By Terry Barrett, CPA | Senior Tax Manager | State & Local Tax Team
It seems like a lot of businesses are being audited these days and thus a good time for some reminders as to sales and use tax responsibilities. The focus of this article is not on a business’ sales but rather on its purchases.
Everyone knows that most businesses have to pay sales tax on their purchases of computers, office equipment, furniture, supplies, etc – most things they use in conducting business every day – unless the items are being purchased for resale or are otherwise exempt from taxation (e.g., software delivered electronically). When a business purchases locally from an in-state vendor, sales tax is normally collected by the vendor on a taxable transaction. For example, if you run to an office supply store or big box retailer they will collect sales tax from you.
But what about purchases over the Internet, by phone, or through the mail? Some vendors collect the Virginia tax; some do not. If no tax is collected from the purchaser does that mean no tax is due? Some people think that’s the case – if you buy over the Internet, it’s tax free, right? Wrong. If a vendor, whether in-state or out-of-state does not collect Virginia sales/use tax on a taxable sale, the purchaser (a business or an individual) is required by law to self-report and pay the tax directly to the Virginia Department of Taxation. If they do not, and they are audited, they will be assessed the tax and interest (and possibly penalties) on the unreported tax. The unreported tax on these purchases will be used to determine an error factor that will be extrapolated over the audit period, thus the end result may be a large audit assessment
Here’s How It Works
In Virginia, as in most states, there is a retail sales and use tax. The sales tax is collected and reported by in-state vendors on taxable sales (e.g., the furniture, office supplies, etc., noted above). Use tax is tax collected by out-of-state vendors that are required to collect the tax on their sales to Virginia consumers, whether businesses or individuals, for goods delivered in-state (note, not all out-of-state vendors are required to collect the tax – thus the problem). Use tax is also tax that applies to the use of tangible personal property in Virginia when tax is not collected on a taxable purchase by a vendor at the time of purchase. It is self-assessed and reported by consumers directly to the Department of Taxation. The sales and use taxes are complimentary, meaning they are not both imposed on the same transaction.
To illustrate in overly simplistic terms:
Most businesses on occasion will make purchases that are not taxed by their vendors. If the business is not registered for the retail sales and use tax, it should have a consumer use tax registration with the Department of Taxation. With this type of registration use tax is self-assessed and reported when a taxable transaction arises – so, returns must be filed only in those months in which there is tax to report.
It is noteworthy that if a business has not been registered for sales/use or consumer use tax with the Department of Taxation and filing returns/making payments, upon audit the Department by law may audit six years rather than the typical three years. This, needless to say, has the effect of possibly doubling the assessment.
Some General Rules (exceptions may apply)
These exceptions are geared towards Virginia businesses but if you have a business in another state, the general rules may still apply.
- If you buy from out-of-state vendors, check your invoices. If there is no sales/use tax on a taxable purchase that equates to your VA rate (5.3% or 6% depending upon where you do business), then you owe use tax on that purchase. Self-assess and report the tax directly to the Department of Taxation. Note that sometimes out-of-state vendors collect their own state’s rate on a sale that is shipped to a Virginia customer – this is incorrect. If you suspect the rate is not Virginia’s (do the math), ask the vendor. Otherwise, if you pay the wrong state’s tax to the vendor upon audit a Virginia auditor will assess Virginia tax on that purchase since the wrong state’s tax was collected by the vendor. Virginia will not give you a credit for paying the wrong state’s tax. You will then have to try to recoup the tax previously paid to the wrong state.
- If the vendor does collect Virginia sales/use tax, check to see if they are correctly taxing shipping and handling charges. Many do not. Shipping charges when separately stated on an invoice are not taxable. “Shipping and handling charges,” “delivery and handling,” “freight and handling” are taxable. In other words, by adding “handling” to the delivery charge the charge becomes taxable. You should accrue use tax on nontaxed shipping and handling charges. The same applies to “late fees.” If a vendor charges a late payment fee, this, too, is subject to the tax. This seems picky but a Virginia auditor will assess the tax on such charges when he or she audits you.
- If you allow your employees to use company-issued credit cards to make purchases, require that they submit invoices to document the purchases and the amount of tax, if any, paid. If no tax was paid on a taxable purchase, use tax should be self-assessed and reported directly to the Department of Taxation.
- If you are purchasing items for resale or for an exempt use and then use some of what you intended to resell, you owe use tax on the cost price of what you used. For example, you are a retailer of doormats. You place one of the doormats at your store’s front door to advertise your goods. You owe “use tax” on the cost price of that doormat.
- Contractors with respect to realty generally are the taxable users and consumers of materials they purchase and use in connection with their contracts. The rules are a little complicated and will be addressed in upcoming blog article but be aware that you generally have use tax reporting responsibilities on nontaxed purchases (so watch those online/out-of-state purchases).
There are exceptions to most of the rules depending upon the nature of the purchaser (e.g., tax exempt), what is being purchased, how the item is being used, where it is being delivered (in Virginia, other states), etc. We will address some of these in future blog articles. However, if you follow some of the above rules, you can save time, effort, and potential tax/interest/penalties later on.
 Individuals may be subject to use tax reporting requirements (on or about line 35 of their Individual Income Tax Returns). If the taxable purchases which were not taxed by the seller were from out-of-state mail order catalogs and are less than $100 for the year, they are not taxable. However, if the taxable purchases are more than $100 from the mail order catalogs or if they are from another source (Internet purchases) regardless of the amount which is not taxed, they owe use tax.