Use Tax (Pt. 2)
Michael J. Fleming is the founder and president of Sales Tax and More, a full-service consulting and solutions firm with a passion for state tax. He is one of the country's leading authorities on sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers.
Michael is a renowned writer and speaker, and he regularly presents on webinars. He is also the host of the Sales Tax and More Podcast, where he shares his wisdom and learnings with his audience in order to help them navigate the tricky world of taxes.
In this episode…
Mike Fleming and Ellie Moffat discuss and answer questions about use tax.
Here’s a glimpse of what you’ll learn:
Auditors and use tax
Commons use tax problems
Contractor use tax issues
Connect with Michael
Episode Transcript - Audio Version
[00:00:00] Welcome to Sales Tax and More, your go-to resource for all things state tax-related. Now, here is your host, Michael Fleming.
Michael Fleming: Hi, Mike Fleming here, founder of Sales Tax and More, and today's co-host of the Sales Tax and More Podcast, where we talk about everybody's favorite topic, which is, of course, sales tax. And today, I just thought of this, Ellie we're gonna be talking about use tax.
That's not really sales tax. But anyway, we're gonna be talking about use tax. We did a two-part podcast series here about use tax, and this is part two. And although you may be watching it at a different time, I'm taping it at the same time, so I'm a little [00:01:00] bit casual today because I just came in from taking care of the horses out on the ranch.
And Ellie will probably make fun of me again. My accent as I'm taking care of horses on the ranch. But might as well go ahead and introduce you to Ellie so she can start making fun of me.
Ellie Moffat: You know what? The accent wasn't as strong that time around. So if you wanna hear the accent and you haven't listened to part one, go listen to it.
It'll give you a basic overview anyway. And yeah, before we get started, we'll do the same introduction again. Please follow, like, subscribe to our podcast. We appreciate having you here so much, and it's great to be here myself. We are a full service consulting and solutions firm.
We have a great team here of experienced tax professionals who are very dedicated to fulfilling your state tax and related needs. So we do a lot of sales tax returns, sales tax registrations, consultations, research, audit defense, exemption certificate management, and like our name states, more. So if you have questions about our [00:02:00] services, please reach out.
We'd love to hear from you, and we'd love to work with you as well. So this episode is gonna be a little bit more of a quiz for Mike here. I guess we can see how he does. And Mike, the first thing we want you to talk about, auditors and use tax. Tie it together for us.
Michael Fleming: All right. So we touched on this in the first part.
But when an auditor comes out, they're not just looking at your sales. They wanna make sure that you're collecting the right amount of tax, that all the tax that's been collected has been remitted, that all of your exemption certificates are in a row. They're also looking at your purchases because just because your vendor didn't charge you sales tax doesn't mean that it's a tax-free transaction.
If it's taxable and the vendor didn't charge you, you're supposed to self-assess and remit it to the state directly as a use tax, a consumer use tax. So [00:03:00] the auditor's looking at your purchases to make sure that all of the tax has been remitted that needs to be remitted.
And if not, then they're going to set that up, and you're gonna have to pay the back tax plus the penalty and interest. So that's a big issue now. There's a secondary issue, we talked about it more. It's one of the primary ways that auditors find targets for leads. If someone's not charging tax, they usually end up on a list, and there's a discovery unit that will follow up on their companies.
But we'll talk about that more in another podcast. Today, we just wanna reemphasize that use tax is either the number one or number two issue for large assessments in an audit. Number one or number two, depending on what type of business you have is certificates. But use tax is the second biggest or first biggest if you don't have a responsibility to collect certificates in an audit.[00:04:00]
And that's why you need to have some sort of system in place to track and and self-assess and remit your use tax. Someone has to be reviewing transactions. Now, you can review all of your transactions if you have a lot of transactions, that's usually cost-prohibitive. You can target certain vendors.
Certain vendors get it wrong all of the time. You can target certain invoices over a certain dollar amount, and then anything under that dollar amount you can do samples on. You can, have tranches for the samples if you wanna do it. So there's a number of different ways to implement a system.
But you've gotta have some sorta system in place, and a lot of software companies are gonna tell you, "Hey, use our software, you don't ever have to worry about anything again." Usually that's a load of malarkey just a [00:05:00] lot of things software companies tell you. You'd have to totally change the way you're doing your accounting and bookkeeping and everything else in order for that to be true, and most people don't wanna go through that.
Software does serve a purpose. I think that you can't just rely on a software company, though. I think that if you have someone managing the use tax accrual process, they can utilize software to make their job a lot easier, but don't fall for that malarkey that all you need to do is utilize our software.
It just is not gonna work. You gotta have someone who is gonna work with that software to make it work for you.
Ellie Moffat: And that's a perfect lead-in to our next little quiz for you, I guess here, Mike, is tell us about common problems. So we're we're just touching base on one of them.
Tell us a little bit more about common problems people are having.
Michael Fleming: Oh, we could speak for hours on common problems. As I said, this is a leading cause, but [00:06:00] what trips up a lot of companies when they're making fixed asset purchases, they often, don't realize the impact they may have, and they may or not have paid tax.
So that's a problem area. Another problem area is large software purchases, and sometimes because software's gonna be used in multiple states, you don't pay any tax at the time of purchase at all. But the use tax has to be reported in each state where the software is actually being used.
So software is another area. Auditors are looking for large purchases of software. Again, fixed assets, large purchases that's where the big bang for the dollar is gonna be for the auditor. They will look at your expenses also but it's those fixed assets that they're really looking out for.
Software is a big thing that they're looking out for. Services, a lot of people don't realize that services are [00:07:00] taxable. The vendors don't realize their services are taxable sometimes. You gotta know the taxability of services, and if they're not charging the tax, you gotta self-assess and remit on that.
If you're a contractor, there's all sorts of issues. If you're making improvements to real property, if something's being incorporated into the real property generally you do not charge tax to your customer because title doesn't transfer until it's already incorporated. It becomes a part of the real estate, and real estate is generally not gonna be taxable.
So you don't charge the tax to your customer. That contractor becomes the consumer of the materials and supplies themself, and they're responsible for paying the tax. They cannot pass it on to their customer as a tax. You can bury it in the price that you're charging for it, but you can't call it a tax because you're responsible for the tax.
That's another problem area there. Whenever you're doing any type of new [00:08:00] construction or remodeling or opening up new locations, there's generally permits involved, and auditors go out and look at the different places where you'd get building permits, and they form an audit target list.
'Cause you're making a lot of purchases when you're doing a remodel or opening a new location or doing new construction. And these purchases, generally you can't buy them for resale, and maybe if you're a manufacturer, there's some sort of manufacturing exemption. But a lot of times you're responsible for paying the tax.
You're the consumer of those items you're purchasing. So that's what auditors are looking for. They're looking for people who are opening new locations. They may even be going to your website and looking on your website where you're gonna be opening up new locations. Permits and new construction remodels you often need permits, so they're gonna be [00:09:00] looking for those.
So those are just some common problems that people are gonna run into with use tax itself. There can also be common problems with your use tax accrual system. And one of the biggest problems are people. You can have a great process, but if you don't train your people on that process and you don't spot check them to make sure that they're following the process, then you may think that you're being protected, but you're not.
Turnover. Just as you get someone trained up, they decide to take a job at another company. You trained them for a higher position. There's a lot of turnover. So when the new people are coming in, you gotta make sure that they're trained. You gotta make sure that they have the right tools, because the person who's managing your use tax accrual system has to know about taxability.
They have to have a tool that they can check to see if something's taxable in your state or [00:10:00] not. That person has to have a knowledge and/or the tools to make those determinations. So those are just some of the common problems. I could go on and on.
Common problems we could talk about the, common problems.
Ellie Moffat: Although we're gonna cut him off ... and we'll, we'll- Yeah ...
Michael Fleming: Or we could talk about the common problems with the use tax system themselves. But as you said- Well- ... you're cutting me off. Okay.
Ellie Moffat: We'll cut you off.
Michael Fleming: We gotta keep this kinda short. We don't wanna lose everybody-
Ellie Moffat: Let us know- ...
Michael Fleming: Out there in the crowd.
Ellie Moffat: Yeah. Let us know if you just want a whole episode of common problems. Let us know. We'll let Mike talk about them for an hour. But Mike-
Michael Fleming: How about a day?
Ellie Moffat: I wanna start... or a whole day.
Michael Fleming: Let's have an eight hour-
Ellie Moffat: Longest podcast episode.
Michael Fleming: Eight hour common problem podcast.
Ellie Moffat: Yes. Everybody's dream podcast. But Mike, I wanna reel you in a little bit here. You've mentioned a few things that were issues with contractors, and I want you to talk about contractor issues specifically, and explain why we're kinda singling this [00:11:00] out here to begin with as well.
Michael Fleming: All right. So with contractors, contractors are people who are building or remodeling homes usually. They're, doing something with real estate. So you could be installing a dishwasher into a home. And most states say that dishwasher is a fixture and it's not an improvement to the real property.
It's too easy to remove and change. Dishwashers break down all the time. You gotta replace them. So that's not really considered an improvement to the property. So a main question for a contractor is something gonna be retaining its identity as tangible personal property, or is it actually going to be a part of the real property?
Because if it's retaining its identity as tangible personal property, a fixture, then generally the contractor is considered a retailer. It could depend on the type of contract. So [00:12:00] that adds another layer of complexity in there. But in general, if you got a time and materials contract you're gonna be considered a retailer of that dishwasher, and you need to collect tax from your customer.
But let's say that you're installing a door and the door is recognized by most states as becoming part of that real property. So therefore you, the contractor, are becoming the consumer of the door and the materials incorporated into the real property. You do not charge your customer the tax.
You pay the tax yourself. Where it gets really confusing is what happens if the contractor is a manufacturer. Maybe I made that door, and then I installed it. So if I'm buying the door, then I pay the use tax based on my [00:13:00] purchase price. If I'm manufacturing the door it depends on the state. Some states are gonna say, "You still use the cost of raw materials. We're gonna treat you like a manufacturer." Other states say, "No. We're gonna make you use the tax basis as the price that you would have sold that door to someone else where you were not doing the installation." So it's some sort of finished price calculation. Some states will spell out what goes into that finished price.
But it's either gonna be some form of finished price or the raw materials. So there's a lot of moving parts when it comes to contractors. Also what type of contract could impact it. Is it lump sum? Is it time and materials? On lump sum contracts a lot of times the contractor is considered the final consumer.
Even when it may not be an improvement to the real property. If you have an exempt customer, the rules may [00:14:00] change. So lots and lots of moving parts when it comes to contractors, which is why we see so many problems with contractors. And each state has their own idea on how to do things, so it's hard enough for a contractor to get it right all in one state.
Contractors are usually good, utilizing their hands. Sometimes only the sales tax issues. That's not their forte and they just end up getting themselves in trouble all the time because sales tax doesn't often use common sense. Sometimes it does, a lot of times it doesn't. And if you're using common sense, you can get yourself in a lot of trouble.
So if contractors in one state are having lots of problems, what happens if you're a multi-state contractor? What happens if you're doing business in three or four states? Here where I live I live within 30 minutes of three states. It would be Texas, Louisiana, and Oklahoma, and all three states have their own ideas on [00:15:00] how things need to be done.
What happens if you're a really big contractor and you're doing business in 50 states? You got a lot more problems at that point. Lots and lots of contractor issues. And again, Ellie, we could be talking about contractor issues all day long. But I know that you like to keep these shorter, keep people's attention because nowadays we all seem to have 20, 25-minute attention spans.
If we go longer than that, whoop, we're gone.
Ellie Moffat: Yeah, we're gone. And you know what? If you're doing contract work in 50 states, good for you. And also sorry about the potential exposure and problems you have. Anything else you wanna say about that, Mike? Sorry.
Michael Fleming: No I think that this is a good stopping point here.
Ellie Moffat: Okay, great. Anything else in general you wanna add to this format of this podcast right now?
Michael Fleming: Yeah, one last thing. We always wanna be perfect. But in use tax, perfection should not be the goal. You don't wanna try to prevent 100% of your problems [00:16:00] because there reaches a point of diminishing returns.
You'll spend more money trying to prevent all of your potential issues on a use tax basis than you would if the state found you. A lot of your purchases may be, maybe you have 1,000 purchases of a dollar each. Do you really wanna go look at every one of those items to make sure the tax is paid on it?
We mentioned earlier you may just wanna do a sample. So you're trying to get the bigger issues. You're trying to prevent where most of your pain is going to be. You wanna capture those, but don't shoot for perfection. And that may seem counterintuitive but you'll spend more money trying to prevent the issue than if the state actually found you and charged you.
You gotta take care of the bigger issues. You gotta have a use tax accrual process. You gotta be paying attention to this. It is a leading cause of large assessments, so you do have to pay attention to it, but you don't wanna obsess over it so much that you're trying to [00:17:00] prevent every last penny from becoming an issue for you, because you'll spend more money than you'll save doing it that way.
Ellie Moffat: All right. Thank you so much, Mike, for letting me quiz you a little bit today. If you have more use tax questions, let us know. If you have questions in general, let us know. We do offer many solutions and services at Sales Tax and More. And if you have questions about them or you'd like to work with us, please reach out to me directly.
My email is emoffat, E-M-O-F-F-A-T @salestaxmore.com. You can also go to our website, fill out a contact form, find out more about it. That's salestaxandmore.com. And in addition to the services we offer, we have an entire series of free webinars, free resources, some charts on our website, so check those out as well. And thank you so much for joining us.
Michael Fleming: Thank you, everyone, and we hope you join us on our next installment of the Sales Tax and More Podcast, where we talk about everybody's favorite topic, which is of course [00:18:00] sales and use tax. Take care, everyone. Bye-bye.