Most small business owners learn about Use Tax the hard way. It begins with a letter that arrives in the mail from the State Comptroller or Department of Revenue. In the letter, it advises that the business is being audited for sales and use tax. Puzzled, the owner calls my office and asks “My business is not required to collect sales tax, so why is it being audited?
After a long pause I ask “Do you purchase supplies online? What about equipment? Do you use out-of-state vendors for purchases?” The answer is almost always “Of course I do.”
“This is not a sales tax audit, it is a Use Tax audit,” I respond. The next question I am asked is “Well, what is that?”
Use Tax is essentially the same as a state’s sales tax but is charged not in the state from which a product or service is sold but in the state where the business receives delivery, uses, stores or consumes the product or service.
For example, let’s say your business purchases supplies online from an out-of-state vendor. Because the vendor is shipping from out-of-state state, no sales tax is charged. You see it as a “discount”.
That “discount” you thought you were receiving likely does not exist. If your state has enacted a Use Tax law (which almost all states that charge sale tax have) it is definitely not a “discount”. You, as the business owner, are required to remit to your home state an equivalent amount of tax equal to the sales tax you would have paid had you purchased the supplies from an in-state vendor. You are obligated to self-report the purchase and pay the Use Tax to your home state.
Now back to the audit…
The auditor will visit your business, and after the initial meet and greet, will request several items from you. In Maryland the auditor typically selects disbursement and purchase journals from three random months over the last year as well as the business’s depreciation schedules from the last tax year-end. From the journals the auditor will identify all purchases and disbursements for which they believe sales tax should have been charged. The auditor will then ask the business to pull the vendor invoices for examination. Based on these invoices the auditor prepares a list of all items to which no sales tax was charged and hence Use Tax will be applied.
From this, you as the business owner think “no big deal”. The business has not remitted any Use Tax but has purchased on average only about $2,500 online each month which would amount to about $150 in tax each month. Three months at $150 per month will total $450. You will write the state a check, lick your wounds and move on. But that’s not how this audit works.
The State of Maryland has a 4 year statute of limitations, meaning the auditor has a 4 year “look-back” period. But rather than go through every month’s disbursement journals, the law allows them to project the $150 per month over the entire 48 month statute of limitation period. So rather than charging you just for the 3 months examined, the $150 is charged for the full 48 months! Do the math and you are charged a jaw-dropping $7,200 in use tax. Add to that any Use Tax on equipment purchased where sales tax was not charged. Add to both of those amounts interest and penalty charged over the 4 year period. The total now is probably in the $10,000 to $12,000 range.
The above scenario is not uncommon. For more information or assistance with complying with your state’s Use Tax law, please contact our office.
You have been warned.