Most of our clients fear an audit by the Internal Revenue Service and wonder what “red flags” they may be raising on their personal tax returns. In reality, there is a higher chance of receiving a sales and use tax audit from the State, than a visit from the IRS.

Sales tax is generally charged on revenue from the sale of tangible property (items you can touch and see) and service revenues are (typically) exempt. As with most laws, the exceptions to these general rules provide confusion and often times lead to violations – albeit unintentional. For example, repair services are generally taxable (even though it’s a service) whereas construction of a home or building is generally exempt (even though the end result is tangible property).

Many of our clients provide a service and thus, sales tax is not a big issue. However, the Use tax can trip them up.

Use tax is supposed to be submitted on any purchase you make where sales tax is not charged at least at the rate of your local municipality. For example, if you purchase supplies for your office and live in Milwaukee County, you must make sure that you paid at least 5.6% in sales tax on that purchase. It sounds like a nit-picky rule, but we’ve actually seen auditors add the tax to purchases when the client was inadvertently charged the Waukesha County tax of 5.1% by the vendor.

​So why is this tax such an issue? We think some states have decided to play “gotcha” with this tax.

In practice, a State (especially Wisconsin) can and will look at every single one of your receipts to ensure sales tax has been assessed. If you don’t have a receipt, the auditor will usually take the position of “How do I know you paid sales tax” and assess a tax. It won’t matter if they have 100 other receipts from that vendor showing that taxes have been properly assessed. If you don’t have the 101st – good luck. The auditor will assess the tax and you will now have to spend time talking some sense in to their supervisor to get it waived.

Two takeaways on the Use Tax. One, you should try to save EVERY receipt and attempt to have them organized in some logical order. It could be by month, vendor, or expense category. On small businesses ($500,000 – $5,000,000 in sales), auditors tend to look at every single receipt instead of an audit where they sample your receipts and only delve further if they are seeing errors. Two, you need to be cognizant to submit the tax by filing a sales tax return (typically on an annual basis).

Although we rarely have an IRS audit of our clients, we have seen a rise in sales and use tax audits. Prepare ahead of time – as the SEALs have taught us, “the more you sweat in peace time, the less you bleed in combat.”

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