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5 Client Sales Tax Questions All CPAs Need to Answer

May 13th 2016
Owner Interstate Tax Strategies PC
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As CPAs, we are often the first called when a client raises any type of tax question. Instinctively, when business clients encounter a tax issue, their default is to call their CPA. Even if that CPA had no involvement with the issue, there is some expectation that they will either know the answer or have a resource that can help.

Over the past decade, business clients have changed their perception of their CPA from that of a “one-stop shop” to that of a “quarterback of an engagement team.” It’s impossible for a single CPA, or even a midsized firm, to have the expertise needed to handle the myriad of federal, state, local, and international tax issues and nuances that could impact their clients. No firm can afford to invest resources to handle questions that only arise once or twice a year. That’s why CPAs need networks of experts that can help their clients.

Over the past 25 years as a full-time sales tax consultant, I’ve been asked thousands of questions by companies and CPAs about sales tax. Although most questions fall into a few major categories, the specific question is unique to the particular business or to a particular state. In talking with CPAs from across the country, I know that they also get a lot of questions from clients.

Even seasoned tax pros confess that they are not always certain about the answers they provide on these multistate sales tax issues and believe that their clients have probably asked questions in the past that they did not fully address. These CPAs also expressed concern that managers and staff were likely getting asked these questions and they were uncertain of the response these professionals were giving clients. In most cases, CPAs get pulled into these issues by their clients, and once you have been contacted, your clients expect correct information.

In this article, I outline five sales tax questions CPAs often get asked and offer my thoughts on the significance of the question, what follow-up questions the CPA should ask, and what type of a response should be offered. These are just samples of questions that arise on a weekly basis in my practice.

1. Should we be collecting tax on the sales I make to customers in other states? This is the question that seems most obligatory of any growing business. It’s a great question that can have a multitude of answers. Rarely is the answer a blanket and unqualified “no” or “yes.” Here are the factors that come into play when answering this question:

  • Does the company have nexus for sales tax or income tax in any of these other states?
  • Who is the company selling products to – other distributors or end users?
  • Will the company have products drop-shipped to the customer, or will it arrange delivery from local inventory?
  • Does the company provide any services in connection with the products it sells?
  • What product is being sold, and are there statutory exemptions in the states where the sale occurs?

Not until you really understand the nature of the business activities in the state, the nature of the transaction, and the nature of the product or service being performed can an answer be provided. The laws of each state vary. What may be a taxable transaction in one state may be a nontaxable transaction in another state.

When CPAs are asked this question, a specific engagement should be arranged to provide the correct answer. Telling a client that they don’t have an obligation to collect tax could be an incorrect answer. If your client is audited and assessed the back taxes due, what liability does your firm have if you instructed them not to collect tax?

2. My vendors are charging me sales tax on the drop shipments they make to my customers. Is this right? Third-party drop shipments are becoming the standard way for e-commerce companies to grow and quickly react to customer needs. Under this process, the retailer instructs its supplier to deliver the product directly to the retailer’s customer. In most cases, this allows companies in one state to fulfill orders to customers located in another state without having to incur double shipping costs or to maintain inventory.

The issue of taxation on these drop shipments is complicated and confuses many retailers that operate in this manner. The reason your client’s business is being charged tax in the state where the property is being delivered is because the vendor/shipper has nexus in that state. The shipper may have a warehouse in the state or have an office or employees who work in that state. These will both create nexus in the state.

Because the shipper has nexus, it will be obligated to charge its customer (your client) sales tax unless your client has provided the shipper with a resale certificate that is valid in the state where the product is being shipped. Failure to provide the shipper with a valid resale certificate will require the shipper to charge sales tax on the sale.

The precise certificate that must be issued will vary by state. Many states accept what we refer to as the “home state” certificate. Other states require exemption certificates that are specific to their state and contain a registration number from that state. California, for example, only accepts a resale certificate containing a California registration number. That means your client must register with the California Board of Equalization to obtain a registration number. This rule also exists in a number of other states.

The answer to this question, then, is that this may be the correct answer, but it does not need to continue if your company is willing to evaluate the resale exemption certificate requirements to determine what the shipper requires.

3. We’ve fallen behind on our sales tax obligations. What should we do? Over the years, I have heard a variety of very bad answers to this question. One answer that has been given to companies that have asked their CPA this question is: “Don’t do anything until the department of revenue contacts you.” This is a terrible and incorrect answer.

As with any tax problem, the sooner you identify and resolve the problem, the better it will be. Failing to address a sales tax problem until it has been raised by the state’s department of revenue will create huge problems for the taxpayer.

Approaching the states when you have a problem can be difficult and intense. However, over the years, I have found the states to be far more open to working with delinquent taxpayers who first approach the states rather than waiting for the state to find the taxpayer. There is no easy way to handle these discussions, but being proactive is far better than waiting for the state to contact your client. And, rest assured, the state will contact your client!

4. We have started to offer a variety of installation and repair services to customers located in different states. Are these taxable? The taxation of a broader array of services is quickly becoming the primary way states are obtaining more sales tax revenue. The taxation of services is far more complex than the taxation of property. Issues impacting the taxation of services include:

  • Is the service offered in connection with the sale of property or on a stand-alone basis?
  • Are the services being provided in a “sale for resale” transaction, or are they sold to the end user of the service?
  • Are the services invoiced separately to the customer, or are they bundled with other items?
  • Does the invoice clearly describe what the services are, and where are the services performed?

States like Connecticut, Massachusetts, New Mexico, Ohio, South Dakota, Texas, and West Virginia tax a wide range of services – whether they are billed separately or included with the sale of products. Some companies attempt to invoice their services as “professional services” knowing that the state does not tax this type of service. Under audit, however, when the precise service is revealed, the state may assert that the service is actually taxable.

When it comes to the taxation of services, the labels you give to these services sold makes a huge difference in the application of sales tax to the transaction.

In addition to sales tax issues, the performance of services in a state most likely creates income tax nexus for the service provider. This can open new issues with the proper apportionment of revenue from the services provided.

5. Our company has started to use independent contractors to sell our product and to perform services for our out-of-state clients. Does that change our sales tax obligation? This question touches on several issues. First, the presence of independent contractors in a state will likely create sales tax nexus for the company. If the company sells products to customers in the state, the taxation of those sales will be impacted by the presence of independent contractors in the state. If the company was able to sell the products to customers in the state without creating nexus, the presence of independent contractors could change this – even if the contractors don’t have any connection with the sale of the property.

Nexus is created at the legal entity level; if nexus is created for one part of the entity, it is created for the entire entity.

Depending on the type of service being performed by the contractor, there may be sales tax due on that service. States like New York and Texas can even tax various real property services, so you need to be alert to the specific activity that is being performed in the state.

As noted above, the performance of services in a state can create income tax nexus in addition to sales tax nexus. The apportionment rules for services are quite different than for sales of property, and CPAs should recognize these nuances when assisting clients.

These are just a few of the questions I hear regularly. If you recognize any of these questions, then you may want to compare your responses to the issues I’m proposing. Every client situation is different, and there is no cookie-cutter answer to any of these situations, unfortunately.

The takeaway is that simple questions can often present difficult answers and lead to the need for deeper analysis. These are great client engagement opportunities and ones for which you should be prepared to bill your clients for. The failure of you or other CPAs in your firm to treat these questions seriously could present serious challenges to your client and to your firm.

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