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Sales Tax

Technical topics regarding tax preparation.
#1
Jonas  
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Hey guys,

This is the first time I'm posting on this site so, we will see how it goes.

I have a new client that is being audited for sales tax, 3 years he didn't pay or filed any returns. I believe his last CPA did him a disservice regarding communication between the two. Anyways, can I amend the 2016-2018 returns for this expense even if he didn't pay it? I would like to increase these refunds so he can pay the audit. We won't fight the audit. Sales tax is on an accrual basis and we have reports to prove economic performance has occurred within the accrual method-due to tax determined and the client never intended or was willing to pay it.


Another question, we have internal reports from his POS, the sales is 50k lower than his bank deposits-which we can't explain. Can I file amended return to lower the income based on the internal reports or will his bank statements in an audit Trump his internal reports? His POS system is ran and maintained by an external company so he doesn't have the ability to change them.
 

#2
Frankly  
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Sales tax collected from customers is not an expense.

If you cannot determine income with any certainty, how can you justify changing what is reported on the tax return?
 

#3
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Gee, is there any chance the $50k excess deposits to bank account compared to POS sales equates to what should have been remitted in collected sales tax? Certainly seems a real possibility.

As said, not an expense. It's a liability and I would not doubt if the state has something similar to Trust Fund Recovery Penalty to hold him personally responsible, too, well beyond the initial sales tax, penalties, and interest.

Here's one problem with many merchants--they incorrectly lump collected sales tax in with revenue, and then try to claim sales tax expense to offset the amount included in income. Is this why you are mentioning sales tax as an expense and seeking "refunds" by amending? I fail to see how this would work, and would likely raise additional flags. If anything needs to be amended, it is to properly reduce gross revenue by amount of collected sales tax, credit sales tax liability on balance sheet, and eliminate any so-called sales tax expense.

For bank statements vs. POS, again, look into how much of the deposited funds represents sales tax. You'll probably find part, if not all, of the answer. Do not amend and reduce income without having substantiation.

Finally, what is the POS he is using where it is run by an external company?
 

#4
Jonas  
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Thanks for the replies. Yes, I understand it isn't an expense but it's included in gross income, because it's included in total deposits. I agree with you guys that it should just reduce income but the previous accountant didn't back it out. POS system is ran by corporate, he's involved in a franchise.

So, my initial question still stands, can I amend to include the sales tax paid in years 2016-2018, when it's actually paid in 2019?
 

#5
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Jonas wrote:So, my initial question still stands, can I amend to include the sales tax paid in years 2016-2018, when it's actually paid in 2019?


Amend what? No sales tax was paid, it just sat as a liability while he willfully spent the sales tax funds deposited to his bank account.

The expensing of sales tax approach is not correct, either. It is just what some tax preparers do when sales tax is incorrectly included in gross income, rather than correcting the accounting and properly reporting on tax returns. If you mean to amend to remove sales tax from gross income, and NOT expense it, and properly report it as a balance sheet liability, sure, go for it as long as it is valid and supportable. But it is completely irrelevant on income tax side when sales tax is remitted, and odds are your client will be facing hefty penalties and interest.

It seems the explanation between POS revenue vs. bank deposits should be reconciled via collected but unremitted sales tax liability.

It is a franchise? Your client could be facing more than just sales tax audit. Depending on what the franchise agreement says, he could be at risk of losing his franchise.
 

#6
Jonas  
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I know expensing the sales tax approach isn't correct but reducing income or adding the expense is the same net tax. Of course it's relevant on the income tax side, it's in gross income when it shouldn't be, he paid more tax than he should have. So, either am reducing income on 2016-2018, or I am taking a deduction in 2019 on his 1040 due to his business being final in 2018.
 

#7
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I'm saying payment of sales tax has no bearing on income tax...it's strictly a liability. We are not discussing use tax.

Yes, amend 2016-2018 to get the sales tax out of reported gross revenue, but do not just offset it with a sales tax expense under other expenses, or report it all in 2019. Amending to remove it entirely from revenue/expense while recording as liability and increasing assets (cash) is correct.
 

#8
Jonas  
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Thank you for the responses!!
 

#9
Doug M  
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#10
tshonk  
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What is the possibility the POS software is a zapper?
 

#11
Jonas  
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Thank you Doug-that's interesting.

TShonk, "Zapper?" I have no idea. Does Zapper account differently?
 

#12
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#13
Chay  
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Frankly wrote:Sales tax collected from customers is not an expense.

Jonas wrote: Yes, I understand it isn't an expense but it's included in gross income, because it's included in total deposits. I agree with you guys that it should just reduce income but the previous accountant didn't back it out.

CornerstoneCPA wrote:The expensing of sales tax approach is not correct, either.

I disagree:

  • Sales tax.
    State and local sales taxes imposed on the buyer, which you were required to collect and pay over to state or local governments, are not income.
    https://www.irs.gov/publications/p334#e ... 1000313417
  • Line 23
    You can deduct the following taxes and licenses on this line.
    •State and local sales taxes imposed on you as the seller of goods or services. If you collected this tax from the buyer, you also must include the amount collected in gross receipts or sales on line 1.
    https://www.irs.gov/instructions/i1040s ... 5537546944
  • Definition of gross receipts.
    [...]
    Finally, gross receipts do not include amounts received by the taxpayer with respect to sales tax or other similar state and local taxes if, under the applicable state or local law, the tax is legally imposed on the purchaser of the good or service and the taxpayer merely collects and remits the tax to the taxing authority. If, in contrast, the tax is imposed on the taxpayer under the applicable law, then gross receipts include the amounts received that are allocable to the payment of such tax.
    https://www.law.cornell.edu/cfr/text/26/1.199-3#c
The treatment depends on whether the sales tax is imposed on the seller or not. In Virginia, it is imposed on the seller. Virginia sales tax would count as a deduction for Jonas' client in the taxable year paid or accrued, and the amount of tax collected from customers would be taxable income.

Jonas wrote:I know expensing the sales tax approach isn't correct but reducing income or adding the expense is the same net tax.

That's true in most, but not all cases. There are certain income tax items that are impacted by gross income and not net income, so it isn't a good idea to get in the habit of thinking this way. It's almost always better to have less gross income than it is to have income and a matching expense.
 

#14
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Chay: When did Virginia impose its sales tax on sellers? Last I dealt with it the tax was imposed on the buyer??
 

#15
Chay  
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I don't know how long the statute has been worded to impose the tax on the seller. The farthest back I can confirm on justia.com is 2006. The relevant section reads as follows:

There is hereby levied and imposed, in addition to all other taxes and fees of every kind now imposed by law, a license or privilege tax upon every person who engages in the business of selling at retail or distributing tangible personal property in this Commonwealth, or who rents or furnishes any of the things or services taxable under this chapter, or who stores for use or consumption in this Commonwealth any item or article of tangible personal property as defined in this chapter, or who leases or rents such property within this Commonwealth
https://law.justia.com/codes/virginia/2 ... 1-603.html
 

#16
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Chay:

I know for a fact the language doesn't go back that far. I participated in sales tax audits in both 2011 and 2016 right before the presidential elections and at that time the sales tax in Virginian was definitely imposed on the consumer not the seller. The language you posted is how it currently reads, which I discovered when I doubled checked the VA code before reacting to your post. I can only guess that Justia is not really an archive, but rather an algorithm which starts with the current law and works backward from legislative changes and one got overlooked?
 

#17
Chay  
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PVCC-cifp wrote:I know for a fact the language doesn't go back that far. I participated in sales tax audits in both 2011 and 2016 right before the presidential elections and at that time the sales tax in Virginian was definitely imposed on the consumer not the seller.

I think you're wrong on two out of three of those statements. I'm sure you did participate in sales tax audits back then, but the language was already in its current form at the time, and it was already decided that the language unambiguously imposed sales tax on the seller and not the buyer.

In support of my position I offer the following excerpts (with emphasis added) from Hardaway Construction v. Department of Taxation (Case No. LR1165-1, Circuit Court City of Richmond, July 8, 2005):

The Commonwealth characterizes Mellot's operations as fabrication. However, fabrication does not implicate the use tax. Fabrication only implicates imposition of the sales tax. Under Va. Code § 58.1-602 a "sale" includes the service of "fabrication." The sales tax statute provides in pertinent part:

§ 58.1-604. Imposition of sales tax.

There is hereby levied and imposed, in addition to all other taxes and fees of every kind now imposed by law, a license or privilege tax upon every person who engages in the business of selling at retail or distributing tangible personal property in this Commonwealth,. . .:

The Commonwealth suggests that the use tax compliments the sales tax and that if fabrication applies to the sales tax then, by inference, it must also apply to the use tax. The court agrees that the use tax may compliment the sales tax, but they are not coextensive. The sales tax cannot be imposed on the purchaser only the seller. The use tax exists to fill the void in the Commonwealth's ability to assess sales tax against purchasers by granting the right to assess purchasers directly. However, the use tax against purchasers is limited to purchases of tangible property. The fundamental distinction applying here is that the use tax does not extend to services. Even if crushing shot rock were fabrication subject to sales tax, the sales tax is levied against the seller, not the purchaser. While the seller has the ability to collect the sales tax from the purchaser, the Commonwealth has no right to collect the tax directly from the purchaser, only the seller.

I'm curious to know how this misunderstanding arose. Was it something about how the 2011 and 2016 audits were conducted? Could there have been some confusion about when a use tax was being collected from the purchaser vs. when a sales tax was being collected from the seller?
 

#18
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I don't know diddly 'bout the Virginia sales tax, like who's liable for it, but I'm pretty mighty awfully very sure that the use tax complements the sales tax, rather than compliments it. Whaddya think?

Just for the record, I went to grade school, junior high school, and high school, in Commonwealth of Virginia public schools. ;)
 

#19
Nilodop  
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... I'm pretty mighty awfully very sure that the use tax complements the sales tax, rather than compliments it. Whaddya think? . That's sic.
 

#20
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"That's sic."
I except your complement! :shock: ;) :shock:
 

#21
Nilodop  
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I excerpt.
 

#22
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Well Chay, I am officially hornswaggled. That is certainly convincing evidence. I wonder when exactly I was transported from my previous reality to the alternate one I now occupy? Thank you for your patience in dispelling what apparently are my own delusions.
 


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