Sales Tax

In my blog post from January 8, 2015, I outlined how the state fiscal crunch was going to catch up with the states and that tax reform would be needed to keep pace with the growing expenditures.  Well, its started.

So far this legislative session, discussion drafts, proposed legislation, and comments in “state of the state” addresses have addressed tax reform head-on.    For example, the Alabama Governor has proposed a series of income tax, sales tax, and tobacco tax measures to help bridge the state’s $700 million budget shortfall.  The Pennsylvania Governor has proposed changes to increase personal income tax and sales tax, but reduce corporate income tax and property taxes.  Nevada’s Governor has proposed legislation to impose a “hybrid” business tax system and move to a progressive fee structure away from a flat $200 per business license fee.  Nevada does not have a corporate income tax.

In Georgia, legislation has been proposed to increase sales tax rates, expand the tax base to more services, remove the exemption from food, and impose a new 5% communications tax.  Not sure if that will fly, but it does show that tax reform is being seriously considered in some corners.  The state of Louisiana has called for a study to “overhaul” the states tax system.  Many states are also considering adopting unitary reporting over the separate reporting for corporations doing business in their state.

How much progress is made this year on these initiatives is uncertain, but, as predicted, states are seriously looking at making changes to their tax structure and sales tax changes is a central part of these changes.  Stay tuned!

Ned Lenhart, President

On February 11, 2015 the Georgia Tax Tribunal issued one of the most interesting Georgia rulings during the past decade.  In the case of Inglett & Stubbs  vs Commissioner of Revenue, the Tribunal held against the taxpayer on two separate issues.  First, the Tribunal reaffirmed that contractors are consumers of the materials they purchase and are not generally retailers allowed to purchase items for resale. Second, and more importantly, the Tribunal affirmed that Georgia taxes items when them come to rest in Georgia unless they are held as inventory for resale.  That is, Georgia does not have any type of “temporary storage” exemption rule that many states have.

Inglett & Stubbs, purchased machinery and construction material for use in construction projects in Afghanistan and other countries where the U.S. military had bases.  Many large items were shipped directly to the overseas locations and these were not taxed in the U.S.  Many other smaller items were sent to Inglett & Stubbs in Georgia where it has a warehouse and distribution facility.  Many of the vendors charged Inglett & Stubbs sales tax on these items because Inglett & Stubbs could not provide any type of resale certificate.  Over $1.9 million in sales tax was paid on these purchases.  A refund claim for the tax paid was filed by the taxpayer and the Georgia DOR promptly denied the claim.  The taxpayer appealed and had its hearing before the Tribunal.

To me, the holding in this case was completely predictable given the body of law and previous rulings.  While this is a major decision by the Tribunal and one that dramatically impacts the taxpayer, I would have been more surprised if they had prevailed before the Tribunal.  The issue that I think this case addresses is how the failure of companies to make strategic decisions around sales tax can be a very costly mistake.  Very simply, had the taxpayer realized that tax was going to be due on the temporary storage of products in Georgia, they should have set up a temporary location in Tennessee which has an “import for export” exemption. Also, the company could have created a separate purchasing entity that would purchase these items “tax free’ from their suppliers and then exported them for sale to the construction company.  Two very easy and totally legal solutions to avoid every penny of Georgia sales tax.

This case will likely be appealed to the Georgia Supreme Court. Stay tuned.

Ned Lenhart, CPA
President

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

On September 19, 2014, the Texas Comptroller issued its decision 106,632.  On the surface, the issues seemed fairly routine.   A Utah taxpayer was audited and assessed tax on sales of downloaded software.  The decision outlines many procedural issues but the most startling point of the ruling is the conclusion reached by the Hearing Officer that the Utah vendor had nexus with the state of Texas by virtue of the presence in Texas of software that had been downloaded onto servers located in the state. https://www.salestaxstrategies.com/sales-tax-audit-defense.html

The company did not send salesmen into the state to solicit sales and it did not conduct other types of training or support services in the state.  The decision states: “The substantial physical presence requirement is determined by the character of the rights and interest Petitioner retained in the software and digital images download by users located in Texas.”  Because Texas deems downloaded software to be tangible personal property and because the taxpayer (Petitioner) only grants a limited set of rights to the user and retains other rights for itself, that the Petitioner is deemed to own personal property in the state of Texas.  That’s right, the state of Texas has now concluded that software residing on the servers of another to which the licensing company has retained some intellectual property rights thereto, is deemed to be the ‘ownership’ of property in the state of Texas and creates nexus for the company.

The decision went on to say that based on the volume of business the company had in the state that there was “substantial physical presence”-not just a minimal physical presence in the state.  Granted, the taxpayer did not object to the assertion that the downloaded software was tangible personal property, so part of their problem may be a self-inflicted by not vigorously objecting to the characterization of their intangible property as being tangible.

Regardless of the taxpayer’s error, this is a very frightening outcome and a dramatic advancement of the theory of nexus for sales tax purposes.  For remote sellers of software they would be forced to abandon their intellectual property rights of the software sold or be forced into a sales tax compliance position that, heretofore, has not be promoted by any other state.  Just because downloaded software is taxed as “tangible personal property” does not make it “tangible personal property”.  There is nothing physical about software that is received electronically and exists only in an electronic state on a computer.  If more states pursue this dramatic and unprecedented advancement of nexus, software vendors across the country should be in fear of audits and assessments.

Ned Lenhart, CPA

The Minnesota Supreme Court just issued its opinion in LumiData, Inc. vs. Commissioner of Revenue (Sept 10, 2014).  The case involves the appeal by LimiData to a ruling by the Minnesota Tax Court stating that the sale of the software sold by LimiData was fully taxable even though significant customization took place.  Minnesota law very clearly states that separately stated software modification costs are not taxable.  However, LumiData did not separately state the modification charges and just billed its customers a lump-sum for the software and claimed it was all “custom” software which is not taxable.  The Supreme Court pointed out that the core software product was the same for each customer but that the core software had to be modified to fit each specific customer.  If LumiData had separately stated the customization costs, then LumiData would only have been required to charge tax on the core software product. https://www.salestaxstrategies.com/index.html

At the Tax Court level, the accountant for LumiData testified that based on her understanding of LumiData’s business, she had advised them that they were providing a nontaxable sale of customized software.  However, it was revealed the accountant never inquired about the degree of customization that took place of the software, she was not aware that LimiData was not registered for sales tax, and she was not not aware of the Minnesota requirement that customization services be separately stated.   Based on the Tax Court transcript, I’m not sure what basis the accountant had for rendering her opinion on the taxation of the LumiData product other than just guessing!

The unfortunate thing is that this same scenario plays out each day in accounting and CPA firms located throughout the country.  Professionals that are busy or are unprepared to handle these types of questions nonetheless render opinions that can have significant implications to their clients.  If you are a CPA or a tax professional and you have clients that are asking you questions about these sorts of things please contact me for help if you are not familiar with the issues.  As you can see from this case, the cost of your mistakes can be significant.

I hope that the accountant has sufficient malpractice insurance!

Ned Lenhart, CPA

On August 20, the New York Department of Taxation and Finance issued ruling TSB-A-14(28)S indicating that the software used to control devices used by patients with debilitating diseases such as ALS qualifies as a prosthetic device and is not subject to sales tax. The party submitting the ruling request produces a software product that enables a disabled person to utilize a single switch such as an eye blink, eye brow twitch breath puff, inhale/sip or head rock to operate a standard Windows based computer to restore some ability to communicate visa the computer.  The company argued that the software replaces or compensates for permanently inoperative or malfunctioning body parts rendered so by a disease or injury sustained by the patient. https://www.salestaxstrategies.com/sales-tax-issues.html

The ruling states that because the software replaces the disabled person’s motor skills to type of otherwise control a computer’s buttons or mouse, is used primarily for this purpose, and is not useful in the absence of the user’s disability, then the software meets the definition of a prosthetic device.   I think this is a very sensible and meaningful ruling by the Department of Taxation.  With the advance of medical technology and the incorporation of software into more devices, I would expect to see more states adopt this same position.

Ned Lenhart, President

The New York Tax Department just released the statistics for FY 2014 which ended June 30, 2014.  Total revenue received was almost $67 Billion!!  Personal income tax was 64.3% and State sales tax was 21%.  The remaining revenue came from corporate tax, property tax, excise tax, and fees. https://www.salestaxstrategies.com/sales-tax-audit-defense.html

Nationally, sales tax represents about 38% of total state revenue, but that percent is skewed by the states like Texas, Florida, and Tennessee which rely on sales tax for the bulk of their revenue.  Still, 21% is a pretty significant percent of state revenue to come from the sales tax.  In reviewing the stats from the past 10 years, sales tax actually contributed a higher percent of total state revenue during 2003 and 2004 (27% for each year) than it did in 2014.  Between FY2013 and FY2014, however, the sales tax collections grew by 3% while the individual income tax collections grew by 5%.

In addition, Governor Andrew M. Cuomo recently announced that New York State will expand its Crimes Against Revenue Program, providing an additional $860,700 to 12 county district attorneys’ offices to enhance their investigation and prosecution of State tax evasion and welfare fraud cases. Six district attorneys’ offices will receive grants for the first time while six others currently receiving grants will receive additional funding.

Ned Lenhart, CPA
President

This post has nothing to do with sales tax, but I was fascinated by the conclusions of a survey recently done by L. Harris Partners.  They recently surveyed 4,000 different clients of CPA firms and 600 partners of CPA firms.  The surveys took place throughout 2012 and 2013.  The survey’s covered a lot of different topics and reached a variety of conclusions. The conclusions that were most significant to me are:

• 29% of clients surveyed were not aware of the range of services offered by their CPA firms,
• 32% of the clients surveyed said that they use multiple CPA firms to get the services they want,
• only 8% of CPA partners believed their clients used other CPA firms!

So why do I find surveys like this interesting?  Because I get a lot of my work from clients who have other CPAs who they use for other work.  In essence, I am grateful that 32% of the companies are using firms other than their CPA.  I wish it were more.

However, there is no excuse for a client not to know the services provided by their CPA.  It’s also perfectly reasonable for CPAs not to offer all the services that their clients need.  In that situation, the CPA must have the network of specialists to refer clients to in that situation.  This is how I work with CPAs since most firms really don’t have a deep bench when it comes to multistate sales tax matters. www.salestaxstrategies.com.

If you are a CPA then you should pay close attention to the results of this survey.  Make sure your clients know what you do and make sure, if they are going to use another CPA, that you are involved with that selection process so you can hold onto that relationship and the revenue.

Ned Lenhart, CPA

Here is a post from my GA June Newsletter.  Although this mentions Georgia, the same principle applies to any state where you are filing returns.  Trust but Verify!!

“When I started my business, I hired someone to file my sales tax returns, but last week I just received a notice from the Georgia Department of Revenue stating that no returns or payments have been made for the past year. What do I do?”

 During May, I had heard this message (or something very similar) from five different Georgia businesses.  These are the worst calls to get because there is so little that can be done to fully mitigate the damage created by the people they entrusted to handle their sales tax filings.  My simple message to every business owner when it comes to having others file your sales tax returns is “trust but verify”. 

 Each scenario was different, but the common theme in these calls is the same.  The business owner hired an employee to file returns or has an external bookkeeper, accountant, or CPA to handle the tax filings.  Sales are made, tax is collected, and the business owner assumed everything is going just fine until a notice arrives from the Georgia DOR.  In some cases, the owner saw the notice and we were able to quickly respond.  In other cases, the notices went to the person responsible for filing returns and they were hidden. At this point, panic sets in and things quickly spiral out of control.  In addition to the back taxes that are owed, there is 25% penalty added, and interest is accruing at 1% a month. The interest and penalties are compounded if the state issues a fifa notice.  In one case, the late filing and payment of $120,000 of tax became a $235,000 sales tax problem with penalties and interest.

 CPAs must advise their clients that, as a business owners, it is THEIR obligation to ensure that the sales tax collect is remitted to the state.  It is THEIR obligation to “trust but verify” that the person hired to do this is, in fact, doing what needs to be done.  They must verify that the return is filed and that the return is paid. This verification should be part of your monthly financial analysis and closing process.  As business owners, they are personally liable for any mistakes made by other.

 Here are some basic sales tax pointers for small businesses:

 File sales tax returns even when no tax is due. Failure to file returns when due can subject you to a $100 penalty for each return. 

1. Don’t register for a sales tax number until you are sure that your business is operational. 
2. Don’t call the Department of Revenue to ask for help.  The DOR is not in the business of helping you manage your sales tax issues and they are not your friend.  Contacting the DOR will only complicate your situation. Get professional help as soon as you suspect you have a problem.
3. Don’t ignore the problem and hope it will go away.  It won’!  Get help immediately.  The sooner the better.
4. Get help immediately upon being contacted by the DOR.  Do not attempt deal with them directly. 
5. “Trust but verify.”  I don’t care who does your sales tax returns, make it a point to verify that each month your returns are filed and paid. If returns are not filed and taxes are due, see Question 3 above!