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:
- 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.
- 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.
- 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.
- 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.
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 – $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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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:
- 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.
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MD Tax Assessment Amount – $85,660.97
Reduction Amount – $62,718.99 – 73%
Offset Credit/Refund Approved – $20,570.04
Interest Saved – $22,053.89
Penalty – Waived at Settlement
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.
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