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

Audit Interpretations: Safety Equipment

This is the start of a new series of posts about audit interpretations. In particular, I'm going to try to include situations that don't appear in the law (or require a clarification the taxpayer won't like). I'll also try to report on flat out abuses where the taxpayer, if they had challenged the auditor, would probably not have been robbed.

The first item comes from Michigan this week.

Two people on two different days, when we talked about safety equipment, told me this one. They said they had been assessed on the safety equipment worn by the office personnel when they went back into the manufacturing area. The goggles, etc. worn by the plant workers weren't a problem.

It looks like the auditor was right. Michigan law says that stuff that is used for administrative uses isn't exempt. Obviously the AP specialist isn't going in back to work a lathe, they're getting paperwork taken care of. In other words, administrative use.

Tricky.

Sales Tax Guy
See disclaimer.

Shocking But True!

This may come as a surprise to some of you, but there are manufacturers out there who didn’t know that they have really cool exemptions.

In most (but definitely not all) states, if you’re a manufacturer, you can invest in machinery, get it repaired, and buy consumables tax free, or at a lower rate. And even in states that aren’t very generous to manufacturers, there still may be some exemptions available.

And it’s not just manufacturers. Here are some other industries where I’ve seen exemptions that other folks at the chamber of commerce mixer don’t get:

Manufacturers
Mining
Common carriers
Funeral directors
Utilities
Radio and TV stations
Movie producers
Photographers
Contractors

So check your state’s laws to see if there might not be some exemptions for your business.

Sales Tax Guy

Golden Rule: Use Tax is Imposed Even if You've Already Paid Sales/Use Tax

Generally, use tax is imposed on the storage, use or consumption of tangible personal property (TPP) in ANY state where it is used.

In other words, if you purchase an item in Pennsylvania for $100,000 where the tax rate is 6% and then bring it to, say, Tennessee, where the rate is, say, 9%, then you will owe Tennessee additional use tax because you're using the TPP in Tennessee. Even though you've already paid Pennsylvania!!!

But, don't panic. There are lots of exceptions (and gotchas):

1. You'll get credit for the taxes you've already paid to Pennsylvania. So, you'd only owe Tennessee 3% (the difference between 9% and 6%) or, using the above example, $3000. So it's not double taxation (which I know you were thinking); it's just catching up to the use tax rate in the state where you're using the TPP.

The gotcha is that some states may restrict the credit they give in these ways:

• They will only give you credit if the original state gives a similar credit (which just about all of them do).
  
• They may only give you credit for state taxes you've paid, not local taxes. Or they may require that you offset state taxes against state taxes and local taxes against local taxes. But other states will allow you to pool the taxes.

2. This rule doesn't apply to your household and personal property. So if you're planning a cross country road trip, don't worry about your $2000 camera.

3. Most states do not apply the rule against property that has been sent into their state to be repaired, fabricated or otherwise worked on by a local vendor, and then sent back out of the state.

4. While the default basis for the tax calculation would be the original invoice price of the item, many states will base the additional use tax on some adjusted value, usually fair market value when the property enters the state. For example, if you brought that $100,000 machine to Tennessee, they would base the additional 3% on the original invoice cost of $100,000, even if you've been using it for 5 years. But if you had brought it to Louisiana, the basis would be whatever the fair market value of the machine was when you brought it into the state. So, if the machine was only worth $20,000, then you would owe Louisiana (assuming their rate was also 9%) 3% of $20,000 which would be $600. Much better than $3,000.

Every state does this differently, and sometimes it's hard to find that basis. The default is the item's original invoice price...you have to look for the exception. Disclaimer: I didn't find an exception in Tennessee. If you know of one, please let me know (with a citation). I did find the exception in Louisiana.

5. Some states are very nice and simply say that, if you've used the TPP for more than, say, six months outside of the state, then they don't impose an additional use tax. Or they'll use the fair market value as opposed to the original purchase price. Either way, much better.

6. Some states have exemptions for commercial use in the state for certain types of activities, like sports such as horse and car racing.

7. Here's a gotcha. That TPP that you bought and used in Pennsylvania may not have had any tax imposed on it at all because it was exempt in Pennsylvania. But that same item is fully taxable in Tennessee. So you will wind up paying the full 9% ($9,000) use tax! Watch out for exemptions that exist in the origin state that don't exist in the destination state.

7. Some states have exemptions for property that comes into the state for the sole purpose of being stored, with no intervening use, and then shipped out of the state. So if you've brought TPP into Louisiana, for example, that was simply stored to be shipped out of state, and so labeled (that is the specific requirement in Louisiana), then they would not impose use tax.

8. Finally, TPP that is simply in-transit through a state can't be taxed - the Constitution's commerce clause.

Sales Tax Guy
(please read the disclaimer)

Golden Rule: The Lumping Rule

Generally speaking, when you lump (or bundle) a taxable charge together with a charge for something that's not taxable, you will make the entire transaction taxable.

For example:

If I get my car fixed in North Carolina (and about half of the states), there's no tax on the labor, just the parts. But that's as long as the mechanic shows the parts and labor charges as separate items on the invoice. If he bills me $800 for the labor and $200 for the parts, then he would only charge me tax on the $200 of parts.

But if he just billed me $1000 for "parts and labor" with no breakdown, then I would have to pay tax on the entire amount.

There are variations on this rule, particularly for situations where the parts are insignificant in relation to the total invoice. And you'll see rules that set the amount of the taxes at 50% in some bundled situations. And here's another example of a combination of a sale of non-taxable services and taxable TPP.

But beware that this is a fundamental part of the way sales and use taxes work.

Sales Tax Guy

Golden Rule: Be Careful About Your Information Sources

Alternatively, Get It In Writing!

1. Auditors aren't going to be helpful. They're job is to reach into your wallet and extract money. Therefore, don't count on them to do the right thing by you. Sometimes, if you're lucky, the auditor will point out where you have overpaid taxes. Sometimes. See my articles on audits for more information.

2. Your accountant and lawyer probably have virtually no knowledge about sales and use tax. The vast majority didn't learn anything in college about it. And the subject isn't on the bar or CPA exams. So, unless they have developed a specific expertise, they generally don't know much about it. So if they tell you, "don't worry about," ask them for something in writing. Then they'll worry about it.

Oh, they know about income taxes. And because of that, they'll think they know about all taxes. But not this one. In fact, it's been my experience, that a professional who specializes in income taxes won't be an expert in sales and use taxes. And an expert in sales and use taxes won't be much help when it comes to income taxes.

3. You learned it wrong from whoever trained you. Either they didn't know, they've been doing it wrong, or something got lost during the training. Or you heard it wrong. Oral communications is the worst form of information transfer. This is why you should have a good sales tax manual.

4. The law is complicated. There are lots of places where it comes from. There are lots of interpretations, lots of ways to get it wrong. And there are lots of exceptions.

In other words, get it in writing, from an authoritative source that'll impress the auditor.

Sales Tax Guy

News Links

Board of Equalization Announces Enhanced Compliance Effort
More than 8,000 businesses in seven different zip codes throughout the state are being notified this week of impending visits from Board of Equalization (BOE) specialists who will be canvassing the areas to ensure the businesses are properly registered and paying taxes.

Simpler sales tax sought
Short article about the streamlined sales tax project.