Don't ask me what I want it for,

If you don't want to pay some more,

‘Cause I’m the taxman,

Yeah, I’m the taxman.

             - Taxman; The Beatles (George Harrison)

Did you know that you could be underpaying your sales taxes, often by a lot, and not even know it?

Worse, did you know that if your vendor undercharges you for sales tax, you are still responsible for it? And, that if you don’t pay the owed tax – whether you know that you owe it or not – you can face penalties, as well as interest on the back-owed sales tax?

It’s true.

And, fun fact, states are increasing their tax audits on companies, with a major emphasis on these types of taxes.

The Reality

The reality is that if you order goods and services from another state, you may assume that the vendor has covered the sales tax; but if not, you are on the hook for that tax. (Remember what happens when we “ass-u-me.”) In my experience, it’s borderline shocking how often vendors make mistakes on the sales taxes that they charge their customers.

One of those mistakes is in not charging the correct tax for where the product or service will be used vs where it might have been shipped. This is what’s known as a consumer use tax. The difference is that sales tax is triggered by a transaction, consumer use tax is triggered by how and where the product is used.

How do you know if you owe consumer use tax? Well, naturally, it’s one of those, “if you answer yes to any of these questions…” types of deals. Check all that apply:  

-        Does your business have a central point of purchase and then distribute purchased goods for use in other states?

-        Do you buy cloud-based software products and then provide the licenses to employees across multiple states?

-        Do you purchase goods or services from a company who doesn’t collect sales tax based on the state where they will be used – or they charge the wrong amount?

For example, say your California-based company buys a product from Wyoming, and that vendor charges you 4% sales tax, which is the WY rate. But since the product will be used in CA, which has a 7.25% sales tax, you, the purchaser, owe the state of California the difference, which in this case is 3.25%

Where does that leave you? I mean, it’s not your fault if your vendor doesn’t charge the right tax. Right?

The answer, paraphrasing Shakespeare, “the states demand their pound of flesh.” (Unless they’re vegans, of course.)

If you’re in business, it’s up to you to track consumer use tax when and where it applies.

Not surprisingly, consumer use tax is often missed, and by a lot of companies. So the good news is, you aren’t alone. The bad news is, well, I probably don’t have to tell you that you don’t want to upset tax people at the state – or any – level. There could be substantial fines and penalties for non-compliance.  For example, your company can be:

• called in for an audit by the state’s department of revenue
• reassessed for what you did not pay
• charged penalties and interest for any non-payments
• required to produce documentation as far back as three years – at a minimum

Yikes!

Who knew??

Well, now you do.

BTW, it’s not all bad news – you might be overpaying. And you might be getting money back from the states. But you won’t unless a) you know about it, and then b) you claim it.

The Solution

I recommend that my clients look at how they’re currently doing consumer use tax processes in their organizations and then take at least two steps:

Step 1: Make sure that your accounting processes are set up appropriately for each state where you do business. For example, go to a state’s sales and use tax website and learn their policies. I randomly picked Virginia and found the following:

When do you owe consumer's use tax?[i]

Generally, you owe consumer's use tax on tangible items you rent, lease, or buy that you didn’t have to pay sales tax for when you purchased them. Common examples:

• You bought something on the internet or through a mail order catalog and didn’t pay Virginia sales tax. Most online retailers collect Virginia sales tax, but if you order from a company that doesn’t, you need to pay use tax.
• You bought something in another state that doesn’t charge sales tax, but brought the items back to Virginia to use here.  
• Items exempt from sales tax in Virginia are also exempt from consumer's use tax include:
• Nonprescription drugs and medicines you buy for the cure, easing, treatment, or prevention of disease in human beings 

Step 2: Automate

Manually managing consumer use tax is extremely labor-intensive. You would have to manually check every invoice and track it on a spreadsheet, which is basically impossible, and even if you could it would be very prone to errors. (Remember the concept of "swivel chair computing" from past posts?)

Automation provides a better, smarter way than maintaining complicated spreadsheets or creating expensive custom solutions. One system that I like for consumer use tax automation is Avalara. Here are a few of its key functions:

• uses built-in rates and user-defined rules to determine tax obligations across multiple locations, even complex transactions, automatically
• checks rates according to jurisdiction, product taxability, and any special rules that may affect the sale
• uses rules to confirm consumer use tax for trusted vendors or automatically calculates use tax when the tax paid is zero
• creates a central source of use tax-related data and maintains a clean audit trail of your self-assessment decisions (and for audits, God forbid)
• as your business grows you can easily increase the levels of automation

Side note: I’ve been recommending Avalara products for many years now. See my previous LinkedIn article “The Top Five Software Products for Startups” as an example.

The Bottom Line:

Use automation software to catch vendors’ consumer use tax errors before they become your problem. Remember, if you buy something from a vendor and they make a mistake on the tax – you are liable! Be smart, avoid the fines and fees for underpaying.

If you’d like to talk more, please reach out to me on LinkedIn or at  kimberly@finopsadvisory.com. I’d be happy to help. Or, make a comment below; I’d love to hear your thoughts.

All my best,

Kim