Exceptionally large Maryland manufacturer and government contractor who manufacturers products and provides services to the federal government and has locations throughout the United States was selected for another sales and use tax audit. This Taxpayer was last audited in 2001 and Marsu assisted in that audit and had filed and gotten refunds approved by the Comptroller. Taxpayer had received their audit workpapers and was working on filing their own refunds but wanted assistance with reviewing the audit and in filing any additional refunds. Marsu assisted the Taxpayer as follows with the asset and expense schedules:
For capital assets, the auditor reviewed all Maryland assets and listed 107 invoices as taxable. Marsu reviewed each invoice to determine where and how each asset was used to establish if an exemption was available or if sales or use tax was paid. Marsu was able to document 48 invoices were non-taxable. The tax assessed was reduced from $83,751.76 to $51,996.24, a savings of $31,755.52.
For expenses, the auditor reviewed a one-month sample period and listed 38 invoices as taxable. Marsu reviewed each invoice and was able to get only 11 invoices deleted, but these 11 invoices represented 84% of the sample dollars. The tax assessed was reduced from $99,122.83 to $16,109.73, a savings of $83,012.60.
With Marsu’s assistance, this Taxapayer was able to significantly reduce their tax assessment and to recover all sales and use taxes paid in error. The original workpapers had the Taxpayer owing $182,874.59 in taxes and the final workpapers had the Taxpayer receiving refund checks in the total amount of $1,076,284.68, a savings of $1,259,159.27. Since the Taxpayer had filed their own refunds that exceeded the tax assessment amount, there was no interest and penalty assessed. This saved the Taxpayer approximately $73,149.84 in interest and penalty because the refunds were filed.
Main Audit Issues
The only minor audit issue here is that the Taxpayer sometimes misses paying use tax on some of its assets and expense items. Their percentage of error is exceedingly small. For assets, there were 6,041 assets and tax was not properly paid on 59 of them for an error rate of less than 1% – .0097665. I think that is a pretty great job. For expenses, the assessment ended up to total $16,109.76 which is a monthly average of $335.62 which is not terrible for the size of the company. A review of the final 27 invoices on the expense schedule shows that the assessment came from mainly office supplies and online purchases. One area that the States love to audit, and Taxpayers have difficulty with is credit card transactions. Usually the monthly credit card transactions are not reviewed by the Taxpayer to pay use tax and a lot of times these transactions come from out of state transactions where MD sales tax is not collected.
Audits of Exceptionally Large Businesses
Auditing exceptionally large businesses for sales and use taxes is very time-consuming job not only because of the sheer volume of records, but also because of the different exemptions or exclusions available for businesses that operate in and have contracts in multiple states. Just for the asset portion of this audit alone, this Taxpayer had to at least provide invoice copies of over 6,000 assets for the auditor to review to establish minimally that sales or use tax was paid so the asset would not be assessed. This does not even count the expense audit and heaven forbid if the Taxpayer had taxable sales and the auditor would have to review at least a one-month sample.
Time is one of the things that the States have as an advantage over the Taxpayer. The State’s auditor does not have a time limit or a job profit and loss statement to answer to. When the auditor does their audit, they will list everything possible on the workpapers and hope it sticks. If the Taxpayer does not invest the time by providing the requested information and then thoroughly reviewing the workpapers to provide additional information, then the Taxpayer will be over assessed. That is why is it is beneficial to bring in experts who for 40 years have been reviewing workpapers and dealing with auditors, supervisors, and hearing officers. Plus any refund that Marsu gets approved will offset any taxes due and decrease the interest and penalty due. After the audit is finalized, Marsu will review with the Taxapayer the refund that was approved so the Taxpayer can implement changes to their accounting system to take advantage of the annual tax savings.
If you are a Government Contractor or a multi-state contractor and have been audited in the past, then please call Marsu now to determine if your case can be reopened pursuant to Section 13-509 of the Annotated Code of Maryland to get any taxes improperly assessed back as a refund or if you are just due a refund of sales and use taxes paid in error. Marsu’s review is performed on a contingent basis and no fee is due if no refund is approved by the Comptroller’s Office.
Large commercial and federal government contractor provides general contracting services in Maryland and Washington DC. This Taxpayer was selected by the Comptroller’s Office for a first-time MD sales and use tax audit. The Taxpayer undoubtedly got sticker shock when the auditor provided them the initial workpapers where they owed $598,110.61. Marsu was contacted by the Taxpayer’s lawyer and accountant to assist in the review of the workpapers. This Taxpayer was deemed a consuming contractor and the assessment was for the failure to pay use tax on their expenses and assets. Marsu assisted the accountant with the two schedules as follows:
For capital assets, the auditor reviewed all Maryland assets and listed just 2 invoices as taxable. Marsu found no errors with this schedule.
For expenses – Job Cost Materials, the auditor reviewed a three-month sample period and listed 45 invoices as taxable. Marsu pulled each job folder and reviewed each invoice and was able to get 26 invoices deleted from the schedule and had 2 invoices removed and put on a separate schedule and taxed individually. The tax assessed was reduced from $590,987.93 to $61,753.77, a savings of $529,234.16. Five of the remaining 19 invoices were credit card transactions and were not reviewed by this Taxpayer for use tax payments.
For expenses – G & A Expenses, the auditor reviewed the same three-month sample and listed 9 invoices as taxable. Marsu reviewed each line and provided documentation to get 1 line deleted from the workpapers. The tax was reduced from $6,247.28 to $4,161.89, a savings of $2,085.29. Eight of the 9 invoices listed were credit card transactions which were not reviewed by this Taxpayer for use tax payments.
For expense projection methodology – Job Cost Materials, Marsu documented and presented an alternative projection methodology that was approved by the Comptroller’s Office. This new methodology saved the Taxpayer $23,564.77 in taxes in the final workpapers.
With Marsu’s assistance, this Taxapayer was able to significantly reduce their tax assessment. The original workpapers had the Taxpayer owing $598,110.61 in taxes and the final workpapers had the Taxpayer owing just $66,789.86. Marsu performed a reverse audit and documented sales and use taxes paid in error and the Comptroller’s Office approved and included the refund in the amount of $17,085.98 in the audit workpapers as required by law.
Main Audit Issues
The Comptroller’s Office properly deemed this Taxpayer as a consuming contractor; therefore this Taxpayer is liable for sales and use taxes on all materials purchased directly by them and tangible personal property deemed tangible personal property after installation by a subcontractor into a job.
Unfortunately, this Taxpayer dealt with a lot of these gray area tax issues where there is not a lot of written information on, but the Comptroller’s Office loves to audit for and assesses many a business. This gray area deals with Regulation 19 and the State’s definition of tangible personal property. Pursuant to Regulation 19C, the Comptroller’s Office has written the following:
Reg. 19C(3) – “If the intention of the annexation is for a temporary purpose, that is, for the enjoyment or use of the material as a chattel or personalty, the material will be considered to retain its character a tangible personal property. Machinery used in a production activity retains its character as tangible personal property without regard to the method or permanency of its annexation to real property. Farm equipment, a foundation in support of machinery and equipment used in a production activity and any machinery, device, or equipment which is required for conformance with air or water pollution laws or regulations retain their character as tangible personal property”.
Reg. 19C(4) – “Factors to be considered in determining the intention of the party making the annexation are the:
Nature of the article annexed;
Mode of annexation;
Purpose of which it was annexed; and
Practicality and feasibility of removal of the annexed article”.
Reg 19C(5) – “As a general rule, counters, countertops, and cabinetry installed in commercial spaces will be treated as tangible personal property. Doors, windows, molding, built-ins, and kitchen cabinetry installed in residential or commercial spaces will be treated as realty”.
As you can see there is a lot of grey here and the only issue the Comptroller gives a little information about is on the furnishing and installation of countertops and cabinetry in commercial spaces which is automatically deemed tangible personal property with the exception of kitchen and bathroom areas.
I like to talk about this issue in another way to give a different perspective of what the Comptroller’s Office deems as tangible personal property and why. The question you must ask yourself is “whose purpose does the item or article serve, the tenant or the building?” If the item or article after installation was installed to serve some purpose for the tenant, then the Comptroller is going to say that it is tangible personal property and if the item or article serves the building, then the item or article is deemed realty. So if the item or article deals with the doors, windows, except blinds and drapes, walls, ceiling, floors, except carpet, roof, plumbing, heating, central air conditioning or domestic water systems of the building, then the item or article will most likely be deemed realty because they serve the building and not the tenant. In this case, the Comptroller even deemed that a sink that was installed in a work area of a doctor’s office was tangible personal property. The Comptroller deemed that it served the doctor’s office and not the building and entire amount of the contract to install was deemed taxable.
Below are some other examples of items that after installation, the Comptroller’s Office deems as tangible personal property and have taxed in audits that I have been involved in.
Countertops and cabinetry installed in commercial spaces, regardless of how installed and not installed in kitchen or bathroom areas.
Bars and food stations in bars and restaurants.
Reception desks and bank teller stations.
Blinds or drapes installed. Even motorized units that may hide in the ceiling.
TV installation (fabrication labor), programming and cabling.
Projection screens in conference rooms. Unit may hide in the ceiling.
Specialized water systems that are outside the domestic water system that supplies water to the kitchen and bathroom areas.
Backup generator systems for commercial customers.
Canvas or vinyl awnings for commercial customers. Most residential awnings are considered tangible personal property.
All types of signage. See Regulation 36.
Fuel tanks, even those in the ground.
Another issue with this audit was credit card transactions. Even though this Taxpayer filed monthly use tax returns, the credit card bills were not reviewed for use tax due on purchases from out of state suppliers who did not collect MD sales tax. This is a favorite area for the MD auditor’s to review that usually leads to a lot of issues because more and more is being purchased via credit cards these days, there are missing invoices, and there is usually a fair amount of out of state purchases because a direct account is not setup with these suppliers to pay by the normal AP system.
If you are a General or Subcontractor and have been audited in the past, then please call Marsu now to determine if your case can be reopened pursuant to Section 13-509 of the Annotated Code of Maryland to get any taxes improperly assessed back as a refund or if you are just due a refund of sales and use taxes paid in error. Marsu’s review is performed on a contingent basis and no fee is due if no refund is approved by the Comptroller’s Office.
Maryland Taxpayer designs workplace environments, provides and installs office furniture, including workstations, in the Mid-Atlantic region. Taxpayer was selected for a first-time MD sales and use tax audit. Taxpayer contacted Marsu to assist in the review of the workpapers. The Taxpayer was assessed $43,790.62, $35,768.75 for failure to properly to collect sales tax and $8,021.87 for failure to pay use tax on assets and expenses where sales tax was not paid to the supplier. Marsu did the following for each schedule included in the audit:
For sales, the auditor reviewed a block sample of two months and listed just 4 invoices as taxable to get the $35,768.75 tax assessment amount. Marsu convinced the hearing officer that the two month sample did not fairly represent the Taxpayer’s business and that the sample period should be expanded and a five month block sample was agreed upon. This five month sample included the original two months selected by the Comptroller’s Office. The auditor came back out to the Taxpayer’s office to review the additional three months and listed an additional 21 lines to the sales schedule as taxable sales. Marsu reviewed the job folder for each sales invoice and was able to document that 13 lines should be deleted from the schedule. The tax assessed was reduced from $35,768.75 to $6,957.40, a savings of $28,811.35.
For sales projection methodology, the projection methodology did not fairly represent the Taxpayer’s business over the audit period and Marsu convinced the Controller’s Office to enlarge the sample period and to accept a different projection methodology that greatly reduced the sales tax collection liability.
For expenses, the auditor reviewed the same two month block sample and listed 6 invoices as taxable. Marsu reviewed these 6 invoices and found no errors.
For assets, the auditor reviewed all assets in the audit period and listed 31 invoices as taxable. Marsu reviewed these invoices and was able to document that 2 invoices were non-taxable. The tax assessed was reduced from $7,051.09 to $5,971.09, a savings of $1,080.00.
With Marsu’s assistance, this Taxpayer was able to significantly reduce their tax assessment by 63% and save $13,000.82 interest and to have the penalty abated at settlement. Marsu did perform a reverse audit, but this Taxpayer did not overpay on any sales or use taxes on their business purchases.
Main Audit Issues
When the Comptroller’s Office performs a sales and use tax audit, the procedure in how the sales and expense projections are calculated is always the same. The Comptroller takes certain information off the federal income tax returns and assesses the Taxpayer by multiplying the total expenses or sales for the audit period by the error factor calculated in the sample used and then multiplying the resulting taxable base by the 6% tax rate to finally calculate the amount of tax due. The problem with this methodology is that the sample does not always fairly represent the Taxpayer and his business over the four year audit period. Sometimes the sample is heavy in some type of taxable transaction or transactions that exaggerates the projection or sometimes the sample is light in non-taxable transactions that would also exaggerate the projection because they are not fairly represented.
This Taxpayer had a little bit of both problems in their sales projection. The sales sample selected by the state only had 4 sales invoices that were deemed taxable, but they were 4 large invoices which projected to a large assessment and the percentage of non-taxable transactions were not fairly represented in the original two-month sample. By expanding the sample size from two to five months, the average liability per month decreased so the total tax liability decreased and Marsu presented another projection methodology that pulled the non-taxable transactions out of the projection entirely.
A second issue that this Taxpayer had was that the Taxpayer was not collecting tax on all taxable separately stated lines items on their invoices. The Taxpayer was collecting tax on the furniture that was being sold but did not collect tax on the “fabrication labor” used at the jobsite to fully assemble the furniture or workstations. The Comptroller’s Office position is that all costs used to assemble a piece of property for the first time, on the jobsite or elsewhere, is taxable.
If you are a retailer who collects tax and is not being audited, then please call Marsu to do a mock sales tax audit to determine if the company is properly collecting sales tax. See our Mock Audit Services tab on the website. State sales tax collection assessments does not only deal with getting proper resale certificates, but with collecting tax on all appropriate line items on your invoices. General rule is that all lines are taxable unless there is a specific exemption in the law. Of course, the main exemption in Maryland is on freight, shipping or delivery that is separately stated on the invoice. If the invoice says shipping and handling, then that item is taxable because you are bundling a taxable and a non-taxable item together and that makes the entire charge taxable.
Maryland manufacturer who sold products on a wholesale and retail basis was selected for a Maryland sales and use tax audit. Marsu was contacted by the company’s lawyer to assist in the review of the workpapers. The Taxpayer was assessed $85,660.97 for failure to collect sales tax on their sales and a small assessment for failure to accrue use tax on assets purchased when tax was not billed. Taxpayer was also issued a 60 day letter for their resale certificates which means that the Comptroller gave them 60 days from the date on the letter to obtain all properly documented Maryland resale certificates from their customers or the sales would be deemed to be taxable regardless if they were for resale or not. Marsu did the following for the capital and sales schedules in the audit:
For the capital assets, the auditor reviewed every asset purchase in the audit period and listed every invoice that did not have sales tax billed and collected. The auditor listed 6 invoices on this schedule and Marsu was able to get three of those invoices deleted from the schedule for the manufacturer’s exemption. The tax assessed was reduced from $2,618.37 to $252.67, a savings of $2,365.70.
For sales, the auditor reviewed a six-month sample period and listed just 19 lines, but the projection totaled $83,042.60 in tax liability. The majority of the assessment came from just two customers. One who did not have a resale certificate until after the 60-day grace period and the other went bankrupt and we could not get a resale certificate even if they had one. The Comptroller’s Office would not negotiate on the resale certificate customer because of the 60-day letter, but Marsu was able to get the bankrupt customer out of the projection and assess that customer on an actual basis over the audit period. Of the remaining lines listed, Marsu was able to get five (5) more lines out. The tax assessed was reduced from $83,042.60 to $22,689.31, a savings of $60,353.29.
Marsu also performed a reverse audit and documented sales taxes paid in error and the Comptroller’s Office approved and included the refund in the amount of $20,570.04 in the audit workpapers as required by law. The original workpapers had the Taxpayer owing $85,660.97 in taxes and the final workpapers had the Taxpayer owing $22,941.98 in taxes, a saving of $62,718.99.
Main Audit Issues
The Comptroller’s Office has the legal right to issue a taxpayer a sixty (60) day letter to have the Taxpayer obtain properly documented Maryland resale certificates for all customers that they do not collect tax from or The Comptroller will deem those sales as taxable and 6% tax will be due. See Title 11, Section 408 which allows the Comptroller to issue a Taxpayer a 60-day letter. The Taxpayer had a lot of customers that were for resale and the Taxpayer had actually done a great job in getting the majority of properly documented Maryland resale certificates for the auditor. The one thing the Taxpayer could have done a little different was to prioritize the resale certificates by dollar value in the audit so they would get the resale certificates for the customers that made up the largest portion of the $83,042.60 tax assessment. The one customer that they did not get a resale certificate in time for was worth $11,802.00 in tax.
The importance of getting properly documented resale certificates when the customer’s credit is approved or at the time of the first sale is also shown here by the fact that the Taxpayer got assessed for tax for a customer that went bankrupt. For whatever reason, the auditor had selected a sample sales period that was over two years old and that made it more difficult for the Taxpayer and Marsu in securing valid Maryland resale certificates and made it impossible for the customer that went bankrupt. Luckily Marsu was able to have the Comptroller assess the tax on the actual sales for the audit period instead of the projected tax assessment for this customer. The projected tax assessment was $34,397.00 and the actual amount due was only $3,790.49, a saving of $30,606.51.
The last important issue with the sales audit was that several of the lines included in the audit were sales where the customer picked up the product at the Taxpayer’s manufacturing plant in Maryland. Even though each customer could have had a resale certificate from their home state, DC, OH, PA, VA or WVA, pick-up sales are taxable unless the customer has a valid Maryland resale certificate.
Maryland countertop manufacturer and installer was selected by the Comptroller’s Office for a Maryland sales and use tax audit. Taxpayer manufactured and installed countertops for residential and commercial customers in DC, MD, and VA. This Taxpayer had never been audited before and Marsu was recommended by the Taxpayer’s lawyer to assist in the audit process. Unfortunately, Marsu was not contacted in time to review the workpapers in the field with the auditor so the lawyer had to request an informal hearing and Marsu had to present the documentation to a hearing officer. The Taxpayer had been assessed tax on sales for failure to collect sales tax on commercial jobs and for failure to remit use tax on expenses and capital assets. Marsu assisted the Taxpayer in reviewing each schedule as follows:
For sales, the auditor reviewed nine months of sales invoices and listed only 14 invoices as taxable, but the projected liability was $77,663.09. Marsu pulled the job folders to review each job and was able to document that 1 job was non-taxable, reduce the liability for 3 jobs and got the Comptroller’s Office to tax 2 jobs on an actual basis. These adjustments reduced the tax assessed from $77,633.09 to $25,496.05, a savings of $52,137.04.
For COGS expenses, the auditor reviewed twelve months of invoices and listed 301 invoices as taxable. Marsu reviewed each line item and provided documentation to have 142 lines deleted and 2 lines reduced. These adjustments reduced the tax assessed from $24,908.39 to $14,924.70, a savings of $9,983.69.
For assets, the auditor reviewed every asset purchased during the assessment period and listed 14 invoices. Marsu reviewed each of the assets and was able to provide documentation to get 3 of the lines deleted. The tax due was reduced from $10,469.55 to $2,754.10, a savings of $7,715.45.
Marsu also performed a reverse audit and documented sales taxes paid in error and the Comptroller’s Office approved and included refunds in the amount of $17,335.29 in the audit workpapers as required by law. At the time of the audit, the Comptroller’s Office was offering an Amnesty Program and the Taxpayer enrolled and was able to pay only half the interest due and have the penalty abated.
Main Audit Issues
Countertop manufacturers and installers have been a favorite audit target of the Comptroller’s Office for many years. If the Taxpayer is not properly collecting tax, then the tax assessment will be in the tens of thousands or even in the hundreds of thousands of dollars depending on the size of the company and type of work performed. As you can see from this case, this Taxpayer is a testimonial to that fact. This Taxpayer did a fair amount of commercial work and was not collecting sales tax.
Twenty years or so ago, the Comptroller’s Office added the infamous two sentences to Maryland Tax Regulation .19 – Real Property Construction, Improvement, Alteration and Repair that sums up their position on taxability when auditing a countertop manufacturer and installer.“As a general rule, counters, countertops, and cabinetry installed in commercial spaces will be treated as tangible personal property. Doors, windows, molding, built-ins, and kitchen cabinetry installed in residential and commercial spaces will be treaty as realty”. So if a Taxpayer does commercial work and it is not in a kitchen or bathroom, then the Comptroller’s position is that the job is taxable and will assess the Taxpayer for failure to collect tax unless tax was collected by the Taxpayer.
So if you the Taxpayer furnish and install any of the following for a commercial business, then tax should be collected from the customer – any countertop and cabinetry installed in a non-kitchen or non-bathroom area. Examples are bank teller stations, bars, beverage counters, food stations and wine racks in restaurants, built-in shoe racks, cashier counters, lockers, reception desks, and service desk and counters. Other examples include countertops and cabinetry in all non-kitchen and non-bathroom areas in office buildings, like in copy or conference rooms. The Comptroller’s Office in this case even assessed a stone countertop ledge and cabinetry that was installed in the conference room underneath the windows even though the ledge and cabinetry was installed to bare stud walls and an operating table in a veterinarian’s office.
How Audits Happen
This audit represents a typical way that a Taxpayer gets selected for a sales tax audit. The Taxpayer’s customer gets audited first and the auditor sees that the countertop manufacturer is not collecting sales tax, so the auditor turns in the Taxpayer for an audit.
Countertop manufacturers and installers are one of the most often audited types of businesses. That is because the MD sales tax law is so confusing and there are so little guidelines available. If you are a countertop manufacturer and installer and have been audited in the past, then please callMarsu now to determine if your case can be reopened pursuant to Section 13-509 of the Annotated Code of Maryland to get any taxes improperly assessed back as a refund or if you are just due a refund of sales and use taxes paid in error. Marsu’s review is performed on a contingent basis and no fee is due if no refund is approved by the Comptroller’s Office.
A small Maryland Taxpayer that provides printing and mailing services was being audited by the Comptroller’s Office. The accounting firm and Taxpayer had reviewed the original workpapers and provided the field auditor with some documentation to get the tax assessment down to $25,145.41. Marsu was contacted by the Taxpayer’s accounting firm to assist in continuing the review of the workpapers. Since the accounting firm and Taxpayer had completed the review of the workpapers with the auditor in the field, Marsu had to request an informal hearing to get any other adjustments out of the audit and to submit the refund request to the Comptroller’s Office. Like most Maryland sales and use tax audits, the workpapers had liabilities for assets, sales, and expenses. Marsu assisted the Taxpayer in reviewing each schedule as follows:
For sales, the auditor reviewed a two-month sample and had originally listed 195 invoices as taxable and now 57 invoices remained. Marsu reviewed each remaining sales invoice and provided documentation to get 26 more sales invoices deleted from the schedule and 7 invoices reduced. The tax assessed was reduced from $22,739.41 to $10,049.15, a savings of $12,690.26.
For expenses, the auditor reviewed a one-month sample and listed 21 invoices as taxable and now 5 invoices remained. Marsu reviewed each expense invoice and provided documentation to get 1 invoice reduced in the schedule. At the time of the audit, the most current year tax return was not filed, and the expenses were estimated based on the previous years’ tax return. With the new tax return information, the tax assessed was actually increased from $1,254.50 to $1,285.77, an increase of $31.27.
For assets, the auditor reviewed every asset in the audit period and listed 4 invoices as taxable. Marsu reviewed each invoice and provided documentation to get 2 invoices deleted from the schedule. The tax assessed was reduced from $1,151.50 to $654.47, a savings of $497.03.
After reviewing the audit workpapers, Marsu performed a reverse audit and documented sales and use tax paid in error and the Comptroller’s Office approved and included the refund in the amount of $45,248.22 in the workpapers as required by law. The hearing officer applied $11,989.39 of the refund to the outstanding tax assessment from the audit and instructed the Refund Desk to issue the Taxpayer a refund of $33,258.83.
Main Audit Issues
Another typical case where a small growing business did not have the manpower and knowledge to request and obtain proper executed MD resale certificates and to properly collect sales tax on sales of printed materials delivered in MD. This Taxpayer had evolved into a fulltime printer who not only provided mailing services, but sometimes printed the customer’s materials and shipped the final product all over the United States. One thing they forgot to consider was that any printed materials delivered to a MD location was taxable unless a properly executed MD resale certificate was obtained. Marsu assisted the Taxpayer in getting the properly executed MD resale certificates and to limit the liability on each sales invoice in the audit workpapers to those materials delivered to MD, if any, for the remaining sales invoices in the audit. Luckily the Taxpayer had customer files of the delivery locations for all the recipients for each job, so Marsu could easily document the adjustment requested and these adjustments were approved by the Comptroller’s Office for out of state sales which are not taxable for MD sales tax purposes.
If you are a printer who collects tax and is not being audited, then please call Marsu to do a mock sales tax audit to determine if the company is properly collecting sales tax. See our Mock Audit Services tab on the website. State sales tax collection assessments does not only deal with getting proper resale certificates, but with collecting tax on all appropriate line items on your invoices. General rule is that all lines are taxable unless there is a specific exemption in the law. Of course, the main exemption in Maryland is on freight, shipping or delivery that is separately stated on the invoice. If the invoice says shipping and handling, then that item is taxable because you are bundling a taxable and a non-taxable item together and that makes the entire charge taxable.
Total Original Assessment Amount – $11,835.94
Refund from Original Assessment $5,152.14 – 43%
Refund from Reverse Audit – $49,501.47
Unfortunately, I hate to admit it but, this is the only closed case that Marsu has ever been given the opportunity to appeal. This Taxpayer had been previously audited in 2004 and assessed and paid $11,835.94 for failure to pay use tax. The Comptroller classified the Taxpayer as a consuming contractor who performs real property work and was audited as such. In 2006, Marsu appealed the assessment under Section 13-509 of the Annotated Code of Maryland and was able to reduce the original assessment and get the Taxpayer a $5,152.14 refund check. This was a 43% reduction from the original assessment which includes penalty and interest.
After reviewing the old assessment, Marsu performed a reverse audit and was able to secure the Taxpayer a sales tax refund for $49,501.47.
Main Audit Issues
I understand that Taxpayer’s feel like they go from fire to fire in their business and when the fire is put out, they do not want to revisit the issue again. In this case, not only did the Taxpayer get almost half his money back that he paid for the audit, but he received an additional refund that averaged $12,375 a year. So for over the past 14 years, this Taxpayer has saved $173,250 in taxes that he would have paid if he had not allowed Marsu to do their free review.
One important point here is that I understand that Taxpayers believe that tax auditors are all experts in their field. The truth is that they are not always an expert and they definitely are not an expert in what your business does. The auditor comes into the audit with preconceived ideas of how sales and use taxes apply to your business. When you should be collecting tax and when you should be paying taxes to your suppliers. This is especially true for real property contractors like my electrical contractor friend here. If there is a small part of your business that is different than the auditor’s preconceived ideas, the business could be inadvertently overpaying their sales and use taxes. Even if the auditor sees that the Taxpayer is due a refund, the auditor will most likely not inform the Taxpayer of the overpayment. Another important point is the Taxpayer needs a representative that will look out for the Taxpayer and that is what Marsu does. The reverse audit is performed on a contingent basis. If no refund is found, then no fee is due. Marsu only gets paid after the refund is approved and credited against the current tax assessment amount or paid to the Taxpayer. Even if no refund is found, the Taxpayer at least gets the assurance that their sales and use taxes are not being overpaid and it cost the Taxpayer nothing to get that assurance.
In March 2018, the Taxpayer was referred to Marsu by their accountant to address their methodology of paying use tax to Maryland and Virginia. Taxpayer manufactures countertops at their Maryland facility and installs countertops in Maryland and Virginia for residential customers only. Marsu determined that the “first use theory” applies and all sales and use tax on the materials incorporated into the countertops is due to Maryland because the materials are used in Maryland first thus titled passed in Maryland and Maryland is due the tax. So the Taxpayer closed their VA use tax account and in January 2019, the Commonwealth of Virginia selected the Taxpayer for a sales and use tax audit because the account was closed. At the initial meeting with the auditor, Marsu explained what had happened and why. The auditor agreed that this tax interpretation was correct. The auditor performed a cursory review and found no basis to assess the Taxpayer. Taxpayer was issued a zero assessment.
Main Tax Issue
States are always fighting over sales and use taxes due by contractors that have real property contracts in multiple states. This is especially true for companies that work in DC, MD, and VA. Marsu is always explaining the “first use theory” or that “title passes” in the Taxpayer’s home state to the auditors or hearing officers in the adjacent states to get invoices out of the audit workpapers. Just because the material is ultimately used in their state, the auditors and hearing officers think they are due the tax.
Virginia countertop manufacturer and installer was selected by the VA Department of Taxation for a Virginia sales and use tax audit. This was the first-time audit for this Taxpayer. Marsu was contacted by the owner of the business because the Taxpayer had just received workpapers stating that they owed $150,065.52 in sales and use taxes. Marsu immediately contacted the auditor and was able to start the review process in the field with the field auditor and supervisor which is a lot easier than having to request an informal hearing and having to explain everything all over again to a hearing officer. The auditor had reviewed a sample period for sales and expenses and projected the assessment over the audit period and reviewed all assets purchased during the audit period. Marsu did the following for each schedule in the audit:
For sales tax collected, but not remitted, the auditor reviewed four sample months to confirm that sales tax collected was remitted. Taxpayer remitted taxes as they collected tax from customer instead of remitting taxes as billed (By law, taxes are supposed to be remitted as billed, not as collected). Auditor had problems reconciling the amount that was paid in the three of the four months selected and calculated a large deficiency. Marsu reexamined the three months and provided documentation that the Taxpayer had actually remitted all of the tax in two of the three months and had a small error in one month because of a change in bookkeepers. The tax assessed was reduced from $85,577.22 to $534.67, a savings of $85,042.45.
In the sales sample of four months, the auditor listed four invoices where sales tax was not properly collected. Marsu reviewed these four invoices and obtained a resale certificate for one of the invoices. Luckily this one invoice was the largest invoice and consisted of 68% of the dollars listed in the schedule. The tax assessed was reduced from $28,493.20 to $1,709.58, a savings of $26,783.62.
For expenses, Virginia was trying to assess the Taxpayer as a consuming contractor because the Commonwealth believed the Taxpayer did not meet the three prong test to be classified as a manufacturer/retailer because the Taxpayer did not have an inventory of products for sale, but purchased materials on a job cost basis. Marsu provided documentation that the Taxpayer actually did have inventory on hand and did not have to pay tax on the materials incorporated into the job where they had already collected sales tax from their customer.
For expenses, the auditor reviewed three months and had listed 139 line items as taxable. This list included COGS, assets, shop supplies and administrative expenses. Since Marsu proved to the auditor that the Taxpayer had an inventory, all the COGS materials were deleted from the list. For the assets and shop materials, Marsu provided the auditor a description of exactly how the assets and shop supplies were used in the manufacturing process and these transactions were deleted from the list. For the administrative expenses, Marsu was able to obtain copies of these expenses to show the auditor that sales tax was billed and collected by the supplier. After all the deletions, only 17 line items remained. The taxed assessed was reduced from $35,995.10 to $2,159.71, a savings of $33,835.39.
The original workpapers had the Taxpayer owing $150,065.52 in taxes and the final workpapers had the Taxpayer owing only $4,403.96 in tax, a savings of $145,661.56. With penalty and interest, the Taxpayer paid $5,433.95 to settle the assessment.
Main Audit Issues
In VA, the sales tax laws regarding manufacturers/contractors/retailers are different than in DC and MD and is discussed in detail in VA Administrative Code 10-210-410(G). In VA, a Taxpayer who is installing fences, venetian blinds, window shades, awnings, storm windows and doors, floor coverings, cabinets, kitchen equipment, window air conditioning units or other like or comparable items is considered a retailer and should collect tax on the sale if the Taxpayer meets the following three conditions:
Maintains a wholesale or retail place of business
Maintains an inventory of the aforementioned items and/or materials which enter into or become a component part of the aforementioned items
Who performs installation as part of or incidental to the sale of the aforementioned items
In July 2010, VA changed their law regarding countertop manufacturers/installers. Prior to this, a countertop manufacturer/installer was a consuming contractor and paid tax on all materials incorporated into the job and collected no tax. The law change made a countertop manufacturer/installer a retailer and should collect tax on their sales. With this law change, this Taxpayer started to collect tax on their sales because they met the three above conditions.
I am not exactly sure what happened during the auditor’s original examination of the Taxpayer’s business in determining if the Taxpayer was a consuming contractor or a manufacturer/retailer. For whatever reason, VA believed that the Taxpayer did not carry an inventory of granite or marble slabs and therefore did not meet the three-part test of being a retailer and was deemed a consuming contractor. I am chalking this error up to a miscommunication between the Taxpayer and auditor. I am guessing that the auditor did not explain the three-part test to the Taxpayer, so the Taxpayer did not know the importance of their answers regarding this issue. Regardless of what happened, the key point here is that we were able to straighten it out and the Taxpayer’s assessment was corrected in this area. I thought it was sad though that the Commonwealth of Virginia was trying to get the tax from both ends of the transaction. First from paying the tax on the materials when purchased and then from collecting the sales tax from the customer. If the Commonwealth thought that the Taxpayer was a consuming contractor, then I would have thought the Commonwealth would have just been happy in getting the tax on sales price vs. the cost of the materials and not try to assess tax on the COGS when the Taxpayer had already collected the tax from their customers.
Second issue is that by law sales tax is to be remitted as billed and not as collected. I know this creates a cash flow issue, but that is the law.
The key issue with dealing with any type of auditor is communication. Marsu believes in knowing the answer before the question is asked and if Marsu does not know the answer, then Marsu has the ability to say I am not sure, and I will get back to you with the answer. The problem here is that the Taxpayer should know everything about their business, but does the Taxpayer know how to properly answer the questions for sales tax purposes? Probably not. When the audit starts, the auditor will have some preconceived ideas of what the Taxpayer should be collecting tax on, if any, and what the Taxpayer should be paying sales and use tax on. These preconceived ideas will probably come from the auditor’s experience of auditing other like Taxpayers or viewing the Taxpayer’s website. In the first meeting with the auditor, the auditor will usually discuss the Taxpayer’s business to exactly find out what the business does. The auditor will be asking targeted questions that deals with collecting tax vs paying sales and use tax on materials purchased for the business. The auditor will be clinging to every word that the Taxpayer says, and their preconceived ideas can change with whatever you tell them. This includes miscommunication to when the auditor improperly interprets what was said or the lack of what was said. If Marsu is involved before the audit starts, then the information for sales and use tax purposes can be effectively communicated to the auditor and hopefully no improper interpretations will be made.
Additional Law Change
Effective July 1, 2017, VA reversed their 2010 law change regarding countertop manufacturers/installers and deemed them to be consuming contractors again. Therefore, these Taxpayers pay tax on their materials incorporated into the job and collect no tax when the job is installed.
If at times, the Taxpayer just manufacturers a countertop without installation or manufacturers a countertop with material provided by the customer, then the Taxpayer should collect tax on these transactions. To do this, the Taxpayer needs to have a VA sales tax license to collect tax.
VA Total Assessment Amount – $37,293.07
Total Reduction Amount – $5,145.05 – 14%
VA Refund Approved – $15,287.22
DC Refunds Approved – $9,233.50
MD Refund Approved – $89,452.26
Exceptionally large Maryland mechanical contractor working in DC, MD and VA was selected by the Commonwealth of Virginia for a VA sales and use tax audit. This was the Taxpayer’s second VA audit in the past ten years. Marsu had assisted the Taxpayer in the previous audit and was called upon again to help. Because the Taxpayer was so large, Marsu recommended this time that the Taxpayer have VA perform a Stratified Statistical Sampling audit instead of the normal block sample audit because if a big or large error is in the block sample it distorts the projected liability. Stratified Statistical Sampling eliminates this problem. Once VA understood how big the Taxpayer was and the volume of records involved, VA agreed to the Stratified Statistical Sample audit. Marsu assisted the Taxpayer as follows with the Sample and resulting expense schedule:
For the Stratified Statistical Sample, Marsu reviewed the expense accounts and job type selected by the auditor to be included in the audit, what information could be provided in the download given to the auditor, and what information would be provided for the invoices selected. After all the parameters were determined for the download, the Taxpayer had the program written to create the file of all the AP invoices and what data to be included for each invoice in the file. After the audit file was created for the three-year audit period and since the Taxpayer’s AP records were all scanned, the Taxpayer was able to print out all the selected AP invoices by supplier, in date order for the auditor’s review.
For the selected expense invoices, the auditor reviewed 1,190 invoices and only listed 34 invoices where sales or use tax were not paid. This Taxpayer had a great accounting system for properly paying sales and use taxes and Marsu knew that from the last VA audit. Marsu reviewed the 34 lines and was able to reduce the taxable base by $9,981.14. This reduction resulted in the assessment being reduced from $37,293.07 to $31,147.41, a savings of $5,145.66. The savings included interest. Penalty was not assessed by VA, because of how compliant the Taxpayer was.
Main Audit Issue
With this Taxpayer, there is really no issue with the procedures in place to pay sales and use taxes on their real property construction jobs. The Stratified Statistical Sample file for the VA audit had over 25,471 lines in it with a dollar value of $39,343,230.43. The sample itself only had 1,190 invoices in it but represented 61.2% of the dollars. For the top two dollar value ranges in the sample, VA reviewed 100% of the invoices and if any of those invoices had been in the normal block sample audit with no tax being paid, the assessment would have been a lot higher than the Sample assessment of $31,147.41.
Reasons for Success
Unfortunately, states love to audit real property contractors. Real property contractors are considered consuming Taxpayers and owe tax on all the materials incorporated into their jobs and these Taxpayers have been audited so much it has become second nature for some of them to pay use tax on transactions where sales tax is not charged. This is the case with this Taxpayer. After a while, the Taxpayer needs to push back and that what happens when a Taxpayer hires Marsu to assist them with an audit. Not only will Marsu assist the Taxpayer in lowering the assessment to the lowest amount possible, Marsu will document all refunds that the Taxpayer has inadvertently overpaid. Plus I have seen it where Taxpayers who have been audited on a regular basis in the past have had that trend stop after Marsu has gotten involved with the audit to reduce the tax assessed and has filed an offsetting refund with the State Agency involved. In this case, the Taxpayer only owed a net of $15,860.19 after the refund and the auditor spent hundreds of hours doing the review with results that on an hourly basis were very below average. In some cases, the Taxpayer actually got a refund back from the State performing the audit. In this case, the State is really a loser.
For this audit, the Taxpayer actually made money. Marsu had DC, MD and VA refunds approved in the amount of $113,972.98 minus the VA audit of $31,147.41 for a profit of $82,825.57. Marsu did not have a lot of time invested in the VA audit review. Marsu mainly advised the Taxpayer on the Stratified Statistical Sample audit methodology and reviewed only 34 invoices. So for this three-year audit, the Taxpayer saved an average of $27,608 per year and if the Taxpayer instituted all changes, the Taxpayer has saved $220,864 over the past eight years.