Contractors have the unusual burden of being considered the consumer of building materials under New York State (NYS) sales tax law. Because of this, generally, if you are a contractor you must pay sales tax on your purchases of building materials, for both Repairs & Maintenance (R&M) and Capital Improvements (CI), unless an exemption applies and a properly completed exemption form is in your hands. The most common exemption is the purchase of building materials for tax exempt entities and IDA projects.
This seemingly simple concept can create havoc for contractors, as it affects contract bidding, billing your customers, the need to apply for credits and refunds from NYS, and the paying of use tax for out-of-state purchases. The rules are confusing, hard to comply with, and often seem counter intuitive. If sales tax is not handled properly the contractor can find itself with an unexpected cost that hits the bottom line.
Another issue that causes contractors to lose sleep at night, can hurt customer relationships, and eventually cause the loss of profits, is the determination of R&M vs. CI. When dealing with contracts involving real property in NYS, it’s either one or the other. Again, just like being considered as the consumer of building materials, this need to determine R&M vs. CI is quite problematic, often requiring assistance from your tax professionals. Yes, the CI Certificate comes from the owner, but very often the Contractor plays a part in the decision process, and that decision also affects your contract bidding, subcontracts, billing your customers, and applying for credits and refunds.
No wonder contractors are a prime target for NYS sales tax audits.
Make no mistake: to cash-hungry tax authorities your business represents a revenue stream, plain and simple. Their job is to maximize that stream and a sales and use tax audit is one of their primary tools. In a sales and use tax audit an auditor reviews your business records over a period of days/weeks/months to determine whether you are underreporting or underpaying taxes that are legally due. In addition to the costly time & effort that sales tax audits require on your part, the resulting tax due, interest and penalties can be substantial. To you it’s an unexpected hit to your profits; to the state, it’s “found money.”
Given this kind of return on their efforts, it’s no surprise that when states need more funds they send out more auditors. In short, they’re out there looking closer, more aggressively, and with greater frequency than ever before, and the more tax jurisdictions you do business in the greater the likelihood that you will be audited.
How states determine who to audit
If you know what they are looking for you can take steps to avoid being audited. But, what are the triggers? Here are the top issues that will prompt a sales tax audit:
1. Nexus but no registration.
2. Resale certificates.
3. No Use Tax reporting.
4. Gross sales in a quarter significantly higher or lower compared to previous quarters.
5. Higher than normal exempt sales.
Just because you’ve been selected for a sales and use tax audit doesn’t mean you’re automatically going to have to pay a significant amount. Conversely, just because you’ve done everything right doesn’t mean you’re not going to have to spend considerable time and money proving it.
On average an auditor spends one-two weeks examining records for a sales/use tax audit of a medium-sized company. After examining the records the auditor will issue a preliminary assessment report and allow you time to gather additional information and challenge their findings. Follow-up meetings will be scheduled to discuss the issues before settling the audit.
The most common pitfalls
Here are the top items most likely to trip you up:
1. Use tax.
2. Exemption and resale certificates.
3. Unreported sales.
4. Charging wrong rates.
5. History of audits and assessments.
6. Unique rules and regulations.
7. Business and property acquisitions.
8. Business Activity Questionnaires.
The best defense is a good offense
A cost-effective path to proactive sales and use tax management.
There are ways for companies to reduce the risk of being audited, minimize the economic impact of audits, and cut the costs of compliance and defending themselves.
Preparing and simplifying your documentation in advance can streamline the audit process, and help you avoid audit sampling methods that may be to your disadvantage. Understanding the ins and outs of sales and use tax applicability, exemptions and resale certificate usage can keep you out of trouble.
Finally, too often the goal in sales and use tax compliance is focused on making sure that enough tax has been paid. An analysis of sales and use tax procedures may reveal that the company is paying too much tax.
Please contact John Fontanella at The Bonadio Group, jfontanella@bonadio.com, 315-214-2724, if you would like to discuss further and arrange for an analysis of your sales and use tax procedures.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.
