Many business taxpayers overlook the sales and use tax area when seeking to reduce costs and improve bottom-line performance because generally sales and use taxes are buried, or hidden, in a taxpayer's cost of goods sold. These taxes, often referred to as "nuisance" or "orphan" taxes, frequently exceed the liability for state and federal income taxes combined.
Unlike income taxes, which are computed based on net profit after expenses; sales taxes are computed based on gross taxable sales. Use tax is generally computed based on the purchase price of consumed goods. Consequently, sales and use tax audit liabilities can dramatically exceed income tax liabilities. In addition, the complexity and inconsistency of the regulations and tax laws throughout the country can be a nightmare for multi-state companies.
Sales and use taxes are triggered by thousands of individual transactions; thus, it is impractical for accounting departments to give each transaction a thorough review for liability. Many sales and use tax issues are so intricate they require engineers familiar with the technical aspects of a manufacturing process in order to properly determine which part, if any, of an item is exempt. Clerical personnel in non-tax departments often assume the ultimate responsibility for routine determination of a company's sales and use tax liabilities.
Furthermore, vendors, not the business taxpayer, often make these tax approvals. Standard practice employed by most vendors is to bill tax to a customer if there is any doubt that a transaction may be taxable. No matter how large or skilled a company's staff, some type of tax is usually being overpaid. These overpayments are due largely to the complex, inconsistent and ever changing tax regulations, rates and exemptions.
Typically, it is assumed that state auditors will identify overpayments as well as underpayments. In reality, this is not always the case. The field auditors represent a significant revenue source for the state. Generally the only transactions scrutinized by the auditor are those for which no tax has been paid as they are eager to guard this revenue. For these reasons states pursue audits, which often result in an assessment. While auditing for underpayments, the majority of overpayments are not noted.