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Avoid unpleasant tax surprises for your IT consultancy

Sales and use tax audits don't need to be anxiety-provoking events for IT consultancies. Here are suggestions on how your firm can avoid tax nightmares.

I find that most technology consultants are better at solving complex technical problems than they are at managing billing issues; it's rare that an IT consultant excels at project management, systems administration, desktop support, and bookkeeping. That's why smart consultancies typically tap an office manager and outside accountant to manage billing, payroll, and tax tasks. But what about sales tax? Who's watching the house there?

As state and local governments in the United States (and provincial authorities in countries overseas) battle drastic revenue shortfalls, tax bureaus will become more aggressive about collecting sales and use taxes. Most businesses leverage QuickBooks, Peachtree, or similar financial management software to track tax liabilities and forward the appropriate revenue collected on behalf of the government each month. You can look up what your business collected, run a report, and send the sales and use tax to the local tax authority. Then why are sales tax audits at the top of the list of things that make a business owner go weak in the knees and get sweaty palms?

Audits are no fun, but organizations that take steps and prove proactive are much more likely to escape sales and use tax audits intact. Here are tips consultancies can adopt to help avoid having to pay back taxes, or worse, fines and penalty fees:

  • Know whether your city, state, province, or tax jurisdiction taxes the services your office provides. If services are taxed, don't just ensure your office's financial software applies taxes to service ledger entries -- you should ensure the taxes are calculated at proper rates. Some jurisdictions have raised tax rates; you must make sure your software has kept pace.
  • Calculate sales tax at proper rates on hardware, software, and equipment sales. Don't assume that since product sales are most often taxed (unlike services in the preceding bullet) the software is calculating sales taxes using the proper rate. The longer you wait to update your financial management software, the higher the possibility errors are being made; you should confirm that sales taxes are being calculated at current and proper tax rates.
  • Double-check interstate sales tax responsibilities. Say your office is located in Kentucky but does business in Indiana, Ohio, and Tennessee, too. If you ultimately deploy computers in other states (or provinces if overseas) for clients, your office likely needs to pay sales and use taxes in those states (or provinces), too. In some cases, this is true even if equipment is purchased by your office and delivered to your organization to be resold, staged, and prepped there before being deployed on a client site in another state or province.
  • Seek clarification whenever gray areas arise. Consultancies frequently resell subscriptions that must be regularly renewed, such as gateway licenses that run on routers, offsite backup contracts, and web hosting fees. Be sure to check with an accountant familiar with your governing authorities' rules and regulations to determine whether those subscription sales are subject to sales and use taxes.
  • Don't overlook charging tax on items for which you've already paid sales tax. Confused? So was my office before a sales tax audit a few years ago. Whenever an engineer was in a pinch and needed a printer, Ethernet cable, battery backup, or external hard disk really fast, we'd just pay the premium associated with purchasing these items from the closest office supply superstore (where we didn't have a chance to submit a sales tax exemption form). We paid sales tax on the purchase, so we resold those items to our clients at the price we paid (which included sales tax). We were later informed by a state sales tax auditor (during a sales tax audit) that we should have charged sales tax on those items, too, including calculating sales tax on the sales tax we paid! That proved a very expensive mistake, so avoid this error. Purchase equipment only from sources that don't charge you sales tax (due to your filing the appropriate reseller paperwork), or charge sales tax on your purchase to protect yourself from subsequent penalties.
  • Take your accountant to lunch. Once a year you should take your accountant to lunch just to ask what sales and use tax issues the accountant's other clients struggle with. Then, you should ask what processes you can adopt to avoid those issues. Also, ask your accountant to carefully review your office's sales and use tax procedures to ensure you're not missing small but incremental issues that could add up exponentially over time.

You should revisit your processes periodically, and seek regular feedback from a qualified accountant, to avoid unpleasant tax surprises. In addition, you should seek specific advice from a tax accountant.

Also read: Tax questions IT consultants should ask their accountants.

About

Erik Eckel owns and operates two technology companies. As a managing partner with Louisville Geek, he works daily as an IT consultant to assist small businesses in overcoming technology challenges and maximizing IT investments. He is also president o...

5 comments
ylto
ylto

I agree completely with your advice that grey areas be researched and answered in advance. Here in Oklahoma I too frequently find myself buying miscellaneous items in support of the technical services I provide. We do not mark up such items, and our state tax office has told us (in writing) that so long as they are used in the furtherance of our work and dont contain a markup there is no need to charge, collect, or remit any sales tax to the state on those items. Dont you love how states vary on these things?

smathes
smathes

In NY, if you pay sales tax on an item purchased for resale, you can claim a credit for sales tax paid on the purchase when you file your sales tax return. You must keep the receipt showing the sales tax you paid, and if you file a paper tax return, you must attach a copy of the receipt supporting your claim for credit.

HAL 9000
HAL 9000

Audits by the Tax Man are worst thing you can undergo. The first year I had this business going I was audited. Took two weeks to prepare then for 3 days I and the Accountant where in the Tax Office with a Please Explain for everything. The end result was it cost me several thousand $ to have the tax man write out a cheque for 10 cents which I had overpaid. Sorry but even without taking into account loss of Income which is standard for Audits it was a very poor return on investment and not something I want to undergo again. OH and here it costs the Tax Man $4,500 to write out that 10 cent cheque and post it out to me. Personally I didn't want that cheque or the problems that went along with getting it. ;) Col

pgit
pgit

All this crap is a complete waste, the amount of paperwork required, the manpower, the gray and fuzzy "enforcement" of grayer and fuzzier "laws" and regulations... imagine the economy without this huge tax system-induced overhead. If they ran the government like they're supposed to, you'd rarely ever hear about it. Instead, it occupies the majority of the news, and increasingly every corner of your business, life and mind. It's a parasite, hopefully mankind will evolve beyond this blind statism. But the immediate future doesn't look good on that score. 10 cents. I'd have framed that check and would tell them I deposited if if they asked.

HAL 9000
HAL 9000

When it comes to Money Maters and because of that they need the Bureaucracy to catch the cheats. I???m not actually saying I agree with this but a cousin of mine works for the Tax Office here as a Senior Investigator and about 6 years ago was taken to court for not filing a Tax Return. He argued in Open Court that as he was paying Tax in a Pay as you Earn and he knew the way that the Tax Office worked he was willingly donating the excess tax that he paid tot he Tax Office. I???m not really sure how the guy being audited felt when the Feds arrived I think he thought [b]OH SH1T[/b] and then they arrested the Investigator and took him away to court. What made matters worse is that he won the case and now there is no need for Pay as you Earn Tax Payers to fill a Tax Return if they don???t want a Refund. I personally think that the real reason that he doesn???t fill in any paperwork is that he does that all day and simply refuses to do it when he???s not being paid to. The Wife has to fill in any Insurance Claims and so on, anything that requires paperwork he simply refuses to do. ;) As for that 10 cent Cheque after 16 months I was asked to bank it because it was throwing their Monthly Balances out and it was costing them 10K to find out why the Books didn???t balance every month. Talk about an expensive mess. :D Col

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