In 1930, Mississippi became the first state to adopt a general sales tax. Since then, all but four states have jumped on the bandwagon, and 46 states means 46 sets of rules, regulations, rates and exemptions.
For many years, sales tax laws in other states weren’t of much concern to small businesses. It was mostly big companies that engaged in interstate commerce.
Today, however, the world is one big shopping mall, and with a few keystrokes consumers are able to buy goods in any state from Maine to California. But in a 1992 decision, the United States Supreme Court exempted out-of-state retailers from collecting sales taxes in states where they have no physical presence, like a store, office or warehouse. (And if the question ever comes up at a cocktail party or on Jeopardy, the legal term for this physical presence is “nexus.”)
Although the Supreme Court decision involved a mail order company, the ruling has been applied to all remote sellers, including online retailers. The result? Companies have increased their geographic market, costing states billions in sales tax revenue.
So, what are states doing to rectify this situation? Many are trying to strengthen “use tax” compliance.
A use tax applies to transactions not subject to sales tax where tangible personal property, bought in one state, is used and/or stored in another state. The use tax is generally imposed at the same rate as the state’s sales tax, and should be remitted to the state by the individual or business making the out-of-state purchase. That means you may owe use tax on the office computer you ordered from a different state and didn’t pay sales tax on.
Use tax looks like sales tax, smells like sales tax and costs like sales tax, so states are making up for sale tax loses and enforcing the collection of use tax by conducting “sales/use tax audits.”
What all this means to you and your company — whether you do business in one state or 10 — is that you need to be prepared. There has been a noticeable increase in sales/use tax audits as states attempt to recoup those lost sales tax revenues.
NO TWO STATES ALIKE
Because tax laws vary so much from state to state, I can’t address specific sales tax questions here. I can only offer tips on how to survive an audit. If you think I’m exaggerating the differences between states, consider this: Massachusetts has multiple pages of legal jargon when it comes to the question of whether or not sales tax is charged to customers renting portable restrooms. Here’s a sample:
“If charges for the rental of the portable toilet units are separately stated from charges for servicing them, it does not matter whether the cost of the units is consequential or inconsequential in relation to the total cost. Sales tax is imposed only on the separately stated rental charges. Lessors of portable toilet units are required to collect and remit sales tax in accordance with the rules explained in Massachusetts Regulation 830 CMR 62C.16.2: Sales and Use Tax Returns and Payments.”
The State of Washington, however, answers the same question in one simple paragraph: “Rentals of portable chemical toilets are not rentals of tangible personal property. Typically, the owner both rents units to consumers and provides maintenance. Thus, the service is taxable under the Service and Other Business Activities B & O tax classification. The charge is not subject to retail sales tax or Retailing B & O tax.”
And here’s a quirkier example of the differences between state sales tax laws: Antacids are exempt in Connecticut, but are taxable once you cross the state line into Massachusetts. It doesn’t take much research to realize learning all the differences in sales tax laws from state to state would require more antacids than both those states combined could hold.
IF YOU’RE AUDITED
The best defense in any kind of audit is thorough record keeping. Detailed documentation could save your company big money in taxes and penalties, while decreasing the amount spent on defending an audit.
Some of the records that may be reviewed include: sales tax returns, worksheets, canceled checks, federal income tax returns, state tax returns, general ledger, general journal and closing entries, sales invoices, exemption documents supporting non-taxable sales, charts of accounts, fixed asset purchases/sales invoices, expense purchases, merchandise purchases, bank statements, canceled checks and deposit slips, cash receipts and depreciation schedules.
A state sales/use tax audit usually begins when an auditor contacts you by letter or phone to schedule a pre-audit meeting. In this meeting, the auditor will typically present an audit authorization letter and other documents for you to sign. He or she will then explain what records are required to complete the audit and ask for additional information such as details of your accounting procedures.
To prepare for the scheduled audit, you will need to gather and organize the records requested by the auditor. Don’t provide too much or too little information … just what they ask for. Too much information can potentially uncover liabilities they weren’t even looking for and waste a lot of your time and theirs. Too little information might raise the auditor’s suspicions and cause the scope of the audit to be expanded.
While sales tax and use-tax regulations vary slightly for retailers, laws vary wildly for construction, manufacturing, distribution and other businesses like portable restroom providers that have mixed taxable and nontaxable transactions. To help you understand where you may have sales tax exposure and get a jump on a possible audit, learn the laws of your individual state and the states where you have nexus.
Most states detail their rules on the Internet. To get started, go to this map www.taxadmin.org/fta/link/default.html on the Federation of Tax Administrators Web site, click on your state and start studying. You’ll soon realize those lawmakers back in Mississippi had no idea in 1930 the size of the genie they were letting out of the bottle when they created sales tax.
