on schedule either.
4. He has had problems with the IRS too.
5. While not mentioned in the article, I'm betting he got more than a few letters from the state inquiring about when he was going to pay up.
5. He has virtually no assets.

And he wonders why the state won't give him a break and lenders won't give him money. Talk about a bad credit risk. The amazing thing is that he still has employees coming to work to take care of the critters. Hey, I'm in favor of taking care of the critters, but how is this guy paying his employees? Is he going to have to deal with unpaid wage claims at some point too?

While I'm a big appreciator of persistence, there is a signal that any business should heed when considering its viability. If the management can't (or won't) remit their sales taxes (which have been collected in trust for the state), and choose to use those funds to keep the business going, then it's probably time to rethink the business plan. This situation is not the beginning of the end. It's pretty much the last ledge before the business falls into the abyss.

And if I was working for a company where this was going on, I'd be asking for daily paychecks and hitting the bank on the way home to cash them.

Is it right to steal from the state, and defraud customers to keep the business going?

Stealing from the state? Yeah. The taxes weren't collected for the business's benefit. The seller, in most states, in merely the collector and is holding the taxes in trust. If the seller doesn't send the funds in, it's theft as far as I'm concerned.

Defrauding the customer? The customer didn't pay the business an extra few percentage points for the business's profit. They paid it under the assumption that the state would get that money. If the business isn't going to send the money in, then the business defrauded the customer.

The same thing applies to taxes you withhold from your employees' paychecks. If that money doesn't get deposited quickly... Well, let me just say this. I've heard that the IRS agents who audit companies for this particular problem - not making tax deposits - carry guns. Because people who violate this particular law, tend to find themselves wearing orange jumpsuits.

Bottom line folks. If you're small business, don't think that sales tax money sitting there waiting to be sent to the state is available for interest free loans you can take care of later. It isn't. And you won't. You'll probably wind up just like this poor pet store owner.

So if you've collected taxes, PAY THEM!

See, way more than what I could have squeezed into a Twitter post.

Sales Tax Guy

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You Must Build a Taxability Matrix

In a previous article, I mentioned that you should have a taxability matrix. This will help your purchasing agents, requisitioners, and anyone else who needs to decide on the taxability of a purchase.

The matrix will be a listing of items that you typically purchase, and the taxability of them based on these factors. This isn't easy. Few people like to write policies and procedures, but this is one of those you really should have. This is the core of any sales tax manual. It'll accomplish a few important things:

It gives your people the information they need to determine the taxability of a purchase, whether they're in Purchasing or some guy out in shipping who needs to order forms. All they have to do is look at the matrix and they can figure out what to check on the "taxable?" box on the requisition or PO.

The matrix gives you the ability to get changes out to these folks as well. Let's say you discover a mistake, find out from sales that you're dealing with a new state, a new law is passed, etc.; you simply republish the matrix. And if you're hip, groovy, and in the 21st century, this isn't even on paper, it's on your intranet someplace.

The matrix will gives you something to hand to the auditor that says, "here is how we do it." Instead of having to pull 10,000 invoices to figure that out, the auditor may need to pull a lot fewer since they can see how you say you do it. They just have to test to see if the procedure is being followed. They can argue if a particular item on the matrix is correct or not, but if you've done the backup research as you were developing the procedure, you're going to be so prepared for any argument.

You know, I kind of feel sorry for any auditor who walks into the buzz-saw of an organization with a good taxability matrix.

So, aside from inertia and the overwhelming power of procrastination, why aren't you developing that taxability matrix?

This article has been written from the perspective of the buying side of the business. A similar taxability matrix should be developed for what your company sells. I'm guessing it'll be somewhat shorter since most companies sell a smaller variety of goods and services than what they buy, and certificates may make the job easier. But developing the protocol still should be done.

Sales Tax Guy

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The Four Loopholes (Loophole Number 3)

There are four loopholes which created the need for use tax. Over a short period of time after inventing sales tax, the states started discovering that there were some situations where they weren't able to get the sales tax revenue they were expecting. We'll use this series of posts to discuss each one.

Withdrawal from Inventory (or Conversion to Use)

What's the fundamental and almost universal exemption?

OK, I'll tell you. Resale! Because sales and use taxes are generally intended to be imposed on the final consumer, the retailer shouldn't have to pay taxes on his or her purchases that will be resold to others. Read more in this incredibly well written article. And we have a lot of articles connected with this topic - including this one.

The loophole arises when a retailer buys stuff to resell, then turns around, changes their mind, and uses it. A lumber yard uses some building materials to build a new shed. A store takes picnic supplies out of inventory for a company outing. A computer store takes a price tag off of a laptop and gives it to the new guy. And the car dealer gives sales reps demos to drive.

These are all examples of withdrawal from inventory or conversion to use. I prefer the second term, but you'll see the first term more often in your research.

This was a loophole. If the state only has a sales tax, they don't have an obvious way of recovering the tax that the retailer should have paid at the time of purchase - on the building materials, picnic supplies, laptop or car. So the states invented use tax. When the retailer uses his goods by withdrawing untaxed stuff from inventory, the states can now get their money.

And if you read the instructions for your sales and use tax return, you'll usually see this particular item mentioned as one of the types of things that belong in the "use tax on your purchases" line.

More on this topic, with more illustrations, here.

Sales Tax Guy

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Twitter!

Today, based on recommendations from friends, I set up a twitter account for Sales Tax Guy. Yay!

I'll use twitter to announce blog updates, news about sales and use taxes, seminar and webinar information, etc.

http://twitter.com/salestaxguy

The Process

Here is the entire process (at a very high level) for making sure you accrue for sales and use taxes.

- The user sends in requisition to purchasing.

- Purchasing orders and decides at that time on the taxability of the purchase (yes, purchasing makes the decision -- I hear wailing and gnashing of teeth).

- The vendor ships or performs service and bills you.

- AP reviews the invoice and the PO and determines if taxes were charged and if they needed to be charged.

- If taxes weren't charged, and item really is taxable (contact your vendor to make sure you don't over-accrue), then AP codes and enters the invoice with a debit to tax expense and a credit to use tax liability.

- The tax return is prepared by accounting and the use taxes on purchases come from the accrual by AP. You may want to have a system where AP forwards copies of accrued invoices to validate the accrual, but that's up to you.

Done. How hard was that? What could be simpler?

Oh, yeah. Purchasing is the one who gets to make that decision about taxability (there's the wailing and gnashing of teeth again).

Why? Because purchasing already knows what was purchased and how it is being used. These are two things that AP doesn't necessarily know, and it probably isn't obvious from the paperwork or accounting codes. So they have to contact Purchasing. Which annoys everybody. If purchasing knew what the rules were, problem solved. "But wait!" you say, "Purchasing doesn't know the rules." That's where a taxability matrix comes in handy (don't worry, future article).

Hmm, I wonder how many of you AP folk are emailing this article to your purchasing pals right now. Go ahead, you know you want to.

Sales Tax Guy

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