Getting Sales and Use Taxes Wrong May be Costly
Getting Sales and Use Taxes Wrong May be Costly
Many businesses do not consider the process of filing sales and use tax returns to be a complicated task. As a result, they often delegate the duty of filing sales tax returns to a clerical level person within the accounting department. That person, if they get any training at all, is usually given a checklist of things to do and reports to run in order to file the return. Generally, management will not review their sales tax return filing process unless they’re undergoing an audit and the results are negative beyond minor oversights. In many cases, even unfavorable audit results do not bring about a review or changes in their reporting methods. I have seen many cases, as an auditor, where we show up to do another audit and the errors are nearly identical to the previous audit(s). The reasons for not incorporating the issues raised from prior audit(s) vary: changes in accounting personnel, the taxpayer never really agreed with the original audit findings, or the accounting department was simply too busy with other priorities.
As a former Senior Tax Auditor with the State Board of Equalization, I can tell you from experience that nearly every audit uncovers underreporting errors. Rarely do audits result in a net refund or no change. Auditors are trained to design their audits to discover underpayments of tax – not overpayments. Auditors do sometimes include offsets (overpayments) against the audit liability, but in general, auditors do not design their audit tests to uncover overpayments.
Why so complicated?
There are numerous ways that taxpayers can make errors on their returns. Several factors can combine to make the process of filing a reasonably accurate return difficult to achieve. They include: multi-state operations, the type of industry you’re engaged in, the size and complexity of your business, sophistication of recordkeeping, and/or turnover in the accounting/tax department, etc.
If your business operates in several states, you are required to know how sales and use taxes apply in each state in which you are considered “engaged in business”. In some states, you are required to register and file separate returns with certain cities. That means knowing taxability rules for the items you sell, how to allocate taxable sales to local jurisdictions, maintaining proper documentation for exempt sales, keeping up with changes in rates and laws and responding to audits and other correspondence from the state.
The complexity of sales and use tax laws vary depending on the industry in which you operate. Taxpayers must be knowledgeable about laws and regulations specific to their industry to reduce the likelihood of errors. Errors of this nature can result in significant liabilities or credits since they are usually made over and over again during a three-year statute period.
Use Tax Issues
In addition, taxpayers must also know about use taxes and how they apply to their purchases. Auditors frequently discover errors involving use tax in the paid bills and fixed asset purchases. In some cases these types of errors result in large assessments.
Are your vendors overcharging tax? Are they not charging tax when it appears they should? Under what circumstances are you required to self-report the tax? Does it matter if the vendor in question is in-state vs. out-of-state? In certain industries, because of the complexity of the rules, vendors will simply tax the entire charge because they don’t want to pay tax later in a potential audit without the benefit of collecting tax reimbursement from their customers. This excess tax reimbursement occurs simply because the vendor does not want to take the time to properly learn how tax applies to their sales. In addition, some vendors may oversimplify their sales invoices by not separating charges from the sale of tangible personal property from other potential non-taxable charges (i.e. installation labor, training, optional warranties, etc.) thereby complicating the amount that should or should not be subject to tax.
Every state requires taxpayers operating within their borders to maintain records sufficient to accurately determine their taxes. Failure to properly maintain records may subject you to an overassessment of tax simply because: the auditor made an aggressive estimation, disallowed claimed exempt sales without support or assessed use tax on certain purchases because of an inability to demonstrate that tax was paid. In addition to the tax assessed, auditors may impose penalties for negligence. Interest charges on unpaid tax are required by law and can be significant.
What activities create a requirement to register and file returns within a state? What are the implications for failing to register and file with a state? How long is the statute of limitations for not filing returns? You may be unpleasantly surprised by the consequences of being discovered by state officials for not registering and filing returns when required to do so. The statute of limitations for unfiled returns varies from eight to 10 years depending on the state as opposed to three years for registered businesses. In addition, you will not have had the benefit of collecting tax reimbursement on those sales. Finally, failing to file returns generally results in unrecorded liabilities. For businesses that report financials to third parties, an estimate for unrecorded liabilities and the unfiled returns must be disclosed in your financials.
Is It Time for a Check-up?
Businesses should periodically perform a check-up of their sales and use tax policies and procedures to ensure that they don’t have an unpleasant surprise when their next audit occurs. When problems are discovered early enough, measures can be taken to minimize or eliminate their impact during a subsequent audit. In some cases, there may be significant overpayments of tax, which if left unclaimed are lost forever. On the other hand, when an auditor discovers a deficiency, there may not be a viable alternative to paying their assessment. If you’re unsure about your company’s compliance with sales and use taxes, please contact your tax professional. He can help provide that peace-of-mind that you won’t have a nasty surprise during your next audit.
If you have questions or would like to review your sales and use tax position, please contact your White Nelson Diehl Evans tax professional.
About the author:
Marc Brandeis is a former Senior Tax Auditor with the California State Board of Equalization. He also worked as a consultant for a “big four” accounting firm before starting his own consulting practice. With 15 years of sales and use tax experience, he has helped numerous taxpayers navigate the complex rules of sales tax compliance.