Reverse Sales Tax Audit For Manufacturers: The Tax-Saving Measure You Could Be Missing
March 12, 2018
By Ryan Hauber, Partner
If tax savings is on your mind, like it is for most this quarter, developing an all-encompassing tax strategy is necessary to maximize available opportunities at the federal, state and local levels, especially for manufacturers. A comprehensive tax strategy is about more than entity tax rates and income tax; sales tax is also a crucial component of your business’s overall financial well-being. Manufacturers are eligible for a host of sales tax exemptions including utilities, computers, software, machinery, equipment, raw materials, supplies and more. However, the retailer or wholesaler you’re dealing with likely isn’t concerned with your exemptions and will charge the standard sales tax rate, unless you state otherwise.
The good news is a state’s statute of limitations is the only thing preventing manufacturers from reclaiming this overpaid sales tax. With a reverse sales tax audit, you can identify and recover these lost funds. In my personal experience, my firm has found savings with a reverse sales tax audit 70% of the time in manufacturers both large and small. That’s a lot of missed opportunity. States allow refunds for up to a pre-determined number of years based on their statute of limitations, but reverse sales tax audits and any uncovered refunds can be performed and submitted at any time before the state’s deadline.
Manufacturers both large and small can miss these overpayments and end up handing over a tremendous sum of unnecessary sales tax. With so many exemptions available to them, small manufacturers can get overwhelmed trying to keep up, and large manufacturers operating in multiple states can miss changes from state-to-state. With a reverse sales tax audit, these specific transactions of exempt purchases can be analyzed, reported and refunded, potentially saving you thousands of dollars.
Keeping track of what’s exempt and what isn’t can be a full-time job, and the state and local tax laws continuously change. In Iowa, for example, a measure was passed in 2016 exempting supplies used in the manufacturing process from sales tax. This was a huge benefit to taxpayers but could easily have been overlooked without proactive tax planning in place. In my experience, about 90% of these sales tax exemptions are similar from state-to-state with just slight nuanced differences among them. Areas where manufacturers can see significant gain — but could be missing out — are in utility payments, software upgrades and expansion projects.
Utility studies are generally simple to perform from the accounting standpoint and have the potential to return a big refund for the client. The utility exemption is determined by the ratio of energy consumed by the equipment used in the manufacturing process to the energy consumed by the remaining equipment. The process of a utility study is straightforward: The taxpayer provides the last three months of utility statements, a review is conducted to ensure they are being billed correctly, and if they are not, a new rate is calculated based on their exemption and a refund is submitted. Despite the simplicity and ease of claiming this exemption, it is frequently missed by large and small manufacturers alike. Based on studies performed on clients, some CPA firms have uncovered savings in over 80% of utility studies for their manufacturers.
Companies looking to upgrade their software may also be eligible for exemption from sales tax. Determining whether the software is taxable can be simple; in the case of software purchased and delivered electronically, it is tax exempt in several states (check your state’s tax code). (Tip: According to our IT partner, almost all software is delivered electronically.) However, complications in determinations arise. In Illinois, for example, there is a five-point test to determine if the software purchase is tax-exempt. The agreement must restrict the customer from duplication, prohibit the customer from licensing, backup procedures must be documented, and the customer must destroy or return copies of the software upon termination of the agreement. The nuances of each of these test points can discourage manufacturers from attempting the analysis at all. However, taking time to determine an exemption can pay off big.
Any time a manufacturer undertakes an expansion project, renovation, process overhaul or major investment, a reverse sales tax audit should come into play. If you’re processing a lot of invoices, many of these tax exemptions get passed over in the haste to organize, plan and pay. However, thousands of dollars can be saved on your big investment when the proper sales tax is calculated.
A comprehensive tax strategy includes understanding your sales tax obligations and exemptions. As a manufacturer, leaving your sales tax payments to chance can be a costly risk. If you’re not sure of your obligations, a reverse sales tax audit and utility study should be part of your 2018 tax plan.
This article was previously published on Forbes.com.