Wednesday, April 01, 2009

Sales and Use Taxes in a Nutshell

What every business owner, CEO, executive director, executive, requisitioner, purchasing agent, sales manager, and accounting person needs to know about sales and use taxes - in five minutes or less.

The problem for all of you is that you don’t know what you don’t know. My objective here is that you will at least know what you don’t know. Then you can ask more intelligent and pointed questions of the people you rely on for tax expertise.

So, here we go:

1. Those people you rely on for tax expertise probably don’t know much about sales and use taxes. They do know about income taxes, but they didn’t have to know anything about sales and use taxes to pass the bar or CPA exam. And a one hour break-out session at the annual CPA state convention really isn’t enough.

By the way, included in this list of people who aren’t necessarily experts are the sales tax auditors, and the people back at the department who answer the phone. Blame poor training and a desire to make the state’s payroll next week. These folks don’t memorize the law, and they’re much more likely to find situations where you owe taxes, rather than where the state owes you money. There won’t be any pats on the back if they return to the office having to give you a refund.

2. Forget everything you knew about income taxes. They just don’t count here. There are a couple of rules the states will sometimes use that come from the Internal Revenue Code, but that’s only so they don’t have to reinvent the wheel. For example, some states will classify non-profit organizations as exempt from sales tax if the organization meets the IRS rules (eg. 501c3 organizations). But most states use their own rules.

3. Sales and use taxes are not an option. If you make taxable sales, in most states you must charge your customers tax. And you must remit that money to the state. You can't "borrow" it. And buyers, if the vendor didn’t charge you taxes for some reason, then you must pay the use taxes in most states.

4. What's taxable. By default, the sales and use of tangible personal property are taxable. Most states will tax the sales and use of some services (see below) and some states will actually tax real property as well. Here's a checklist of the different taxing policies

5. The state you ship from is irrelevant. In the vast majority of transactions, the state whose rules and rates you have to follow, and taxes that apply, will be where the product is shipped to, where it is delivered, where it is first used.

6. And if you have any kind of physical presence in that state where the delivery occurs, you may have to register in that state, collect their taxes and file their returns. And you don’t get any brownie points for collecting the tax and remitting it to your state. The other state won’t give you credit for collecting and paying the wrong tax.

States can be pretty creative about what will give you that physical presence in their state (this is called nexus). For example, do you have a sales rep, consultant, trainer or some other person visit the state a couple of times a year? That may be enough. Note that they don’t have to live in that state. They just have to visit. Or do you have a piece of equipment sitting in a state? One BIG state says that’s enough to have nexus. Do you sublease hotel rooms and re-lease them to others? Then you may have facilities in the state…in other words, nexus.

7. There are 46 states, including the District of Columbia, that have a sales and use tax. And they all do things differently, sometimes dramatically differently. But they generally follow a similar structure, which I’ve taken to calling the golden rules of sales and use tax. And many of them do have similar taxing policies.

8. Services are often taxable. Probably the most commonly taxed are rental of tangible personal property, utilities, printing and fabrication, and repair labor. Remember, just because it’s not taxable where you are doesn’t mean anything. Remember, what counts is where it’s delivered. In the case of services, the delivery point can mean either where the service was performed, where the customer received the benefit of the service, or both. In other words, the destination state is what counts. And there are services that are only taxed in a few states, but they are taxed (eg. accounting and attorney fees, headhunting fees, insurance appraisal services, etc.)

9. States impose use tax on any use of tangible personal property in the state. This means that if you’ve bought property in one state, then move it to another state, you may owe use taxes in that new state. It gets even nastier if you have inter-corporate transactions. In those situations, you may be making brand new taxable sales if you “sell” equipment from one corporation to another corporation within the same company.

10. You should assume everything you sell, and everything you buy, is taxable until you can assure yourself that it’s not taxable. There are obviously going to be exemptions. But your thought process should be to assume it's taxable, then look for the loopholes. This is the approach the auditor will take, so you might as well get in that mindset. Here are some examples of sales where the seller got surprised by something that was taxable and they didn't realize it...until the audit.

11. Just because you make sales that aren’t part of your line of business doesn’t mean you aren’t making taxable sales. What about your cafeteria? Vending machines? Do you regularly sell surplus equipment? Do you make convenience sales to your customers? Do you sell logo merchandise to customers and employees? Do you have an annual clearance sale for employees?

12. You’re overpaying sales and use taxes. But the sales tax auditor will never point that out to you.

13. Just because you paid tax on something when you bought it doesn’t get you off the hook for charging tax when you sell it. If you’re making a retail sale, the fact that you mistakenly paid tax on it doesn’t mean anything. You should have bought it for resale.

14. When you get audited (notice I didn’t say “if”) you should be nice. Most auditors that I've talked to tell me that if you're professional in your treatment of them, they'll be professional in your treatment of you. And get professional guidance. The sales tax auditor may not know what he or she is doing, you don’t know what you don’t know, and your “normal” CPA or lawyer isn’t much better. This is not a good formula. Consider getting a sales and use tax professional involved early in the process.

15. By the way, get it in writing. Make the vendor who insists that your purchase is taxable show you where it says that. And make the auditor show you where the law says you owe a gazillion dollars. And be prepared to provide people with proof when you tell them something they didn’t know.

16. There are lots of exceptions. Remember, there are 46 different states doing it their own way. And within each state, there may be different taxing jurisdictions (eg. Colorado), and complicated laws written by politicians who are either corrupt or stupid.

Now what do you do? Get at least one person on your staff trained on sales and use taxes. Make them the designated expert. Before you assign Accounts Payable to this, note that this tax crosses ALL departments. The person you assign better be able to talk to sales, operations, etc. with some authority. I repeat: this is not just an AP issue. Bookmark this blog and read it regularly. Go to seminars. Invest in a library of reference materials. Sign up for webinars. Find a professional who knows something about this.

And I apologize to just about everyone in the world who've I've offended in this article.

Sales Tax Guy

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1 comment:

Anonymous said...

There are 46 states that tax sales, however don't forget in those other states there are possibly local taxes.
I agree throw out the Income Tax as sales tax is a whole different tax world. You may know the law however interpretation is what it makes it work. Many older auditors are retiring and are not leaving much to the newer auditors. If you go on the websites and research the information Taxing Authorities are teaching the new auditors, some of it is correct, some is not correct, however it’s the law to them. Give them some latitude as you didn’t learn everything in one year.
An example: We were audited by a city in a certain state and their interpretation of the law was conceptualizing and designing the program, planning program requirement, project management, writing code, testing and evaluating the program, implementing the program were all part of the taxable portion of the data processing program.
Two years later all of the above is now a personal service and not taxable.
Newbies, I have been in the state and local taxes for over 30 years and I still don't know it all. Stay with this guy as he seems to know his stuff.