Use Tax: A Blind Spot for Small Business?

Oh no, not another tax!

What is Use Tax?

Use Tax is the final net that states throw out to capture Sales Tax on eligible purchases.  In general, if a seller doesn’t collect Sales Tax on their goods and/or services, then it’s up to the purchaser to pay what is then termed “Use Tax.”

When I was a controller for a large business, our accounts payable specialist was responsible for accumulating all the transactions that passed over her desk that didn’t charge for Sales Tax, but should have.  She tallied up the appropriate details, put the totals onto the state’s standard form and cut a check to remit those taxes due each month.  If we were ever audited, those forms and details would prove we paid Use Tax where applicable.

Startups and small business owners typically aren’t aware of this requirement and most don’t have the level of expertise or time to ensure compliance with Use Tax rules.

Case Study

This came to our attention recently when a client of ours was randomly selected for a Sales Tax audit by the state of Virginia.  At first the response was, we sell software-related services to the federal government who is exempt from Sales Tax, why is Virginia bothering me with this audit?

During the entrance interview the auditor clarified that the audit is for Use Tax and that he would be looking through all the purchases that the company made going back several years (he ended up going back to 2009!)  Our client was very small back then (only one employee: the owner) and he purchased items on his personal credit card, through online sites, and in secondary markets like CraigsList.

Significant Audit Findings

Using random sampling, the auditor found that for those purchases made in the early days before his accounting operations were more sophisticated, either there were no receipts where he could discern whether Sales Tax was paid, or the vendors actually did not charge Sales Tax.  Because it was a statistically valid sample, guess what!? He extrapolated the errors to the whole population of purchases over the years by multiplying the error rate of the sample times all the purchases made.  This amount became due to the state of Virginia…plus interest.  Thankfully, because this was the first time the business was audited, they waived penalties.

Lesson Learned

While it seems like a tedious chore as entrepreneurs are in their initial stages of setting up a business, keeping receipts and organizing them for later discovery is crucial.

There are plenty of simple online tools that can help you keep track of receipts and bills like Shoeboxed and Hubdoc.  Once you start to grow and evolve, you will benefit from a bona fide expense tracking system that syncs with QuickBooks or other general ledger software.  As part of our overall outsourced accounting model, LK&A designs and maintains systems like Bill.com, Expensify, SpringAhead, and Tallie as a key part of our clients’ comprehensive accounting systems.

Is YOUR Business Prepared for a Sales & Use Tax Audit?

Contact us today for a complimentary call to discuss where you would like to improve your business’s expense tracking and sales & use tax needs