Cash-strapped state governments are increasingly turning to sales and use tax compliance audits to raise funds. In the past, enforcement in this area was often lax and, as a result, plastics firms have been lulled into a false sense of security regarding their sales tax procedures. In fact, the risk is very high and the exposure is much larger than typically thought.
The aggregation of tax liability throughout the year is substantial. In addition, if an auditor finds a problem in one period, inquiries are extended to all open years, generally three years from the time the return is filed. If a return has not been filed for any period, the government can go back six years or more to collect the taxes due.
Penalties and interest on the basic taxes involved are an additional cost and the exposure can be tremendous.
A common misconception is that sales made to out-of-state customers are not subject to sales tax, which is a destination-based tax designed to be collected at the point of sale. For example, if a plastics business picks up a product from a facility outside of its home state, it is liable to pay that state's tax. The company may need to apply for an exemption certificate from the state in which it is making a purchase, as many states will not recognize such certificates from the customer's home state. Therefore, it is important for a company to be familiar with state laws regarding out-of-state exemption certifications. If plastic products or materials are being shipped out of state by common carrier, generally no tax is owed. Regardless of whether picking up its purchase or having it shipped, a company should document its files by attaching the bill of lading to the sales invoice.
Another problem arises when a company has nexus or, in other words, has established a presence in the designation state. Nexus is created when a business has personnel, service or delivery in the state on a regular basis. In such a case, a company is liable for sales tax to that state.
If all solicitation of business in the destination state is conducted through mail and products are shipped by common carrier, no tax is due.
The final hurdle in a sales and use tax compliance audit is likely to be an analysis of purchases. This includes inventory, capital expenditures and expensed items. Each class of purchase needs to be examined for its eligibility for exemption from sales tax based on its acquisition for resale or other qualifying exempt purposes. Common examples of exempt materials are containers and packaging and manufacturing equipment.
It is possible that some companies do not strictly adhere to the law with regard to an analysis of purchases. Failure to collect sales taxes can be very costly. In instances where the tax has not been charged to a customer, it may be difficult to bill for that tax in future periods if noncompliance is discovered upon audits. Many taxing jurisdictions will attempt to collect the tax from both the buyer and seller. To protect against this situation, a taxpayer may want to contact the other party and ask if they have been audited by the same jurisdiction. Many states have formal procedures when dealing with overlapping audits.
In the event that noncompliance has occurred, taxpayers can utilize voluntary disclosure programs, which many states have in place. By coming forward first, the length of exposure and potential penalties can be minimized.
It is important to understand that states are becoming very aggressive in this area. State governments have a growing need for revenue, and technology has simplified their ability to cross-check information from various sources. Not having been challenged in the past does not mean immunity for the future.
Barry Horowitz is a partner with Eisner & Lubin LLP of New York, a certified public accounting and consulting firm specializing in the manufacturing and plastics industries.