I frequently talk with companies who sell to end-user/consumers who have told me that they don’t have any sales and use tax risk because they pay sales tax to their vendors – while they failed to charge sales tax to their customers. They are comforted by the fact that “the state got their tax revenue and therefore shouldn’t come knocking for more”. When I tell them that they still have a sales or use tax liability, they are surprised. When I tell them they may not get ANY credit for the tax they paid to their vendors, they get irate – “What do you mean I still owe the tax – that’s double taxation!”
Sales tax is imposed on the sale at retail of tangible personal property. Therefore, sales tax generally doesn’t apply to wholesale transactions – as long as the appropriate exemption/resale documentation is executed. When a reseller fails to provide the appropriate exemption documents to its vendor, the vendor is required to charge sales tax to the reseller. Subsequently, when that reseller sells to the end-user/consumer, there is a sales tax due on that retail sales price.
Under audit by the state, the fact that sales tax was paid to the vendor by the reseller is irrelevant and may not be used to offset the tax due on the retail sale to the end-user/consumer. When the reseller isn’t registered for sales and use tax purposes, the statute of limitations doesn’t apply. As a result the state can assess the reseller on sales made for the last 10 years or more – although generally speaking the state won’t assess for more than 7 years.
To recover any sales tax paid in error to the vendor, in most states the reseller is required to request directly from the vendor a refund of the sales tax paid. The statute of limitations applies to the sales tax paid by the reseller to the vendor. So in a state with a 3 year statute of limitations, the reseller has no recourse for recovering any tax paid to the vendor beyond the last 3 years. If the audit goes back 10 years that could mean they will forego 7 years of sales taxes paid in error to the vendor. Even within the statute of limitations, the reseller may be able to recover the tax paid in error to its vendor, but the assessment will be based on the gross sales price which includes markup – so there isn’t a complete offset to the audit assessment.
Since the sales tax rates are on average in excess of 9%, a company could lose a significant amount of their profits as a result of a sales tax audit – at least in the state(s) where audited. In addition, the state is going to apply penalties and interest. With penalties and interest, you can experience a net negative impact of 10% to 15% of your gross profit, even after you recover taxes paid to the vendor.
Companies are best advised to truly understand their sales tax nexus footprint and where they are required to collect and remit the sales tax. Sales tax is meant to be a burden on the buyer and not the seller. The seller is simply the convenient collection agent for the state. The lesson here is to invest in the compliance processes to ensure sales tax is truly a pass-through for your business and has minimal impact on your bottom line.