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.