I spend most of my day discussing sales tax issues with companies large and small. Whether we are assisting a start-up with sales tax compliance requirements or helping a large company with a complicated sales & use tax audit, we are always amazed at how often companies do not put processes in place to ensure they do not overpay sales & use tax on their purchases. We understand that properly collecting and remitting sales tax from customers is the number one priority when it comes to allocating internal resources to sales tax issues. If not properly collected, the sales tax liability potentially transfers from the customer to the company. However, 6 out of 10 of our clients overpay more in sales tax on purchases than they under collect from customers. The result of identifying the over-payments is that 60% of our client’s sales & use tax audits become net refunds and not net assessments.
Here are the “Top 3 Reasons Why Companies Overpay Sales Tax on Purchases:”
- Vendor Self-Preservation: The first hurdle in preventing over-payments of sales tax on your purchases is to understand that most vendors live by the motto “when in doubt – tax it.” When a vendor is faced with a transaction that may be exempt, they often shift the burden of proof to the company. For example, if you are making renovations to your corporate offices that could qualify as an improvement to real property and exempt from sales tax in most states, the contractor may only treat the transaction properly if they receive a completed certificate of exempt use or capital improvement certificate (Form ST-124 in New York). If the form is not received they may charge sales tax. Another example could involve the electronic delivery of software. Currently, 14 states exempt the electronic delivery of software. However, when a company purchases software, the vendor has no requirement to confirm how it will be delivered or in which state it will be used. In many cases all the licenses will be assumed to be delivered and taxed in one state. For companies in states such as New York, Texas and Massachusetts, this will result in a significant over-payment on your software purchases.
- Smart Technology vs Dumb Humans: There are several options available to assist companies with ensuring that they properly assess use tax on their purchases. However, in most cases, these technology solutions do not assist in identifying over-payments. What we often find is a large increase in over-payments during the first two years of a use tax implementation. The reason for the spike is the inability of the software to remove the largest factor when it comes to data entry errors – human interaction. For example, let’s assume you have separately mapped your general ledger codes properly for hardware maintenance (taxable in most states) and software maintenance (exempt in many states). In many cases, these items are being purchased together. Is accounts payable prepared or willing to enter separate transactions? If not, what general ledger code will they choose – “when in doubt – tax it!” Although we strongly encourage our clients to implement use tax solutions when possible, we also strongly advocate for annual reviews to ensure large over-payments are not occurring.
- Fear of Underpayments: Many companies have been through the painful process of a large, unexpected sales tax audit assessment. Whether the reason was lack of customer exemption certificates, an error in your taxability matrix or a change in state tax law that was missed, someone was to blame. Post-audit assessment triage involves putting processes in place to make sure this never happens again. Many times the result is significant over-payments. We understand the pain of large sales tax audit assessments, as we have received many calls from business owners requesting help with sales tax audits. In a few rare cases, sales tax audits have driven smaller companies to the brink of bankruptcy. However, in the majority of these cases where large underpayments were made by our clients, the reason was the inability to correctly collect tax from their customers and not the underpayment of sales tax on purchases. As a matter of fact, many of our clients that request our assistance with sales tax audit assessments are amazed when we identify over-payments and have those refunds applied directly to the underpayments.
Sales Tax Recovery
Your company will never eliminate sales & use tax over-payments. Best Practices call for periodical reviews to ensure accurate sales & use tax policies and procedures. Although it is possible to perform these reviews internally, many companies with a multi-state footprint choose to utilize outside consultants who specialize in sales & use tax and have experience with state agencies in successfully securing sales & use tax refunds.