pointofdespo: December 2010

Tuesday, December 28, 2010

Sales Tax on Big Chickens?

You're on vacation and you stop in at an interesting looking art gallery. A giant chicken catches your eye and you buy it for $10,000,000. You're a collector of over-sized fowl and this one will be the crowning glory of your private art gallery. It's a good thing you've got that really high limit on your MasterCard.

The dealer prepares the invoice.

Chicken.............$10,000,000
Sales tax (8%)..........800,000
Total...............$10,800,000

Oh, come on! Whoever heard of paying $800,000 in sales tax? This can't be taxable!

Actually, it is. And you've just made the revenue department in this state very happy.

Let's use the golden rule of taxable sales:

1. There's a sale
2. It's tangible personal property. It's obviously tangible. You saw it and you sat on it. And it wasn't permanently affixed to the floor. So it's tangible personal property.
3. The sale was made by an art gallery - someone in the business of selling art - a retailer.
4. You're buying this for your home or office, not to resell, so you're the end user.

Congratulations, you owe sales tax.

Now, you didn't get rich by just throwing around $800,000 here and $800,000 there. There's got to be a way out, right?

Hmmm. Not really. There are some common evasions, but no real and legal way out.

1. You can ask the gallery to ship it out of state to your home in Gotham City, where all the best Big Chicken collectors hang out. There's no sales tax when you ship out of the state, right? The dealer, who just got audited last month, points out that he can't do that. Since you're in the store, and effectively have control of the Big Chicken as soon as the sale is signed, you have taken delivery in the store. That means that the state you're in has jurisdiction and will impose tax. If the seller doesn't do this properly, he'll get nailed by the auditor (again) when she comes back in six months.

2. Even if you convince the dealer (maybe he's new and hasn't been audited yet) to not charge tax and to ship it to your home in Gotham City, you will now owe use tax on that objet d′art in the great state of Gotham. And since you're so stinkin' rich, you know they're going to audit you one of these days. Actually, unfortunately this doesn't happen all that often. You do owe the use tax. Whether you pay it or not is more of a reflection of your character. Bruce Wayne would pay the use tax. Just sayin'.

A different scenario

Let's say you're driving down a dirt road while on vacation, and see a yard sale with that chicken standing there in all of its glory. In a cloud of dust you slam on the brakes and kind of casually ask the rube what he wants for that "old chicken."

"Ah'll take $10,000,000 please. Ah inherited that from mah Daddy and he durn told me whut it were worth."

Dang. You write him a check since he can't take a credit card, and have him arrange for shipment to Gotham City.

Now, there's been a change in the situation. It's no longer a sale by a retailer, it's an occasional sale. Since the farmer isn't a retailer (he was having his annual yard sale) he doesn't collect sales tax. And since you purchased the item in an occasional sale, you owe no use tax, either in the state where you bought it, or in Gotham. Remember, the sale wasn't by a retailer, therefore it wasn't a taxable retail sale.

So in this scenario, you've saved the $800,000 in sales and use taxes. Legally! But only because you bought it in an occasional sale. Buy it from a dealer, and you owe the tax.

As is usually the case, not every state does it in the ways I've described. There are variations in several states on the way they handle in-store purchases that are shipped out of state, as well as use tax on occasional sales. Do your research!

Which leaves us with the moral of this story:

If you're going to buy big chickens, stick to the dirt roads.

Yep, I know. Sometimes these articles just write themselves.

This is our last article for 2010. It has been a good year for us and I hope it has been for you as well. We currently have January and February on our webinar schedule and will be adding March, hopefully by the first of next week. Happy New Year!

The Sales Tax Guy
http://salestaxguy.blogspot.com

See the disclaimer - this is for education only. Research these issues thoroughly before making decisions. Remember: there are details we haven't discussed, and every state is different. Here's more information

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Thursday, December 23, 2010

Peas on Earth

I realize that I'm getting this out kind of late, but we all get Christmas cards late, don't we? Anyway, I'd like to wish all of you a Merry Christmas. And if that's not your holiday, then I simply hope you enjoy the blessings of this season. Thank you for your support.

Jim Frazier
The Sales Tax Guy

FOB

Ever Reward - (Panama) and Charleston Harbor

When I started writing this, I thought I'd give you a link that would explain what FOB meant. I was surprised that there are several different meanings for FOB, other than the one I was going for. This Wikipedia article should be sufficient to help you understand this term as I plan to use it.

To oversimplify, FOB means where the legal title to the shipment transfers to the buyer. If the terms are FOB Origin (or shipping point), then the legal ownership of the goods transfers when the seller ships them. If the terms are FOB Destination, then the seller hasn't transferred the ownership to the buyer until they arrive at her receiving dock.

Legal ownership determines who is responsible for the freight, and who suffers the economic loss when the shipment is lost in transit. If you're the seller, you want to transfer ownership immediately, which means you're going to want the terms to be FOB Origin. If the item is lost, it's the buyer's problem.

On the other hand, if you're the buyer, you would prefer to have the terms be FOB Destination, which means that the seller still is responsible for the shipment, until it arrives at your dock. Purchasing agents usually negotiate terms as FOB destination just for that reason, particularly on more expensive items.

The question of the effect of FOB comes up frequently in sales and use tax conversations because people think that the FOB point determines the state that has jurisdiction over the transaction. It doesn't.

The state that has jurisdiction is, very simply, almost always the state where the physical delivery occurs, or where the buyer takes control over the goods - which is pretty much the same thing. This is because the tax that is imposed, when we're talking about an interstate sale, is use tax. And use tax is generally imposed when the buyer uses (or controls) the goods. No matter what the terms are, the buyer doesn't control the goods until they arrive at her dock (if shipped by common carrier).

Conversely, if the buyer (or her agent) picks up the goods herself (not using a common carrier), then the physical delivery occurs at the shipper's dock. This is so, even if the original terms of the sale were FOB Destination and the buyer changed her mind at the last minute. What counts is where the physical transfer of control took place, not where the contract terms state the ownership transfer occurs.

Think about it. If it was that easy to manipulate the state that had jurisdiction, then all Amazon.com would have to do is put their warehouse in Oregon (no sales tax in Oregon), and then ship everything FOB Origin. Then there would simply be no tax at all. But that's NOT how it works. What determines the state with jurisdiction is where the physical, real transfer of possession or control takes place. That's an event that can't be manipulated by contract language. And so that's the event that really counts.

When FOB does matter

Having said all of that, there are two states that specifically say that the FOB point determines which state has jurisdiction - Tennessee and New Mexico.

Tennessee isn't really a problem because they have a big loophole. As long as the seller arranges for the shipment of the goods, and the buyer doesn't pick them up, or arrange for the pickup, Tennessee doesn't claim jurisdiction. But if the buyer picks up the phone and calls the common carrier and arranges for them to pick up the goods at the dock in Tennessee, then Tennessee does claim that they have jurisdiction. The easiest way to solve this problem, other than letting the vendor arrange shipment, is to make sure the terms are FOB Destination. Then the loophole is moot.

New Mexico is different. They have no loophole. If you order something FOB Origin from Albuquerque, New Mexico says that the tax belongs to them. Period. This goes in the face of all of the things we talk about regarding interstate commerce. But the reason NM can get away with it is because they don't really have a sales tax. They have a gross receipts tax that is solely imposed on the seller. Since the transaction itself isn't being taxed, New Mexico can simply say that they get all of the taxes on anything that is sold in New Mexico, even if it's shipped out of the state. However, they are fair. If the terms are FOB Destination, they don't claim jurisdiction. So, as with Tennessee, the best solution when you're buying from NM is to make sure the terms are FOB Destination.

Please remember that there are some complications if you decide to make all of your purchases FOB Destination.

1. The vendor may not be interested in doing this. This is often an easy negotiating point, but sometimes the vendor stands firm. And you have to bring it up if you want the change. All sales contracts, if they're written by the seller, will state the terms as FOB Origin. That makes sense, since those terms are best for the vendor.

2. You may wind up paying the freight if the terms are FOB Origin. That could be a significant amount of money - even more than the sales tax. So watch this one.

3. In some states, the freight may be taxable if the sale is FOB Origin.

Summary

FOB points don't count in determining the state that has jurisdiction. What matters is where the goods are physically delivered. Well, that's except for two states: Tennessee and New Mexico. In those two states, the FOB point should be Destination to make sure the tax is for the delivery state. And since purchasing usually works to set this up anyway, it may not be a big problem.

Tuesday, December 14, 2010

Gotta watch those widget sales

I had a question from a class participant a few days ago, and it was such a good question, I thought I'd use it here. But I promised her I'd sanitize the heck out of it. So think of this as a question "inspired" by the real question.

"My company is an HVAC contractor [in most states, contractor sales aren't taxable - they pay tax on the building materials they use]. We prepare widgets in our shop that will be attached to the HVAC equipment. Since it's part of the construction job, we just cost the materials used for the widgets to the job and pay sales tax on the few hunks of steel that we use.

However, we have a lot of customers who buy the widgets without our doing any actual HVAC work (our widgets are very popular and user installable). When this happens, we just send the widget to the customer, and bill them. We don't charge sales tax. Should we?"

You should be charging tax on the widgets that you sell at retail to your customers. If the widgets become part of the building where you're doing the HVAC work, then you would pay tax on the widget components when purchased.

But when you sell the widgets outside of a construction contract, you are making retail sales of tangible personal property, and those are taxable sales. You should be charging tax.

The problem is that, if you've already paid tax on the components of the widget when you bought them, and then you collect tax on your retail sales of them, then the state is getting too much money. In most states, there are two solutions (and you need to check your state rules to make sure of your options):

Purchases resold - Many states make provision for purchases you make that were taxed, and are subsequently sold at retail where tax is collected. The states usually let you deduct your "purchases resold" from your use tax liability.

Buy for resale - If your retail sales of widgets are substantial, consider giving your vendor a resale certificate for all of the widget components and pay no tax on any of those purchases. Then collect tax on your retail sales and accrue use tax on the materials that become part of your construction contracts.

Either way, there is extra bookkeeping involved. But if the retail sales of the widgets are substantial, you should come up with a solution before the next auditor finds it.

This is another example of a situation where a business was making taxable retail sales without even realizing it. Does anyone else have this problem? You betcha!

And finally, if you are actually manufacturing the widget, you should look into whether or not there are any manufacturing exemptions available to you.