Three Ways Businesses Can Prepare for a Sales and Use Tax Audit to Maximize Potential Savings
Previously Published on the Mississippi Business Journal
"[I]n this world nothing can be said to be certain, except death and taxes." Many of us are familiar with this famous statement by Benjamin Franklin, and the sentiment expressed then also remains true today. The thing about certainties, even when they are undesirable, is that efforts made in preparation are a wise use of time.
When it comes to taxes, income taxes are usually the focus. For businesses that manufacture and sell tangible personal property or provide certain services, however, another category of important taxes is state sales and use tax - which can directly impact overall income. The general sales and use tax rate in Mississippi is 7%; however, there are numerous statutes that provide for reduced rates.
Generally, state sales tax is due upon the purchase of tangible personal property. While it is a final consumer’s obligation to pay sales tax, businesses are ultimately responsible—and can be held liable—for the failure to collect sales tax. With respect to use tax, it is simply a statutory tax on the use of personal property in situations where there is no purchase from a third party that would generate a sales tax. That “use” for all practical purposes, is taxed just like the “sale” it replaces.
While a sales tax is conceptually a consumption tax on purchases of tangible personal property, Mississippi also taxes certain services under the sales and use tax framework. Miss. Code Ann. § 27-65-23 lists the services that are subject to tax. Mississippi taxes air conditioning installation and repairs, electrical work, landscaping, plumbing, termite and pest control services, and welding, among others.
Mississippi also has a contractor’s tax that applies to non-residential construction when the total contract price exceeds $10,000, as provided in Miss. Code Ann. § 27-65-21. The contractor’s tax rate is 3.5% of the total contract price, which is an exception to the general 7% sales tax rate noted above. Contractors may purchase component materials that will be used in the construction free of tax by using a material purchase certificate.
If a business manufactures and sells tangible personal property or performs any of the taxable services identified in Miss. Code Ann. § 27-65-23, it is likely that such business will be subject to a sales and use tax audit. Being proactive and prepared for that circumstance is time well spent. Consider the following as you begin or refine your preparations.
1. Familiarize yourself with the Mississippi sales and use tax structure, what is generally subject to tax, and the exemptions and rates most applicable to your industry. It is important to note that while a three-year statute of limitations is generally applicable, there is no statute of limitations with respect to returns that were never filed, as outlined in Miss. Code Ann. § 27-65-42. In other words, if a business is not aware of a transaction being a taxable transaction, and does not file a return to remit sales or use tax to the state, then the Mississippi Department of Revenue may commence an audit and assess tax at any time in the future. Further, it is not uncommon for a business to miss out on available sales tax savings. The Mississippi Legislature has provided sales and use tax exemptions, or lower tax rates, for several types of industrial transactions. For example, Miss. Code Ann. § 27-65-101 provides exemptions (just to summarize a few) for sales of raw materials to a manufacturer that are used directly in manufacturing a product, sales of shipping materials associated with the goods sold by a manufacturer or wholesaler, and sales of pollution control equipment to a manufacturer or custom processor. The sale of manufacturing machinery is taxed at the lower rate of 1.5%. There are similar statutes that provide for agricultural, governmental, utility and miscellaneous exemptions.
2. Separate taxable and non-taxable purchases into different contracts or invoices. In routine purchasing from vendors or working with contractors, it is easy for taxable and non-taxable components of a transaction to be combined in a single invoice or contract. After all, a dependable supplier may provide your company with raw materials to make your products (often not taxable) and standard tools and supplies for a workshop (often taxable), and making a single order for pressing business needs feels efficient. However, in a sales tax audit (that could occur months or years later), the auditor will likely assume that the full amount of an invoice or contract is taxable if it includes taxable components and there is no clear distinction in the purchase amount between taxable and non-taxable line items. Separating out taxable from non-taxable transactions on the front end into separate orders or contracts, with the goal of getting separate invoices for taxable and non-taxable transactions, can save substantial time in responding to an audit.
3. Perform an internal audit on your business's sales and use tax compliance. Practice makes perfect. Well, maybe not absolutely perfect. However, performing an internal audit of your business's sales and use tax compliance has the prospect of identifying gaps, inconsistencies and areas for improvement, thereby helping your business map out actionable steps to take in preparation for an audit and possibly identify areas for tax savings.
Taking on any one or a combination of these suggestions should place your business in a better position if and when an auditor knocks on your door.