Preface: Sales tax compliance is advised for every business. While sales tax laws are unique from state-to-state and item-to-item, analysis of sales tax risks on business products or services is advised. Here’s why.
Know Your Sales Tax Risks
By Jacob M. Dietz, CPA
Should you get a sales tax analysis?
Imagine an entrepreneur sitting at their desk opening mail. Suddenly they come to an official-looking letter from the government of another state. Hesitatingly, they open the letter. It states that their business owes tens of thousands in sales tax and penalties and interest.
How did the business get into this predicament? The business tried to render unto Caesar what was Caesar’s. None of us are old enough to have paid taxes to Caesar in the first century, but in the 21st century taxes are complex. An honest businessperson could find themselves with sales or use tax liabilities that they didn’t know they owed. Consider conducting a sales tax analysis to review if your business may have some sales and use tax liabilities.
Small Equipment Dealer
How could a business unknowingly rack up a sales tax liability? Assume Reuben is an equipment dealer who sells small wagons to farmers and gardeners. Most of his sales are to other dealers or to farmers, so most of his sales are exempt. Every month or two, however, he will do an online out-of-state sale to a customer who is not a farmer.
Does Reuben need to file sales tax for his out-of-state sales?
Reuben may want to ask a CPA to do a sales tax analysis for his company. Some questions they may examine are:
- In which states is Reuben selling?
- To what kind of customer is he selling?
- What type of product is he selling?
- How many sales dollars and transactions are there?
Reuben asks his accountant “suppose I sell $250,000 of nontaxable sales to XYZ state, and then I sell $20,000 of taxable sales. Must I file sales tax in that state?”
Taxability Varies by Jurisdiction
Assume Justin owns a clothing company in Pennsylvania. Based on the type of clothing he sells and Pennsylvania’s sales tax rules, he files no sales tax returns in PA. Justin is a very talented entrepreneur, and his clothing business continues to grow from small to large. Justin soon starts selling hundreds of thousands of dollars in clothing to other states. Since PA generally does not tax clothing, although there are exceptions, Justin assumed other states would not tax clothing.
To be on the cautious side, however, Justin decided to have his accountant evaluate his sales tax practices. The accountant realized that Justin did have nexus (substantial connection) with other states that do tax clothing. Based on the thresholds in the other states Justin should be filing. Fortunately, Justin had only recently reached the thresholds, so he was able to get his taxes in order quickly.
What would have happened if Justin had not asked his accountant to analyze his tax situation? Perhaps eventually another state would have audited Justin. It could have forced him to pay the sales tax with penalties. That would have been a blow to Justin’s bottom line. Since he was not collecting the sales tax to pay from customers, he may have been forced to pay it with the company’s money instead of the customer’s money.
Assume Brendan operates a handyman business. He fixes a variety of items, depending on the customers’ needs. One day, Brendan was called out to the home of a sweet elderly couple that needed some items fixed. First, Brendan fixed their chair. Next Brendan fixed their roof.
Is his labor taxable? The labor for the chair repair was taxable, since a chair is a taxable item. The labor for the house roof repair was not taxable, since the item was real property not subject to tax.
How can Brendan keep the taxability straight? He can withstand scorching heat while fixing a roof, but sales tax rules give him a headache.
Is sales and use tax compliance complex for construction companies? Generally, in PA construction contractors pay sales tax on materials that they buy, and then they generally do not charge sales tax on the finished building. Some other sales tax jurisdictions, however, treat it differently. If a construction contractor is working outside PA in one of those other jurisdictions, then they may want to know what those rules are.
What happens if a construction contractor buys materials in one taxing jurisdiction, but builds the project in another jurisdiction?
Outsource your Research
You do not want to be the honest entrepreneur opening the mail and finding that your business has not rendered unto Caesar what is owed. But what can you do? If you are like many business owners, you would rather fix a roof or prepare an estimate than figure out sales tax. Consider outsourcing your sales and use tax research to a trusted CPA.
This article is general in nature, and it does not contain legal advice. Please contact your accountant to see what applies in your specific situation.
Jake Dietz is a CPA, Business Consultant, with Sauder & Stoltzfus, LLC, a certified public accounting firm, in Ephrata, PA, specializing in entrepreneurial business accounting and tax services, bookkeeping, business valuation, and peripheral CPA services. Jake can be contacted at 717-961-9811, or firstname.lastname@example.org