How to avoid state tax audits
As cash-strapped states look for every penny, they’re more aggressively collecting sales tax. That means they might look to audit your franchise. Our guest columnist tells how to avoid that dreaded day.
Collecting sales tax is an increasingly important source of revenue for states seeking to make up for budget shortfalls. These taxes also play a big role in economic development.
Typically, sales taxes represent more than one-third of a state’s revenue, and when combined with special taxation cases such as fuel, tobacco and liquor, the percentage can rise to as much as 45 percent and even higher.
In order to maintain continuous revenue, states want to ensure every penny is reported and remitted by any entity charging sales tax. However, it’s a fact that many companies either don’t report accurate numbers or remit what they should. The result? A dreaded sales tax audit, fines and penalties.
Franchisees get a lot of support from their headquarters in marketing, store location selection and even group purchasing, but one of the things the head office can’t manage is sales tax. That’s why it is important for owners to be fully educated on sales tax and its implications.
Here are the areas of sales tax you need to know about, along with a plan to manage the various complexities of the sales tax process.
Topic one is nexus. Where you do business matters a great deal. Nexus is the legal connection that empowers a state to demand collection and remittance of a business sales tax. From a tax perspective, nexus means you have established a presence in the jurisdiction and you’re a taxable entity.
Nexus regulations define whether sales tax applies to your business and how. Examples of nexus-creating activities include owning tangible property and holding a business license. If you have franchises in one or more states, or even a different city or county, different nexus laws may apply to each franchise.
Nexus is a simple concept, but so many businesses don’t understand the ins and outs, especially when the rules change from state to state. Although the changes probably have the biggest impact on out-of-state remote sellers (think Amazon or other online retailers), all businesses should be aware of nexus and follow each state’s guidelines.
For example, opening a new franchise across state lines is going to mean you have an obligation to follow sales tax nexus in the new state. In addition, if you have employees or contractors working at a customer’s out-of-state location, you may have nexus obligations in that state as well. Nexus obligations can also be generated by owning or leasing personal property in another state; delivering products in another state, even when shipping those products; or storing, warehousing or drop-shipping products in another state.
Creating a plan of attack around nexus is your biggest protection against a sales tax audit. Consider taking these steps:
Determine where your franchise has nexus. Every business must calculate, collect, report and remit sales tax. You may need to consult an accountant or sales tax attorney to conduct a nexus study of your business.
Register your franchise in all required states you are operating. Failure to register can lead to audit and fines.
Ensure your nexus processes are up-to-date. In other words, make sure you calculate sales tax at the proper rate. You must also stay abreast of changes in the laws that apply to your business.
Topic two is use tax, which is tax on the use of tangible personal property not otherwise subject to sales tax. Purchases that may be subject to use tax include those made from catalogs, online retailers and out-of-state sellers.
A sales tax-exempt transaction between two businesses requires the purchaser to pay consumer use tax for the storage, use or consumption of tangible personal property (TPP), and unlike sales tax, the buyer pays the tax.
As the business owner, it is your responsibility to assess when use tax is accrued and/or pay the state or local tax authority. You must also pay use tax when your franchise uses goods from inventory for its own use, if sales tax was not paid at the time of purchase.
Be sure you follow use tax guidelines by paying attention to the following:
Check your state’s department of revenue website to see which purchases your state considers taxable under consumer use rules.
Self-assess if, and when, use tax is accrued, and pay the appropriate tax authority.
Know that not reporting consumer use tax can increase your risks of audit.
Failure to pay consumer use tax can put your business at risk for an audit. It is frequently one of the most error-prone areas of an audit.
The final topic is exemptions. Exemption certificates are state-issued documentation for businesses, churches and nonprofit agencies that are not required to pay sales tax. Your franchise must collect and keep the latest version on file. Also, your franchise must verify that each exemption certificate on file is valid and accurate, and matches up to a purchase.
Mismanagement of exemption certificates puts companies at risk for a sales tax audit. Companies frequently face fines resulting from out-of-date exemption certificates, so ensure you have a process in place to maintain records of these and the transactions related.
Marjorie Adams is president and CEO of AQB, a business process and software consulting firm that improves the efficiency of client accounting departments. Reach her at (800) 931-2120, ext. 701, or firstname.lastname@example.org.