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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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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Picture note: the picture above is hosted on Flickr. If you'd like to see a larger version, click here, then click on the "all sizes" button above the picture.

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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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? ;-)

Don't just accrue use tax!

Part of a series on essential actions you need to take

Obviously, the whole point of use tax is that you owe it if the vendor didn't charge it (in most states). But, don't automatically do it in one situation: if the vendor and the buyer are in the same state - an intrastate sale.*

In that situation, it's worth a phone call to the vendor asking why they didn't charge tax. If the purchase came from out of state, then the likely reason for the failure to charge tax would be that the vendor hasn't got nexus, or doesn't realize they have nexus, or has chosen not to register in the state. Just go ahead and pay the use tax. But if the vendor is in the same state as the buyer, then they are obviously supposed to charge tax. So why didn't they charge you tax?

Purchase Not Taxable

It could be that they screwed up, and you do in fact owe tax. But you may not owe tax if the purchase really wasn't taxable. It's reasonable to expect that the vendor of something is more likely to know how to tax what he sells than the buyer. It's definitely not guaranteed, but they should know more. So ask them.

There was a woman in Johnson City, Tennessee who was accruing taxes on repair labor when the vendor failed to charge tax, which was frequently. I asked her what state this was for, since Johnson City is really close to Virginia. She said it was for her Virginia plant. I pointed out to her that repair labor isn't taxable in Virginia. She was dumbfounded. "You're kidding, right?" She had been accruing taxes for years on something that wasn't taxable. While repair labor is taxable in Tennessee, it was being performed and delivered in Virginia where it wasn't taxable. If she had simply made a phone call to the vendor and asked why they had not charged tax, she would have found out...years ago; and tens of thousands of dollars ago.

Absorption

The other possibility, that will save you money, is that the vendor is absorbing the tax. In other words, they're burying the tax in the "price" of the goods. This is often done because the vendor finds it easier to do this than to try to explain to the customer why they have to charge tax.

I had a guy in Texas who charged his customers tax on repair labor, which is the correct thing to do in Texas. But because the invoices were paid out of the home office in Illinois (where labor is not taxable) the AP department kept short-paying the invoices for the tax on the labor. They were mistakenly thinking in terms of Illinois rules. Obviously they had not been to my seminar.

Phone calls didn't work. So the vendor simply started sending invoices with the repair labor priced a little higher to included the sales tax, which was no longer shown on the invoice. He absorbed the tax. Texas got their sales tax revenue. The AP department paid the bills. The vendor was happy.

The problem with absorption is that, in most states, it is illegal. The reason, aside from some high-fallutin' legal theories about where the burden of tax is imposed, is simply to let the customer, and the auditor, know that taxes have been paid. The invoice is a receipt for the taxes. So if the vendor absorbs the tax, the buyer doesn't know if the taxes were paid and, if the buyer doesn't call the vendor and ask, will pay the taxes a second time. Which the state is kind of counting on.

Of course, the state has no problem with getting their money twice. ;-)

Summary

So, for two reasons, you should call your in-state vendors if you feel you need to accrue the tax: 1. To make sure your purchase really is taxable.
2. To make sure they haven't absorbed the tax and already paid it to the state.

Of course, you may find out the vendor screwed up and didn't charge you tax. Try to get them to re-bill you properly. This will protect against complications down the road when they get audited.

*You should also follow this procedure for out of state vendors who you KNOW have nexus in your state, and are BIG. There's no reason that they shouldn't be charging you tax either. The question comes up once in a while about GIGANTIC vendors and why they aren't charging you tax. If they're that GIGANTIC, they should know the rules, and they are almost certain to have nexus.

I've written up an Illustration and Parable about this.

Sales Tax Guy

Absorption in Action

I was running errands and saw this sign in a furniture store in the Chicago area (I've edited out the name of the company on the sign). It's illegal in Illinois to advertise that there's no sales tax. Evidently, they got the word. Because the next day, the sign was gone.