Direct Pay Permits

This is a compilation and enhancement of several previous articles on direct pay permits.

First of all, what is a "Direct Pay Certificate?"

It's an exemption certificate that the buyer hands to the seller. It relieves the seller of the responsibility of collecting the sales and use tax from that particular customer. This is because the buyer has made a deal to pay the use tax directly to the state. They have gotten a direct pay permit from the state.

Why would these certificates exist? Larger organizations (eg. manufacturers, contractors and utilities) find them helpful because they buy lots of different things, some exempt and some taxable. They have very complex operations, and it may be impractical to have the seller collect the tax. In some cases, the buyer may not even know if a purchase is taxable at the time of the billing. So this makes it easier for both parties.

The customer buys pretty much everything without the vendors having to charge sales tax. The direct pay permit holder then self-assesses the use tax. And the vendors have one less customer to worry about.

Sometimes the purchasing and operational issues are so difficult that the user may even come up with a calculation. A manufacturer might say, "We bought $400,000 worth of shop supplies last month. Our studies indicate that 40% of those supplies become ingredients in the product and the rest are used in our operations. So 60% of the $400,000 is taxable, and that's what we accrue and pay use taxes on."

It's not easy to arrange that kind of allocation if the tax is being collected by the seller. How are they only going to bill for 60% of the tax? On the other hand, all the buyer has to do is make a journal entry, and the problem is solved.

What's in it for the state? First of all, not all states grant direct pay permits, so don't assume you can just apply for one. But the benefit for the state is that the audits are less detailed. Since the user comes up with calculations and ratios as described above, the auditor theoretically has to grind through fewer transactions. And I think another reason is that the state may actually get overpaid! See the discussion below.

Now you may think this is a pretty good idea. But there are catches:

1. States don't like to hand direct pay permits out like Skittles. They often have volume requirements and expect to see adequate accounting systems in place. If you don't have professional accounting management, and you use QuickBooks, you're not going to be able to get a permit.

2. Don't think of this as a way of avoiding/evading tax or getting to hold onto the tax money a little longer. You're going to probably have to pay your use taxes monthly, and you can pretty much count on getting audited every few years. Because the state is now relying solely on your company to self-assess (and we know how reliable most of us are at that), the state is going to be much more likely to audit you. Regularly. Frequently. Set up an office just for the auditors, if you know what I mean.

3. Tied in with number 2, you're likely to get audited before they even give you the permit, just to see if you have those systems in place to self-assess properly. And they're going to want to look at those studies you're using for your calculations to make sure you're doing it right.

4. Beware of mixing up which vendors you pay sales tax and which ones you don't (by giving them the direct pay certificate). I've talked with taxpayers who were not consistent in using their certificate. This resulted in paying sales tax on purchases and then turning around and self-assessing tax on the same purchase. Keep very close track of who you give a direct pay certificate to and who you don't.

5. One of the things I've talked about is that you should be careful about overpaying your taxes because you mistakenly believe something is taxable. A clue to this is when you think something is taxable, and the vendor hasn't charged you tax. A phone call is in order. But if you have a direct pay permit, your vendors aren't going to tax you at all. You'll now be relying solely on your own understanding of the tax laws, and you won't be getting the reality check from your vendors. You may not realize it, but there is some education that is happening because of the give and take with your vendors. Get a direct pay permit and you're on your own.

Whether or not you get a direct pay permit is simply a question of how much easier it would be to self-assess versus the risks of overpayment and audits. I'd strongly recommend you sit down with a local expert to see what they're recommendations are based on your specific situation. And if that alternative seems too costly, then you probably shouldn't get a direct pay permit.

Sales Tax Guy

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My customer says they'll pay the tax on their own

Just because the customer assures the seller that they'll pay the tax doesn't relieve the seller of any burden to collect the tax. But, if the buyer provides the vendor with a direct pay certificate, that'll work.

In most states, there is a recognition that some buyers have such complex purchasing situations that it would be easier to simply let them self-assess the use taxes. However, most states are also strict about who they hand direct pay permits to. Here are the usual criteria:

1. Have good policies and procedures in place to make sure the taxes are properly self-assessed
2. Meet certain volume requirements
3. Go through an initial, detailed audit
4. Go through future audits almost every year.

Once the customer is authorized, they send their vendors direct pay certificates which the seller can then treat just like a resale or other exemption certificate (there are some restrictions). But without that specific piece of paper, do not accept the customers assurances that they'll pay their own taxes, even if it comes in a letter, contract, sales agreement, or PO.

In order to be relieved of your responsibility for collecting the tax, you need a direct pay certificate.

If someone said they're buying for retail, you wouldn't take their word for it. You'd want the resale certificate. Right? Right?

Sigh.

Sales Tax Guy

Why not let my customer pay the use tax?

If my customer pays the use tax, why do I have to charge him tax. Can't I get a letter from him that says he'll take care of it?

The answer is, generally, NO! The state doesn't trust your customer (and with good reason, I might add) to pay the use taxes. You're the seller and you are primarily responsible to collect the sales (or use) taxes from the customers. Even if they "promise" they'll pay.

Most states have a "direct pay permit" which DOES get you off the hook. This is a state-sanctioned way for a customer to tell you, "we'll take care of the use tax ourselves." The customer has to apply for the permit, and they will generally go through more audits than the rest of us. That's because the state really DOESN'T TRUST anyone to pay their use taxes.

Bottom line, you have to collect the taxes from your customer.

Sales Tax Guy

Direct Pay Certificates

First of all, what is a "Direct Pay Certificate?" In most states, larger organizations find them helpful because these types of companies buy lots of different things, some exempt and some taxable. This is particularly true for manufacturers, contractors and utilities. It's easier for them to get a direct pay certificate from the state. This allows them to buy pretty much everything without the vendor having to charge sales tax. The direct pay permit holder then self-assesses the use tax. Now you may think this is a pretty good idea. But there are catches:

1. States don't like to hand DP certificates out like Skittles. Don't think of this as a way of avoiding/evading tax or getting to hold onto the tax money a little longer. Generally states only give these out to larger companies with a need.

2. You can pretty much count on getting audited every three years. Because the state is now relying on your company 100% to self-assess (and we know how reliable most of us are at doing that), the state is going to be much more likely to audit you. Regularly. Frequently. Set up an office just for the auditors, if you know what I mean.

3. Tied in with number 2, you're likely to get audited before they even give you the permit, just to see if you have the systems in place to self-assess properly.

4. Finally, beware of mixing up which vendors you pay sales tax and which ones you don't (by giving them the DP certicate). I've talked with taxpayers who were not consistent in using their DP certificate. This resulted in paying sales tax on purchases and then turning around and self-assessing tax on the same purchase. At lease keep very close track of who you give a DP certicate to and who you don't.

Sales Tax Guy