3 Errors That Will Affect Your Sales Tax Audit

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3 Part Series: Part 1

The atmosphere businesses operate in has dramatically changed. This is the digital age – the existence and continual development of the web has allowed for a thriving digital environment prime for multi-state transactions. With that being said, it’s common for a company to seek and arrange purchases from vendors virtually anywhere, including out-of-state sellers.

Here’s the problem: Out-of-state vendors may or may not be required to collect sales tax from customers in the state in which the purchaser is located. In other words, the out-of-state vendor may not have a sufficient connection to the purchaser’s taxing jurisdiction i.e., the state. The term nexus is used and can be thought of as the threshold of activity a company must either meet, or cross, before a taxing jurisdiction may enforce its taxing authority on that entity. So no nexus, no tax collection requirements (assuming what a company is selling is subject to tax in that particular taxing jurisdiction in the first place).

· For example, Company XYZ is a new errand & food delivery start-up headquartered in Austin, TX. Due to the high demand of delivery needs, Company XYZ has decided to purchase electric bikes to execute a faster delivery service. After some online research, Company XYZ found an electric bike company, headquartered in Seattle, WA. Company ABC (the vendor) does not have nexus in Texas. Company XYZ finalizes the purchase online, and Company ABC arranges the third party shipping of the 2,000 purchased bikes to Company XYZ. Texas sales tax is not collected from Company XYZ, because as stated above, Company ABC does not have nexus in Texas. Company XYZ has no knowledge or clue that it was legally bound by the taxing authority (in this particular scenario: The Texas Comptroller of Public Accounts) to self-report, and pay the use tax amount due on the out-of-state purchase. Let’s break this down: $1,000.00 per bike x 2,000 bikes = $2,000,000.00 in taxable purchases. $2,000,000.00 x Texas’ maximum sales & use tax rate of 8.25% is $165,000.00 in outstanding liability (w/o penalties and interest). Please note: the bikes will not be resold or otherwise exempt; Company XYZ is the final, or end, user of the bikes. These bikes will be utilized as a means to a faster delivery service.

· Use Tax Explained in a Nutshell: To combat sales tax revenue lost on purchases from out-of-state vendors, without a sufficient link to the jurisdiction, states came up with a complimentary tax to sales tax: a use tax on items that would normally be subject to sales tax. Use tax isn’t a new concept and is a tax on the use, storage, or consumption of an item in a taxing jurisdiction where sales tax isn’t applicable. Generally speaking, the main difference between the two is centered on the question: Who is responsible? Essentially, in a use tax scenario, the tax responsibility is shifted from the seller to the buyer. If a purchase is made via a vendor without a sales tax collection requirement, it becomes a company's responsibility to: 1.) Determine if the purchase is subject to sales & use tax in the taxing jurisdiction. 2.) The company is technically required to self-accrue and remit the tax directly to the state, if the purchase is subject to use tax. Generally speaking, the use tax mirrors sales tax.

· Myth Debunked: It's a common myth that prior to the South Dakota v. Wayfair, Inc. SCOTUS decision (June 2018), purchases via online were tax- free. In fact, revert to the use tax example above. Perhaps you may have noticed the flaws. A consumer or purchaser should be accruing and remitting the use tax due on their own. However, with millions of everyday consumers, states could not adequately enforce the use tax requirement on these purchasers, and thus were missing out on millions of dollars in tax revenue on online purchases.

· Changing Trends: It's possible we will begin to see a change in this trend, due to the South Dakota v. Wayfair, Inc. SCOTUS decision. States have already started to broaden their scope of what constitutes a sufficient link to their state (i.e. their taxing jurisdiction to include not only a physical link, but also an economic one). Big online retailers, if not already, will soon be required to collect and remit sales tax on these online sales.

In short, be sure that your company doesn’t forget, or unknowingly fail, to accrue and remit use tax (if due) directly to a taxing jurisdiction on out-of-state purchases. Just because the seller hasn’t collected tax doesn’t necessarily mean that the transaction isn’t taxable.

What can your company do to prevent this common error from happening?

Online access has given consumers and businesses alike a myriad of options and vendor selections. However, your company should be in-tune with purchases made from any out-of-state vendor. It should also familiarize itself with the applicable sales and use tax code, and how it applies to what is being purchased. If sales tax is due, check and see if the vendor has included the appropriate tax amount on the invoice. If so, another important piece of the puzzle is to consider the tax rate the vendor has used in calculating the tax amount due. Some out-of-state vendors will utilize an incorrect sales tax rate. This in turn can equal either tax over-collected in error, or tax under-collected in error – leaving a gap between the total amount of tax due and what tax was actually paid. Under an audit, your company could be assessed for the additional use tax due, if tax was collected at a lower rate than the jurisdiction’s full rate. If the out-of-state vendor has not calculated tax on the out-of-state purchase, it’s likely the vendor either does not have nexus, has nexus but is unaware of the sales tax requirement responsibilities, or has concluded the sale is nontaxable. Your company should determine if tax is due. Next, make a business decision to self-accrue and remit the tax directly to the state. If ignored, your company is effectively taking the gamble of the transaction being picked up under an audit.

Maybe you’re confused? Don’t worry, that’s not uncommon. Don’t hesitate to contact our firm – our team is here to help.

(281) 358-1060 ext. 31


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