Sales and Use Tax: Guide to Doing It Right

• Chapter 0 - Overview
  • Course Objectives
  • Introduction
  • Why a National Sales and Use Tax Course?
  • Who Should Take This Course?
  • How Your Business or Practice Will Benefit
  • Conclusion
• Chapter 1 - Sales and Use Tax Basics
  • Learning Objectives
  • Sales Tax: What Is It?
  • Use Tax: The Complement to Sales Tax
  • Registration and Filing Requirements
  • Items Subject to Tax
    • Tangible Personal Property versus Real Property
    • Tangible Personal Property Versus Intangible Property
    • Mixed Transactions
    • Mixed or Bundled?
  • Exclusions and Exemptions
    • Nature of the Purchaser
    • Nature of the Seller
    • Nature of the Product Being Sold
    • Purchaser’s Intended Use of the Property
  • Questions
  • Appendix 1A – State Definitions of Tangible Personal Property
• Chapter 2 - Nexus and Interstate Sales
  • Learning Objectives
  • Introduction
  • Nexus Defined
  • Advantages of Collecting Sales and Use Tax
    • Statute of Limitations
    • Service to Your Customers
    • Maintain Good Standing in States Where One Does Business
  • Disadvantages of Collecting Sales and Use Tax
    • Administrative
    • Competitive Disadvantage
  • Constitutional Basis
    • Interstate Commerce Clause
    • Due Process under the 14th Amendment
  • Statutory Provisions
    • Interstate Sales
    • Offers in Compromise
  • Electronic Commerce
  • Streamlined Sales Tax Project (SST)
    • Background
    • The Streamlined Sales Tax Project
    • Elements of the Act
    • Effective Date
  • Summary of SST Amnesty Program and Provisions
    • Amnesty Background
    • Eligibility for Amnesty
    • States Offering Amnesty
    • Period of Amnesty
    • Streamlined Sales and Use Tax Agreement
  • Questions
  • Appendix 2A
• Chapter 3 - Specific Industry Discussions and Related Rules
  • Learning Objective
  • Introduction
  • Retailers
    • Sales
    • Resale or Exempt Sale Certificates
    • Purchases
    • Demonstration Items
    • Short-Term Leases
  • Manufacturers
    • Sales
    • Purchases
  • Service Industries
  • Examples of Service Industry Issues
    • Advertising Agencies
    • Printers
    • Contractors
    • Leasing Companies
  • Questions
  • Appendix 3A – Uniformity Recommendation for Determining Sales and Use Tax Priority for Leasing Transactions
• Chapter 4 - Other Exemptions and Problem Areas
  • Learning Objectives
  • Introduction
  • Bad Debts
  • Coupons, Discounts, and Rebates
  • Digital Goods
  • Drop Shipments
  • Food and Meals
    • Airline Meals
    • Employee and Institutional Meals
    • Complimentary Snacks or Meals
  • Freight
  • Gratuities and Tips
  • Installation Charges
  • Labor
  • Lodging
  • Medicines and Medical Supplies
  • Occasional Sales
  • Packaging Materials
  • Software and Computer-Related Services
  • Successor Liability
  • Trade-Ins
  • Tax Incentive Programs and Sales and Use Tax Exclusions
  • Warranties
  • Questions
  • Appendix 4A
• Chapter 5 - Audit Defense Strategies
  • Audit Selection
    • Formulas and Statistics
    • Prior Audits; Data from Outside Sources
  • The Pre-Audit
  • Initial Meeting and Audit Work
    • Controlling the Flow of Information
    • Avoiding Commitments
    • Limits on Time and Distance
    • Be Professional
  • Closing Conference
  • Conclusion
• Chapter 6 - Sales and Use Tax Rules of Four Hypothetical States
  • Learning Objective
  • Overview
• Chapter 7 - Sales and Use Tax Assessment Working Papers
  • Learning Objective
  • Introduction
  • Approach to the Assessment
  • Hi-Tech Computer Center
    • Additional Taxable Sales – Exhibit A
    • Additional Taxable Sales – Exhibit B
    • Additional Taxable Sales – Exhibit C
    • Asset Detail Schedule – Exhibit D
    • Additional Taxable Expenses – Exhibit E
  • Miller Manufacturing
    • Summary of Taxable Assets – Exhibit F
    • Additional Taxable Expenses – Exhibit G
    • Additional Taxable Sales – Exhibit H
    • Additional Taxable Expenses – Utilities – Exhibit I
• Chapter 8 - Summary
  • Learning Objectives
  • Bibliography
• Chapter 9 - Latest Developments
• Appendix A - Sales and Use Tax Checklist
  • I. Nexus
  • II. Reporting, Disclosure, and Payment of Tax
  • III. Specific Exemptions
• Appendix B - Special Materials
• Appendix C
• Appendix D - Additional State and Local Tax Resources, or “Where Do I Go from Here?”
  • Journals and Magazines
  • Books
  • Treatises

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Chapter 0 - Overview Course

Objectives

• Gain an understanding of the basic concepts and principles of sales and use taxes and learn how to apply those concepts and principles in day-to-day practice.

• Gain the skills necessary to ensure that the correct amount of sales and use taxes are paid.

• Avail your client and yourself of potential exemptions.

• Structure business practices to qualify for tax exemptions.

Introduction

For most people sales tax is the simplest of taxes. It is that tax they pay when they buy things. However, for those who have to properly collect and remit sales tax, the compliance costs can be staggering and the complexity simply overwhelming. For example, a corporation doing business in every state need file only one federal income tax return and 46 state income tax returns (Nevada, South Dakota, Washington, and Wyoming do not have a general corporation income tax). However, there are over 7,500 jurisdictions for sales tax, including states, counties, cities, transportation, utility, and other special purpose districts. Fortunately, most of them are state collected, but just trying to track the thousands of annual boundary and rate changes can be overwhelming. Those changes, coupled with technological innovation, decreasing costs in transportation, communication, and purchasing and distribution models means that even the proverbial "mom and pop" business can find itself tied into a national, if not international, marketplace. Thirty years ago state and local sales tax was often treated as the "poor country cousin" compared to the seemingly more glamorous and sophisticated federal income tax. That is no longer the case. State and local taxes, particularly sales tax, has unfortunately, for those who have to collect them, come into its own.

The growth in sales and use tax, accompanied by the inevitable proliferation in exclusions and exemptions, has provided significant opportunities for tax refunds, planning, and savings. Coupling this with the fact that states are very aggressively raising taxes, pursuing taxpayers harder, and expanding the depth, scope, and severity of audits, the sales and use tax is a logical place to investigate tax planning opportunities.

Many speculated in 1986 that sales and use tax would be on the decline because of the federal disallowance of sales and use taxes as an itemized deduction for individuals. Not so! In fact, sales and use taxes have grown exponentially since 1986, and now that the federal sales tax deduction has returned, there is no reason to believe that the growth will diminish. According to the U.S. government census bureau, sales taxes provide for an average of 33.8% of all state tax collections while individual income taxes provided 33.3%. For the past 20 years sales tax revenue has been growing at an average of 4.6% per year. The 2005 census data show that the general sales tax is the largest state tax revenue source in 21 states with state tax rates ranging from a low of 2.9% in Colorado to a high of 7% in Mississippi, New Jersey, Rhode Island, and Tennessee. (See Appendix C for a list of state sales tax rates.)

Although sales and use taxes are one of the more regressive taxes, they do not seem to draw the same magnitude of outrage, as do significant hikes in property or income taxes. But sales and use taxes are pervasive (you may pay sales and use tax several times a day), and while they may not be substantial on individual transactions, their total cost can nevertheless add up. However, most sales and use taxable transactions generally do not present the immediate financial drain of a property tax or of an income or franchise tax. Accordingly, they usually do not draw taxpayer opposition as do income or property taxes.

The generalities in the preceding paragraph are not without exception. Numerous attempts have been made by state legislators to expand the sales and use tax significantly, particularly in the area of services. These attempts, however, have been widely opposed by taxpayers.

What has increasingly brought sales and use taxes into the spotlight are the growing multi-state businesses, especially mail order and, more recently, Internet or online businesses. Although mail order or e-commerce businesses may be popular with shoppers, Main Street businesses are crying "foul!" because the out-of-state competitors often have a price advantage by not having to charge or collect sales tax. The states and local jurisdictions are anxious to tap into these nonresident businesses, or remote sellers, as an additional revenue source.

While these issues have attracted significant attention in recent years, we will not limit our sales and use tax coverage to them. We will also concentrate on the meat-and-potatoes issues of more common local tax exemptions, exceptions, and regulations that may be equally impressive to your client by having more dollar impact in refunds or reduced operating costs than the more theoretical gray multistate issues.

In fact, if a business is a single-state operation, local issues may well be the crux of its sales and use tax problems and/or opportunities. To conceptualize the cost of sales and use tax issues, consider that many businesses may pay sales or use tax on over one-half of their non-payroll operating expenses. It is easy to see how sales or use tax planning to minimize or eliminate sales and use tax could generate significant recurring savings.

Technology has generated various complex issues in the sales and use tax area. For example, while most jurisdictions distinguish between sales of tangible personal property and intangible personal property, sales of data (or other transmissions of information via CD, tape, disk, satellite, radio wave, or other means of transfer) have caused confusion among taxpayers and state officials alike. Additionally, sales over the Internet and E-commerce are growing more rapidly each year.

As you can see, sales and use taxes have always been a significant business expense but have not necessarily drawn the attention they deserve or require. With rising costs, more competitive business practices, and states with tighter budgets, the opportunities in the sales and use tax area for public accountants, as well as those in industry, will continue to abound.

Why a National Sales and Use Tax Course?

Sales and use tax courses are not widely available in colleges or other institutions of higher learning. Most of the sales and use tax courses available are geared specifically to a state or group of states. Until recent years, sales and use tax courses were difficult to find even at the local level. Although no two states are identical in the sales and use tax areas, a general sales and use tax course seems appropriate for a variety of reasons.

First, states deal with sales and use tax issues in limited ways. For instance, computer software is either taxed or exempt in a state, contingent on whether the software is a custom program or a prepackaged program, and whether it involves training, information systems consulting, data entry, devising a business plan for a programming department, etc. Realizing that computer software is generally a complex sales and use tax issue, the assessment of computer software or related services during an audit should direct you to the state's related statutes, regulations, or other administrative pronouncements pertaining to that issue.

Fortunately, there are various periodicals and other publications available that include state-bystate summaries regarding the taxability of specific transactions. Such tables or charts can be very convenient both from a planning and an audit perspective. The key is to recognize that computer software is an issue worth investigating.

As another example, consider the often confusing area of sales and use tax on utilities. Exemptions may be available for utilities that are

• Related to processing or manufacturing.

• Used indirectly in processing or manufacturing.

• Required for heating or cooling a processing or manufacturing area.

• Used to complement assembly.

After taking this course, you should be alerted to situations where there is a potential sales or use tax opportunity. In each situation, you would need to review the appropriate rules, regulations, and practices of the particular jurisdiction to see what exemptions may be available.

Besides the tangible or product area, audits typically touch on numerous service or labor issues. In some jurisdictions, fabrication, installation, assembly, or repair labor may be taxed, but some of those same categories may be exempt in other jurisdictions. Again, the focus here is to alert you to transactions that should be analyzed for any possible exclusion from tax.

Instead of being overly theoretical in discussing the various exemptions (which could very well put you to sleep), this course intends to teach by example. Later, you will have the opportunity, in a non-intimidating environment, to review some sales and use tax audit working papers and corresponding invoices, and apply pertinent sales and use tax rules of fictitious taxing jurisdictions to the facts presented. Going through the sample audit working papers and the discussion and analysis of the audit report should assist you not only in investigating the issues to minimize tax in the immediate situation, but also in generating ideas for avoiding similar unfavorable tax consequences in actual sales and use tax situations. This may also create opportunities to obtain refunds or advise your client or other company officials on prospective actions in the sales and use tax arena.

In summary, the national sales and use tax course approach is intended to make the reader aware of the pertinent issues. By having an awareness of which items may or may not be subject to tax, and understanding the general applicability of some exemptions to many of the states sales and use tax, one should be able to review an audit assessment or a taxpayer's scheduled expenses without necessarily researching every specific item.

Who Should Take This Course?

This course is intended to be an introduction to the sales and use tax area. CPAs, CFOs, attorneys, and other professionals, as well as those people dealing most with sales and use taxes (accounts payable personnel and bookkeepers) will benefit from this course. It is interesting to note that very few accounts payable personnel have attended sales and use tax courses that the author of this course has taught. They probably spend little time reading up on sales and use taxes. This is unfortunate because the accounts payable personnel are generally in the best position to question sales tax charges or use tax payments.

It is important that bookkeepers or accounts payable personnel learn sales and use tax procedures so most issues can be caught at the front line. Usually, the vice president of finance, controller, accounting manager, tax supervisor, or other titled person does not want to deal with these issues because he or she may think that their time schedule will not permit it, or they incorrectly assume the results may not warrant the effort.

This course addresses issues pertinent to public practitioners as well as accountants in industry or other nonpublic positions. Although the sample audit working papers included in the materials may not be a specific business you would normally service, many of these same issues can arise in any given business.

How Your Business or Practice Will Benefit

In light of the competitive business environment that includes not only public accounting but virtually all businesses, this course should assist you or your business in reducing costs, generating additional revenues, and creating goodwill with clients or superiors.

As mentioned previously, many businesses pay sales or use tax on over one-half of their nonpayroll operating expenses. By implementing a sales and use tax plan to minimize or eliminate the tax on a category of expenses, a significant recurring savings will be generated along with reduced costs.

Even if you only have a very basic knowledge of the sales and use tax area, you should not be intimidated by it. The basic teaching included in this course can assist you whether you are dealing with a state department of revenue, or even when negotiating a fee with an outside expert. For example, the ability to negotiate a settlement has its obvious benefits. Having a basic knowledge of the sales and use tax, you may feel more confident in your negotiations by dispelling the fear that you would otherwise be jeopardizing your case.

Federal taxes have always been the mainstay for tax advisors. The focus has been so heavy on federal taxes that, until recently, state tax planners have had little competition. The state and local tax arena still appears to be less competitive than the federal tax area in many respects. Besides the generally lower level of competition, the author believes that the sales and use tax area will continue to grow rapidly.

Having sales and use tax expertise usually gives the practitioner or firm a higher profile, since most clients want a full service, knowledgeable group. Internally, sales and use taxes can have a drastic effect on the bottom line, both prospectively with planning and immediately in the form of potential refunds on overlooked exclusions and exemptions.

Another advantage to the sales and use tax area is that it can be learned and investigated outside of your busy season, whenever that may be. This is helpful for obvious reasons, both for the public and private practitioner.

If you know the basics of sales and use tax, there are many generic sales and use tax questions you may feel more comfortable discussing with a boss, associate, or client. If you attempt to tackle a sales and use tax assessment, you can improve your skills by reviewing the pertinent statutes and regulations of the assessing jurisdiction. Discussions with the auditors will also be beneficial. This may be especially true if your exam would deal with one or two major sales or use tax issues. In addition, even when considering only one or two key issues, there are generally various other minor issues that come into play. A real life audit gives you a good opportunity to discuss these issues with an experienced person in the field.

Another way to increase your involvement in the sales and use tax arena is to focus strictly on one or two key aspects of sales and use tax planning. If you are in public practice, these issues may have widespread applicability and could be something to offer all your clients facing similar circumstances. Many individuals and firms make a good living by approaching businesses with one or two key state and local issues; they may review company records to see if the company availed itself of utility exemptions or of exemptions on manufacturing equipment. Oftentimes, these types of sales and use tax issues can result in significant tax savings and be great ways to impress a client or company superior.

Conclusion

The manual is designed to be a permanent reference tool. We hope your reading of this manual enriches your professional learning experience.

Note. We use the terms he and she alternately throughout the course (except when a particular person is mentioned) since both sexes are well represented throughout the profession.

Note. This course discusses many of the general principles and problems common to sales and use tax. However, given the variety of sales tax rules, regulations, and interpretations among the 45 states, the District of Columbia, and thousands of cities, counties, special districts, and other political jurisdictions, practitioners should refer to the specific jurisdiction for definitive guidance on any specific issue arising within that jurisdiction. The basic theories and applications illustrated here serve as a starting point for your own problem recognition and research.

The key in state and local taxes, as in any tax research, is issue identification. This course provides the framework for you to properly identify the key issues and the various approaches to resolving them successfully.

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