January 2015

On December 15, 2014, the Alabama Tax Tribunal issued its decision in the case of Randy Henson vs State of Alabama. At first blush, there is really nothing earth shattering about the conclusion reached by Judge Thompson in his decision. Mr. Henson owned Friendship Automotive which was a car repair shop. The business did oil changes and other small repairs. The business performed taxable transactions and failed to collect and remit the tax. Conclusion, Mr. Henson owes $38,000 of tax and $10,000 of penalties. End of story!  http://www.salestaxstrategies.com/sales-tax-audit-defense.html

A closer review of the case facts, however, reveals a series of taxpayer errors and missteps that lead to this unfortunate conclusion. These missteps started the day he opened his business and continued through the entire audit process. By pointing out and discussing the errors Mr. Henson made, perhaps other Alabama businesses can avoid the same fate the befell Friendship Automotive.

Misstep 1: Taxpayer started his business in July 2009 but did not receive an Alabama sales tax permit in until October 2010. Even after applying, the taxpayer failed to file returns.
Misstep 2: When contacted by state as to why returns were not filed, taxpayer claimed he was not open for business (even though he was clearly open). Lying to the state is not a recommended strategy!
Misstep 3: Taxpayer charged customers a “lump sum” fee for oil changes that included the materials and labor.
Misstep 4: Taxpayer failed to maintain sales and purchase records for the complete audit period.
Misstep 5: Taxpayer failed to provide suppliers with a resale certificate which forced him to pay tax on his purchases and failed to maintain all the records showing what tax had been paid on purchases.
Misstep 6: Taxpayer allowed the auditor to set the sample period and projection method without understanding the consequences of the projection.
Misstep 7: Taxpayer claimed he did not “mark-up” the purchase price of the oil and other supplies sold to customers. Again, taxpayer had no documentation or proof to support the assertion.

The situation described above occurs countless times a year in each state that has a sales tax. Small businesses operate on the fringe of the sales tax rules either believing they are in compliance or hoping that they will never get caught. Clearly, the failure to understand the rules carries a heavy price. Here is some helpful (and perhaps obvious) advice to other small businesses in Alabama and other states based on Mr. Henson’s missteps.

1. If you register for a sales tax number, file returns-even if they are $0.00 tax due filings. Failure to file returns when due can attract penalties.
2. Don’t lie to the Department of Revenue!
3. Understand the tax rules in your state. Separately stated labor charges in Alabama are not taxable. A huge tax savings would have occurred if the taxpayer had only checked the rules.
4. Keep your records and keep them organized. The burden is on the taxpayer to provide the documentation. This applies to purchases and sales.
5. If you buy materials to resell, give your suppliers a properly executed resale certificate.
6. Understand the sampling method used by the state. The Department or Revenue auditors have one goal and that’s to collect as much revenue as they possibly can. It is not their job to educate the taxpayer on sampling methods and the consequences of these methods. If you don’t understand, get help from someone qualified. Spending a little money on professional services can really pay off if you can manage the sample and the audit process.

This is a really bad situation for Mr. Henson. I’m sure he does not have an extra $48,000 sitting around to pay the state this money. Who knows what type of effort the state will take to get their money. For other Alabama businesses and their advisors, please you can learn a lot from Mr. Henson’s mistakes.
Over the years I can’t count the number of people who tell me “it’s only sales tax, how hard could that be!” Well, it’s not very hard if you understand what to do and you do it! For businesses that don’t understand or don’t want to understand, then the consequences can be catastrophic. Just ask Mr. Henson.

Ned Lenhart, CPA

As we begin 2015, it’s a good time to pause and look at the “big picture” long-term prospects of state and local fiscal affairs. As tax professionals, we focus on the details of tax law but often fail to understand the environment in which these laws exist and the challenges that state legislators face to keep governments going. https://www.salestaxstrategies.com/index.html

The U.S. Government Accountability Office (GAO) recently released its 2014 state and local government fiscal outlook report. The report reveals some long-term systemic revenue and spending issues that will eventually impact our clients. The outlook is pretty grim! Here are just a few highlights from the GAO report:
1. Without immediate spending reductions and revenue increases, state governments will have significant budget strains for the next 50 years
2. Rising health-care costs for Medicaid and for employees/retirees is primary driver of the shortfall
3. Decline in income earned by state pension funds adds to unfunded balance. Current unfunded state pension balance is $4.7 Trillion!
4. Receipts from income tax and sales tax are set to decline as percent of GDP
5. Balancing budget will require 18% per-year in combination of spending cuts and revenue increases

The tax and spending implications of this report are significant. Here are few of the effects I predict:
1. Reduced state spending on education and other government services
2. Wage stagnation for state and local employees
3. Modification of employee retirement plans away from pensions
4. Expansion of sales tax to more services and rate increases
5. Legislation forcing e-commerce companies to collect sales tax
6. Reduction in state tax credits and incentives
7. Modification of corporate income tax structure
8. Increased enforcement activities to generate revenue

The GAO report is eye-opening. It reveals that without immediate and somewhat dramatic changes to spending and revenue, the state and local government fiscal outlook is rather bleak. Changing the ObamaCare provisions for Medicaid could also change the long-term spending curve, but who knows if that will happen!

State revenue agencies are not waiting for the legislatures to act. They are increasing collections and changing regulations to increase revenue. Now is the time for your clients to look at these issues and assess their risk. Sales tax continues to perplex many companies and this is creating a real and significant risk for these companies.

Ned Lenhart, CPA
President