Preface: As sales and use taxes in business can create a complex web for tax compliance, harnessing the right tools to manage and reduce those tax risk is advisable.
Appropriate Steps to Avoid the Web of Sales and Use Tax Risks
Credit: Donald J. Sauder, CPA | CVA
The new sales tax laws of 2018 following the SCOTUS “Wayfair” ruling, substantially increases the amount of compliance work already required in the perplexing field of sales tax. Let’s begin our work on the appropriate steps to avoiding the web of sales and use tax risk with these questions:
- Do you ship products across state border’s?
- Do you perform services across state border’s?
- Do sell online?
- Do any employees travel across state lines?
- Are you registered in all the states you have customer in?
- Do you know the state and jurisdictional rules for your revenue sources?
Specifically, the 2018 “Wayfair” ruling “bright-lines” that substantial nexus occurs for sales tax reporting when a value of goods exceeds $100,000, or the number of transactions is more than 200.
While the latitude of this field is advised to be managed with expert accounting advise, great decisions can only be made with even more precise and accurate information.
Let’s consider first some fictional stories with a pertinent hypothesis to gain an increased understanding of what sales tax non-compliance can cost a business, and then talk about easy (but not necessarily inexpensive) steps to proactively ameliorate the web of audit risks with sales and use taxes. Before we begin, there are 7,500 approximate taxing jurisdictions in the US for state and local sale tax, so the proper management of the fields risk, can quickly become challenging, for any tax professional or entrepreneur for that matter.
Residential Services, LLC
Residential Services, LLC was heading into a successful second decade of business having blossomed with a capable team and diligent effort. With superior earnings, the company had devised a strategy of purchasing supplies and materials for projects from a sales tax free state that was nigh and convenient, given their jurisdictional location. The Company then sold the supplies to customers, and other friendly competitors with appropriate markups for the industry. With more than $1.5m of these tax- free supplies transacted per year, the company was earning a comfortable net profit of other income from the “tax strategy.”
The Company had just finished a signature prevailing wage project, when an audit letter arrived from the State Department of Revenue.
The business owner called his accountant and requested their assistance with the documentation assembly response. The accountant sensed a larger problem when the client began to outline the requested items, and called a meeting.
As the accountant asked questions, and understood more about his client’s activities and transactions he realized the scope of the audit and the risk associated. The client was earning nearly $100,000 in net profit from the devised “tax-strategy.” The accountant realized that if they showed the auditor that tax had not been paid on the supplies purchased, the risk was concerning, but there was no escape route from the audit.
At the first meeting with the auditor, the accountant began answering questions and providing requested documents. One question they ask was, “Why did you purchase out of state?” The answer, “Lower prices!” Searching the vendor records and purchase amounts, it was obvious the auditor knew what they were looking for, and requested copies of vendor invoices for the prior two years. Working together with the client, the accountant could only provide 10% of vendor invoices requested.
Given the substantial risks, the auditor realized that they had located a treasure trove of tax collections. Using general assessments, and estimates of material purchases, the auditor assessed a $570,000 audit settlement. The client and accountant realized they had a substantial and going-concern risk from lack of compliance with state sales tax rules.
The accountant told his client that appealing the assessment would likely lead to only more scrutiny and that the “tax strategy” was clear non-compliance with tax rules. After numerous conversations, the client agreed to cooperate and request a negotiated settlement.
The auditor was surprised. The accountant walked with the auditor through the obscure laws of sales tax compliance, and admitted the non-compliance factor, asking the auditor for an affordable settlement. The auditor didn’t agree, and the owner had to obtain a seven-year business loan to finance the payment. Good New? The “small business organization” has survived and is flourishing today, albeit somewhat indebted.
Segment I of III