Disclosure: The following content was written and sponsored by Avalara.
Despite many state budgets faring better than some analysts predicted in 2020, businesses may still be at risk of a burdensome and costly sales and use tax audit in 2021 and beyond. While it may not be a doom and gloom story for all states this year, partially due to COVID-19-related federal government stimulus, decisions that you make now could trip you up in future audits, so staying vigilant about compliance is imperative.
Did you know that sales tax accounts for more than 40 percent of total state and local taxes in some states and goes a long way toward filling a state’s budget coffer? The most recent annual report from the California Department of Tax and Fee Administration shows the sales and use tax audit program audited approximately 1 percent of active tax accounts and uncovered net deficiencies of nearly $553.1 million during fiscal year 2018-2019.
Unfortunately, many businesses are ill-prepared to handle an audit. In a 2017 study by Peisner Johnson & Company focused on California and Texas, nearly 60 percent of audits focus on four industries – construction, manufacturing, wholesale/distribution, and retail.
Common Mistakes Uncovered by Auditors
Here are some of the most common mistakes uncovered by auditors in a study highlighting construction companies:
It’s important for construction companies to understand how their projects are taxed by different jurisdictions, and there are more than 13,000 jurisdictions in the United States. Some states, like Texas, apply tax or exemptions differently based on whether construction projects are commercial or residential, new construction, or remodel. Others, like Florida and Louisiana, don’t make this distinction.
In other words, how are construction companies to know when they are supposed to:
- PAY sales tax?
- COLLECT sales tax?
- PAY use tax?
- COLLECT a resale certificate?
For example, a contractor pays sales tax when there is a lump-sum contract for new construction (such as in certain states like Texas). A contractor collects sales tax when there is a separate contract where materials and labor are billed separately (again, in certain states like Texas).
Contractors must also contend with often-misunderstood consumer use tax. According to a study by Peisner Johnson & Company, mismanaging consumer use tax ranks in the top five for costliest compliance mistakes made by companies.
Contractors pay use tax when their vendor doesn’t charge sales tax on taxable items (materials, supplies, equipment) or when items are purchased outside the state for use in the state in which the project is being completed.
And what about exempt sales? How does that work? In many states, if you perform construction work for a tax-exempt organization, such as a church, that organization’s exemption also applies to materials you purchase for the project.
You’ll probably need an exemption certificate from the organization or, depending on local laws, you may be able to have the organization itself purchase the materials if the tax exemption does not extend to you.
Automation is the Key to Tax and Audit Relief
Manually managing exemption certificates and consumer use self-audits is labor-intensive, inefficient, and prone to errors. Automating your company’s sales and use tax compliance process can go a long way toward reducing your audit risk. Additionally, automation can lessen the burden of compliance, so you can focus on your business and gain peace of mind.
Obviously, we’ve just scratched the surface when it comes to understanding sales and use tax audit risk for construction companies. For an in-depth and visual exploration of the myriad ways a construction company can get tripped up by sales and use tax and exempt sales, I encourage you to download this infographic.
Click here to receive a visual guide to consumer use tax and exemption certificate compliance.