DC Tax Assessment Amount – $35,807.43
Reduction Amount – $25,573.19 – 71%
Interest Saved – $9,816.11
MD Refund Filed – $7,691.40
Maryland HVAC contractor working in DC, MD and VA was assessed by the DC Office of Tax and Revenue for failure to collect sales tax on taxable sales and services. After receiving the initial workpapers assessing the business $35,807.43 in taxes, the Taxpayer contacted Marsu to review the workpapers to determine if the assessment could be reduced. The taxpayer’s business is located in Maryland, but failed to properly register in DC for the collection of DC sales tax, so the statute of limitation for the audit was extended back beyond the normal three year audit period. Luckily the Taxpayer just started his business in 2015, so the starting period of the audit was 2015. Marsu assisted the Taxpayer with reviewing the sales schedule as follows:
- For sales, the auditor did an actual audit and reviewed all DC sales invoices for the audit period and listed 70 invoices as taxable. Marsu reviewed each invoice and proposal and documented that 19 invoices were not taxable and that 14 invoices were reduced. The tax assessed was reduced from $35,807.43 to $10,234.24, a savings of $25,573.19.
- For expenses, after Marsu provided documentation that some of the sales were actually for furnishing and installing equipment deemed real property after installation, the hearing officer requested that the Taxpayer prove that sales tax was properly paid on the materials incorporated into those jobs. Marsu provided the material invoices for each job to document that sales tax was properly paid on all materials to the suppliers and no further tax was due.
Upon getting the workpapers from the Taxpayer, Marsu contacted the auditor and supervisor to see if the workpapers could be reviewed in the field, but the supervisor stated that an informal conference would have to be requested. Marsu requested an informal conference and Marsu provided the above mentioned documentation and the total assessment, including penalty and interest, was reduced from the $56,042.04 to $16,721.14, a savings of $39,320.90. Marsu was also able to get the penalty cut in half by the supervisor and filed a Maryland sales tax refund in the amount of $7,691.40.
Main Audit Issue
In DC, there is a big difference is the sales tax laws regarding real property contractors who furnish and install, repair or alter equipment into real property in DC vs MD and VA. Certain services for HVAC contractors, like maintenance contracts and T&M billings for repair of real property are taxable services and tax should be collected from the customer. Effective July 1, 1989, DC amended their sales tax law to include the T&M billing as a taxable service where sales tax is to be collected on only the material portion of the bill. As mentioned above, the Taxpayer failed to register to collect DC sales tax and was held liable for the tax that the Taxpayer did not collect. Like many audits, this Taxpayer’s audit arose from the audit of one of his customers where the auditor saw that the Taxpayer was not collecting tax.
Please see section on website on DC Real Property Services that are taxable for other services that are taxable besides maintenance agreements and T&M billings.
Other DC Concerns
The normal statute of limitations for a DC sales tax audit is three years, but DC’s policy is that if the Taxpayer should have been licensed to collect tax, but does not get licensed, then DC is allowed to extend the audit back as far as it wants. As mentioned above, the Taxpayer had just started his business in 2015 so the audit period was for a five year period.
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MD Tax Assessment Amount – $182,874.59
Reduction Amount $114,768.59 – 63%
Refund from Reverse Audit – $907,177.37
Refund from Taxpayer – $237,198.19
Interest & Penalty Savings – $73,149.84
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.
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MD Tax Assessment Amount – $598,110.61
Reduction Amount $531,320.75 – 89%
Refund from Reverse Audit – $17,085.98
Interest Savings – $189,486.77
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.
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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.
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