What to Look for in Sales Tax ReportingTim Weidman
We work with clients on sales tax issues that can be challenging to implement correctly, yet essential to protect the business from large sales tax deficiencies. I have found that small mistakes can prove very costly when applied to a large number of sales transactions. Here are 3 practices that we often find lacking that can lead to mistakes in sales tax reporting.
- Account for sales tax from invoice to tax return. This is the most frequent area where mistakes happen, and indeed, the decision involves a tradeoff. We emphasize that sales tax procedures should be simple enough to perform efficiently every month, but robust enough to reflect the variety and complexity of a business’s monthly transactions. The point of sale system needs to distinguish taxable from exempt sales, charge tax accurately based on this distinction, and transmit this data accurately to the general ledger.
We often see businesses oversimplify, using a single sales account, lumping sales tax in with gross sales, and\or calculating sales tax at month end by simply accruing 7 percent of the month’s sales. Some of these techniques can work for small businesses with few taxable sales, but as the business grows, inevitably you will encounter issues like tax-exempt sales, discounts, written off accounts, gift cards, delivery charges, and other items that challenge the simplicity of this method. Also, as gross sales grow over time, there is more money at stake in accurately accounting for net taxable sales and sales tax. Ultimately, it pays to transition to (1) accurately configured taxable and exempt sales accounts, and (2) a sales tax liability account that is updated along with the sales journal. Ideally, this solution captures your tax liability at the time of sale and integrates smoothly into your financial accounting and reporting processes
- Get it right when deciding what is taxable and what is exempt. At a glance, the sales tax landscape may appear simple – tangible personal property is taxable, real estate is exempt, and services are mostly exempt. On closer inspection, there are many wrinkles – contractor elections, gross receipts, resale exemptions, industry-specific exemptions, and fixture classifications, to name just a few.
When deciding whether or not an item is subject to sales tax, there is a lot at stake. Sales tax is the primary source of revenue for most states, and it is audited frequently. If you charge tax incorrectly, you must pay the tax over to the state. If you fail to charge tax on a taxable item, your business will owe the tax that was not collected. In some cases, this unexpected liability can cause severe financial hardship.
Because of this risk, best practice is to charge sales tax when in doubt. At the same time, we hate to see a client charging an extra 7 percent, when an item is not taxable in the first place. Often, the answer is not always clear, as these issues frequently are under audit and\or protest. In the end, it pays to make your decision as informed as possible, in light of the sales tax law and the interpretive positions that each state’s Tax Department has taken.
- Anticipate and manage compliance risks. Expanding your business into new product lines or geographic areas can bring new sales tax obligations – and opportunities. For example, a contractor, a retailer, and a manufacturer each face unique questions about what is taxable and what sales tax exemptions are available in their industry.
Expanding into another state can also create new sales tax obligations. Each time you expand your business or sell items into a new state, you should review whether or not this will create a requirement to register with the state and file sales tax returns, and also what items are taxable or exempt in the new state. Finally, consider what other state tax implications the expansion will have. Frequently, it can create an obligation to file income tax returns in the new state, but you also may gain access to new state tax incentive credits for locating in that area.
We help clients manage sales tax compliance procedures in the face of these challenges. We are experienced in developing an efficient, accurate reporting process, from sales invoice to tax return. We are skilled at evaluating the compliance risk and answering your questions about when is registration required and what items are taxable. As always, please give us a call with any of your questions or business concerns.