Learning about taxes your business needs to pay is exhausting. From the employer’s portion of FICA, federal unemployment, state unemployment, sales tax as well as the other requirements parallel to taxes like annual filing fees, licenses and workman’s compensation, owners’ eyes glaze over as they weigh the complexities and time requirements of tax compliance.
When you look at these taxes in the aggregate, they act like opportunistic mosquitos slowly pricking the business; never enough to hurt it but just to really irritate it.
Sales tax may be broadly used by retailers and paid by consumers but the form filed at the state level includes “Use Tax,” as in, “Sales and Use Tax”. If you’ve ever wondered what this is, congratulate yourself on being the one of a select few who has ever thought of this! Even though you really don’t care about this “mosquito” you will want to know what it is in preparation for an audit.
First, let’s brush up on sales tax.
Sales Tax Basics
Sales tax is generally charged to the end-user of a product, the consumer.
If we were to line up the supply chain from the manufacturer and track a product from its inception, through the wholesaler all the way to the end user, we would find that in some cases multiple wholesalers own a product before selling it to a retailer who sells it to the consumer. Since these intermediaries are not purchasing it for their own use, companies in the supply chain don’t pay sales tax on the transactions.
If your company is purchasing a product to be resold to the consumer then there is an exemption for your company at the state level to avoid these taxes. By enrolling with your state as a wholesaler or retailer, you disclose to them that you are not consuming the products you purchase, and your company can now purchase most products from vendors without sales tax.
The assumption here is that if you have a retail merchant certificate, you will be submitting sales tax you charge to the consumer on a regular basis.
However, depending on your state and prescription writing ability you may not even need to collect sales tax on the services you provide. Your practice is mostly service based which many states exempt from sales tax, giving you a break from this pain point.
Assuming you signed up for a retail merchant certificate years ago when you started the practice, you’ve not paid a dime of sales tax on the purchases you pass along to the end user.
Does this mean everything you purchase for your business is exempt from sales tax because you can use the certificate?
You know the answer, but how does it play out in practice?
What is the mechanism for paying taxes on purchases you consumed (i.e. were not sold to a consumer) but purchased sales tax-free?
Use Tax
The ugly cousin to sales tax, use tax is slipped in opportunistically by some tax people to make them sound smart, as in “Sales and use tax”. Use tax is reported by vendors purchasing products without paying sales tax who then consume (use) those products in the course of business. In most states, the form used to report use tax is the same as the sales tax and the two can be combined to determine taxes.
If you are purchasing products with a sales tax exemption and selling to clients there’s a good chance your business is subject to use tax.
To find where these might be hiding, look at what your practice purchases and uses. Analyzing the purchases made without sales tax, the amount of product consumed (used) should be tracked and reported with the sales tax either monthly or annually to properly account for the sales tax not paid on those purchases.
Seriously, all that work for a little tax revenue?
Like the brown-noser at the front of the class reminding the teacher of the homework assignment, use tax exists to make your life a little more difficult.
Sales and use tax audits are much more common than income tax audits. With the ability to purchase products without sales tax presents the opportunity that your practice is subject to use tax. Implementing a plan and policy today and tracking accordingly will greatly benefit your business when audited.
(You will receive no ROI from this exercise, and it is mainly an extra compliance step for your business. Think mosquitos.)
Rather than looking at an auditor sheepishly when they ask about use tax, you can produce a practice policy describing how you track both sales and use tax.
Showing that you’ve considered this tax might just warm that auditor’s heart, if ever so briefly.