MD Tax Assessment Amount – $138,629.42
Reduction Amount – $84,911.83 – 61%
Approved Credit/Refund – $73,202.29
Interest and Penalty Savings – $55,451.77
Refund Check Received – $19,484.70

Maryland woodworking and cabinet making shop was selected by the Comptroller’s Office for a Maryland sales and use tax audit.  This taxpayer had been audited before and Marsu was contacted by the Taxpayer’s lawyer to assist in the audit process.  Like any other audit, the auditor reviewed a sample period of sales and expenses and projected the assessment over the audit period and reviewed all asset purchases.  Marsu assisted the Taxpayer in reviewing each schedule as follows:

1. For sales, the auditor reviewed three months of sales invoices and listed 77 out of 223 invoices as taxable. Marsu had Taxpayer pull invoices, contracts, and job estimation sheets to prove to the auditor that an invoice was not taxable.  Sales schedule ended up with just 8 taxable invoices where tax was not properly collected.  The tax assessed was reduced from $54,939.82 to $24,488.35, a savings of $30,451.47.
2. For sales tax projection methodology, the Comptroller’s methodology did not fairly represent the Taxpayer’s business over the audit period so Marsu had the Taxpayer document an alternative methodology that was accepted by the Comptroller’s Office. Alternative methodology saved the Taxpayer approximately $10,000 in tax on the sales schedule.
3. For expenses, the auditor reviewed three months of expense invoices and listed 188 invoices as taxable. Marsu reviewed each line item and provided documentation to the auditor that the line was not taxable or that use tax was paid.  The expense schedule was reduced by 67% of the dollar value of the invoices listed.  The Taxpayer had a complicated system of paying use tax and showing that the purchase was for resale.  The Comptroller made the Taxpayer prove each line item that was for resale by matching the purchase to its’ corresponding sales invoice.  This was a very time-consuming process.  The tax assessed was reduced from $78,406.27 to 23,945.91, a savings of $54,460.36.
4. For assets, the auditor reviewed every asset purchased during the audit period and only found issue with one invoice. Marsu agree that the one invoice was taxable.

Marsu also 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 $73,202.29 in the audit workpapers as required by law.  The original workpapers had the Taxpayer owing $138,629.42 in taxes and the final workpapers had the Taxpayer receiving a refund check in the amount of $19,484.70, a savings of $158,114.12.  Since the Taxpayer received a refund, there was no interest and penalty assessed.

Main Audit Issues

Cabinet and countertop manufacturers have been a favorite audit target of the Comptroller’s Office for years.  If a Taxpayer is not collecting tax properly, then the assessment will be in the tens of thousands of dollars or even hundreds of thousands of dollars depending on the size of the company and type of work performed.

Twenty years or so ago, the Comptroller’s Office added the infamous two sentences to Maryland Tax Regulation .19C(5) – Real Property Construction, Improvement, Alteration and Repair that sums up the Comptroller’s position of taxability when auditing a cabinet and countertop 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 or commercial spaces will be treated as realty”.  So if a Taxpayer does commercial work and it is not in a kitchen or bathroom, then the Comptroller’s Office is going to assess the Taxpayer regardless of how the cabinetry or countertop is installed.  Even commercial built-in cabinetry work that is installed directly against wall studs or recessed into the wall is considered tangible by the Comptroller’s Office.  For the Comptroller’s Office the word built-ins are defined as like garbage disposals not built-ins as understood by the cabinetry manufacturers and installers.

So if you furnish and install any of the following, then tax should be collected from the customer – any cabinetry and countertop installed in a non-kitchen or bathroom area, like in a doctor’s office or a work area room (paper copy station), bank teller stations, bars and food stations in restaurants, benches, cashier counters, concession stands, credenzas, lockers, reception desks, and service desks and counters.  The Comptroller has even assessed window ledge under windows in conference rooms, recess cabinetry in walls, and sinks in common areas of doctor’s office or exam rooms.

One minor issue in the sales tax collection area was fabrication labor.  If the Taxpayer takes the customer’s material and manufacturers an item or just performs a simple task as cutting or drilling holes in the material, then the Taxpayer’s labor charge is taxable.  The Comptroller’s Office considers the labor as part of taxable price of the finished product.  Just because the labor to manufacture a product is performed by two or more businesses, it is still taxable.  If one Taxpayer had performed all the labor to manufacture a product, then the total price is taxable.  See MD Tax Regulation 30 – Fabrication or Production for the Comptroller’s description of what fabrication labor is.

 The last major issue in this audit was inventory items used in jobs for resale and also in jobs where the Taxpayer is installing the material into real property.  If the material is used in a job for resale, then no tax is due on the material when purchased and tax is collected from the customer on that material.  If the material is used by the Taxpayer on a real property job that is installed by the Taxpayer, then tax is due on the cost of the material incorporated into the job.  Taxpayer was buying all the inventory items for resale and paying no use tax when used on realty jobs.  Inventory items were items like bolts, caulk, glue, hardwoods, melamine, molding, nails, paint, plywood, screws, shims, stain, thinner and washers.  Problem was that items purchased in bulk were not allocated to realty or resale jobs, so the Taxpayer had no methodology to self-assess use tax on the material cost of inventory items being used in realty jobs.  The Comptroller’s Office took the position that 100% of the inventory items were taxable.  For the hardwoods purchased by the Taxpayer, Marsu matched the purchase to sale invoices to get the purchase removed or reduced on the expense schedule.  For all the other items, Marsu calculated a percentage of sales dollars of non-taxable jobs to total jobs for the sales sample period and used that percentage to reduce the inventory items on the expense schedule.  The Comptroller’s Office accepted this analysis.

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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 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.

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MD Tax Assessment Amount – $43,790.62
Reduction Amount – $29,862.58 – 68%
Interest Saved – $13,000.82
Penalty – Waived at Settlement

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:

1. 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.
2. 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.
3. 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.
4. 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.

Call Marsu

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.

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