State Board Of Equalization Avoiding Common Sales and Use Tax Pitfalls Before we can help you to avoid errors in reporting let me tell how we know where the errors are occurring. Board runs audit program to ensure businesses report neither more nor less tax than required. In the fiscal year 2004-05 the sales and use tax audit program disclosed net deficiencies of more than 375 million and more than 104 million in sales and use tax refunds.

Presumptions of the Tax Code All sales are taxable unless otherwise specifically exempted Claimed exemptions must be supported by documentation Taxpayer is responsible for maintaining and providing documentation for potential examination Law section states “ burden of proving that a sale is exempt is on the person making the sale. § 6091

Analysis of Noncompliance As required by the Taxpayer’s Bill of Rights, the Board annually reports: Area where taxpayer noncompliance is highest AND the types of businesses making the errors. Two categories have topped the lists in recent years: Failing to pay use tax on purchases from out of state vendors Making sales for resale without required documentation Each year as part of our annual report an Analysis is made of the areas of noncompliance based on audits for the same time period. The areas of noncompliance are taken directly from areas of assessment per the tax audits. Whenever there is an assessment from a tax audit, the auditor has to code, by area, where the assessment, was derived

Types of Noncompliance ( As of June 30, 2007) Untaxed Purchases from Out-of-State Vendors 2. Unsupported Sales for Resale Unreported Sales to Employees Difference Between Recorded and Reported Taxable Sales 5. Errors in Compiling Return 6. Reported Sales Lower than Markup on Purchases 7. Inadequate Records Resulted in Unreported Sales Untaxed Materials & Fixtures Consumed on Construction Contracts Withdrawal from Resale Inventory for Own Use Unsupported Sales in Interstate Commerce Delivered to Instate Customer These are the top ten areas of noncompliance per the Annual Report for the fiscal year 2006-07. I will discuss each area and how to avoid problems in that area

Types of Noncompliance ( As of June 30, 2007) Untaxed Purchases from Out-of-State Vendors Unsupported Sales for Resale Unreported Sales to Employees Difference Between Recorded and Reported Taxable Sales 5. Errors in Compiling Return 6. Reported Sales Lower than Markup on Purchases 7. Inadequate Records Resulted in Unreported Sales Untaxed Materials & Fixtures Consumed on Construction Contracts Withdrawal from Resale Inventory for Own Use Unsupported Sales in Interstate Commerce Delivered to Instate Customer The first two areas are #1 Untaxed Purchases from Out-of-State Vendors and #9 Withdrawal from Resale Inventory for your own use

Untaxed Purchases From Out of State Vendors Items purchased without payment of California tax: From out-of-state businesses and Purchased for own use (not inventory) Fixed assets, consumable supplies If out of state vendor does not charge CA tax, the purchaser owes the use tax on the purchase price

Withdrawal from Resale Inventory for Own Use Inventory items purchased with a resale certificate without payment of tax Items withdrawn from inventory for use other than resale (including use as gifts and free samples or for personal use) Use Tax Due on Cost = Resale Inventory Provide samples of your merchandise for give away, or donate owe tax on cost journal entries from inventory to marketing expense, R & D, etc. Analysis of the California Sales and Use Tax Law

This is where it is reported on the return. Reported on Line 2 of the sales tax return as “purchases subject to use tax” Keep documents disclosing how you arrive at the amount on line 2, and you may want to keep a copy of the purchase invoice and attach it to the back of the return for your records. For resale withdrawals, keep expense account or journal entries As individuals we also responsible for reporting and can do this on our Franchise Tax Board return or A BOE Individual Use Tax Return

Use Tax for Individuals Can be reported on BOE individual use tax return Can be reported on California Income Tax return

Types of Noncompliance ( As of June 30, 2007) Untaxed Purchases from Out-of-State Vendors 2. Unsupported Sales for Resale Unreported Sales to Employees Difference Between Recorded and Reported Taxable Sales 5. Errors in Compiling Return 6. Reported Sales Lower than Markup on Purchases 7. Inadequate Records Resulted in Unreported Sales Untaxed Materials & Fixtures Consumed on Construction Contracts Withdrawal from Resale Inventory for Own Use Unsupported Sales in Interstate Commerce Delivered to Instate Customer #2 on the list is Unsupported Sales for Resale

Sales For Resale Common ways to document sales for resale (examples to follow): A Resale Certificate A Purchase Order containing all the essential elements of a resale certificate Resale Card Keep your resale card file up to date but do not throw out resale cards Maintain and update cards periodically Regulation 1668

Basic Elements of a Resale Certificate Purchaser’s name Purchaser’s address Purchaser’s valid seller’s permit number Purchaser’s type of business activity Seller’s name Item(s) being purchased Statement that purchase is “for resale” Date resale certificate is signed Authorized purchaser’s signature Purchaser’s title Doesn’t matter what form important has all elements. Regulation 1668

Resale Certificate Verification To verify Seller’s Permit number(s) submitted on resale certificates, retailers may call 1-888-225-5263 or access our website at www.boe.ca.gov

Resale Certificate Verification

Resale Certificates Available at some stationery stores, in Regulation 1668, and in Publication 73 Must be filled out completely Must be taken timely and in good faith Timely= before seller bills purchaser, within seller’s normal billing cycle, or payment cycle, any time prior or upon delivery of the item Good faith responsible for questioning whether or not an item is for resale. If customer insists obtain a specific description of property. Regulation 1668

Purchase Order Used as a Resale Certificate For Resale SR AC 99-999999 Number - 123456 Taxable Date -3/5/00 4000 Widgets $2.00 each $8000.00 Must specifically state “For Resale.” Statements of “Nontaxable,” “Exempt,” or “Taxable - No” do not fulfill this requirement Purchase Orders that state “For Resale” must contain the same information as required for a resale certificate Regulation 1668

About a Seller’s Permit Allows sales to be made in California Allows a person to issue a resale certificate for purchases of inventory items without paying tax Does not allow buying items for personal or business use without paying tax Permit must be issued in the owner’s name for each business address CALIFORNIA SELLER’S PERMIT SR AC 99-999999 JOE SMITH JOE’S BA R Copy of the permit does not shift the responsibility of tax to the purchaser, only a resale certificate will do that. Regulation 1699

Penalties for Improper Use of Resale Certificates Misuse of resale certificate is a misdemeanor The penalty is $500 or 10% of the amount of tax per transaction whichever is greater I audited a business that had three different purchases totaling about $2000. They had to pay a $1500 penalty for $2000 worth of purchases. The tax would have been about $150. Give more details Regulation 1703

Types of Noncompliance ( As of June 30, 2007) Untaxed Purchases from Out-of-State Vendors 2. Unsupported Sales for Resale Unreported Sales to Employees Difference Between Recorded and Reported Taxable Sales 5. Errors in Compiling Return 6. Reported Sales Lower than Markup on Purchases 7. Inadequate Records Resulted in Unreported Sales Untaxed Materials & Fixtures Consumed on Construction Contracts Withdrawal from Resale Inventory for Own Use Unsupported Sales in Interstate Commerce Delivered to Instate Customer #3 is Unreported Sales to Employees

Unreported Sales to Employees If you sell items to your employees, tax is due on the selling price charged Sales to your employees must be reported on your sales and use tax return `

Types of Noncompliance ( As of June 30, 2007) Untaxed Purchases from Out-of-State Vendors 2. Unsupported Sales for Resale Unreported Sales to Employees Difference Between Recorded and Reported Taxable Sales 5. Errors in Compiling Return 6. Reported Sales Lower than Markup on Purchases 7. Inadequate Records Resulted in Unreported Sales Untaxed Materials & Fixtures Consumed on Construction Contracts Withdrawal from Resale Inventory for Own Use Unsupported Sales in Interstate Commerce Delivered to Instate Customer #4 is the Difference Between Recorded and Reported Taxable Sales

Recorded vs. Reported Taxable Sales Comparison between taxable sales per your books and records and taxable sales reported to the Board. Tax auditor will compare the taxable sales you have recorded in your books and records and taxable sales you have reported on your return. Recommend you make a periodic comparison between recorded and reported. Should be the same, make notes for any differences.

Types of Noncompliance ( As of June 30, 2007) Untaxed Purchases from Out-of-State Vendors 2. Unsupported Sales for Resale Unreported Sales to Employees Difference Between Recorded and Reported Taxable Sales 5. Errors in Compiling Return 6. Reported Sales Lower than Markup on Purchases 7. Inadequate Records Resulted in Unreported Sales Untaxed Materials & Fixtures Consumed on Construction Contracts Withdrawal from Resale Inventory for Own Use Unsupported Sales in Interstate Commerce Delivered to Instate Customer #5 is simply errors in compiling the return

How to Avoid Common Errors Preparing your Return Before preparing your return, read the return instructions. Allow yourself enough time to carefully prepare the return. Double check your mathematical calculations. The Board’s no cost e-file system does the math for you. Include your account number and reporting period on the return. Remember to sign and date your return before mailing it to the Board. Report sales on an accrual basis, not a cash basis. Advise the Board when ownership changes. This may affect an existing liability or future tax. If you have questions, contact the Board of Equalization at 800- 400-7115 for assistance.

Benefits of E-filing It’s fast It’s convenient It’s accurate It’s paperless

E-Filing Eligibility for Sales and Use Tax Accounts Most accounts are eligible (over 850,000) Single-outlet retailers Includes mandatory Electronic Funds Transfer (EFT) accounts (April 2008) Multiple-outlet retailers (July 2008)

Filing a sales and use tax return has never been easier, faster or more convenient! For more information, log on to our website and click on the E-file logo. Select sales and use tax e-filing for the list of approved service providers. www.boe.ca.gov

Types of Noncompliance ( As of June 30, 2007) Untaxed Purchases from Out-of-State Vendors 2. Unsupported Sales for Resale Unreported Sales to Employees Difference Between Recorded and Reported Taxable Sales 5. Errors in Compiling Return 6. Reported Sales Lower than Markup on Purchases 7. Inadequate Records Resulted in Unreported Sales Untaxed Materials & Fixtures Consumed on Construction Contracts Withdrawal from Resale Inventory for Own Use Unsupported Sales in Interstate Commerce Delivered to Instate Customer #6 is Reported Sales Lower than Markup on Purchases

Reported Sales Lower than Markup on Purchases Generally involves cash businesses (markup audits) Grocery Stores, Liquor Stores, Restaurants, etc. Involves total sales, cost of goods sold, and profit amount $100,000 Sales 80,000 Cost of Goods Sold $20,000 Gross Profit $20,000/$80,000 = 25% Markup The difference between total sales per the federal income tax return and cost of goods sold is gross profit. Profit divided by Cost of Goods sold is the markup which is an indicator of whether total sales and/or cost of goods are consistent and whether additional work needs to be done. If the markup is considered low for the type of industry, sales can be impeached and it may be necessary to develop a true markup and apply to cost of goods (purchases). This results in audited total sales and is compared to total sales reported. In this example, if we found out actual markup is 40%, we would take 80,000 purchases, multiply by markup factor of 140% to arrive at $112,000 projected sales. Which amounts to a deficiency of $12,000.

Types of Noncompliance ( As of June 30, 2007) Untaxed Purchases from Out-of-State Vendors 2. Unsupported Sales for Resale Unreported Sales to Employees Difference Between Recorded and Reported Taxable Sales 5. Errors in Compiling Return 6. Reported Sales Lower than Markup on Purchases 7. Inadequate Records Resulted in Unreported Sales Untaxed Materials & Fixtures Consumed on Construction Contracts Withdrawal from Resale Inventory for Own Use Unsupported Sales in Interstate Commerce Delivered to Instate Customer #7 is having Inadequate Records which results in Unreported Sales

Adequate Books and Records Will: Inadequate Books and Records Will: BOOK AND RECORDS Adequate Books and Records Will: Help you run your businesses more effectively Help you complete more accurate tax returns Inadequate Books and Records Will: Force and Auditor to use estimates in your audit

Required Records Records of sales including: sales invoices, cash register tapes, sales journals, etc. Records of purchases including: purchase invoices, cancelled checks, purchase journals, etc. Documentation to support claimed exemptions such as: resale certificates, exemption certificates, purchase orders, shipping documents, etc. Normal books of account Schedules or working papers used in preparing tax returns Records must be maintained for at least four (4) years Regulation 1698

Types of Noncompliance ( As of June 30, 2007) Untaxed Purchases from Out-of-State Vendors 2. Unsupported Sales for Resale Unreported Sales to Employees Difference Between Recorded and Reported Taxable Sales 5. Errors in Compiling Return 6. Reported Sales Lower than Markup on Purchases 7. Inadequate Records Resulted in Unreported Sales Untaxed Materials & Fixtures Consumed on Construction Contracts Withdrawal from Resale Inventory for Own Use Unsupported Sales in Interstate Commerce Delivered to Instate Customer #8 is Untaxed Materials & Fixtures Consumed on Construction Contracts

CONTRACTORS Construction Contract Types of Contractors Contractors in general United States Construction Contractor Types of Contracts and Billings Materials – generally contractor is consumer Fixtures – generally contractor is retailer

Types of Noncompliance ( As of June 30, 2007) Untaxed Purchases from Out-of-State Vendors 2. Unsupported Sales for Resale Unreported Sales to Employees Difference Between Recorded and Reported Taxable Sales 5. Errors in Compiling Return 6. Reported Sales Lower than Markup on Purchases 7. Inadequate Records Resulted in Unreported Sales Untaxed Materials & Fixtures Consumed on Construction Contracts Withdrawal from Resale Inventory for Own Use Unsupported Sales in Interstate Commerce Delivered to Instate Customer #10 is Unsupported Sales in Interstate Commerce Delivered to Instate Customers

Sales in Interstate Commerce Common ways to document sales in interstate commerce: Bills of Lading Freight Invoices Delivery Receipts Correspondence

Unsupported Sales in Interstate Commerce Delivered to Instate Customers Delivery to a purchaser in California for subsequent shipment to another state is taxable. When the goods are diverted by the purchaser in transit, the exemption is lost. Delivery by common carrier. Drop shipments. These are examples of when we commonly see lack of documentation

Services Available BOE Website -- www.boe.ca.gov Local Board Offices Library of BOE information Links to other CA websites On-line Verification of Seller’s Permit numbers Local Board Offices BOE Information Center 1-800-400-7115/TDD 1-800-735-2929 Mon. - Fri. 8am to 5pm 24 hr fax-back service Commonly requested forms and publications to choose from automatically faxed back to you 24 hr voice recordings on specific topics Taxpayers’ Rights Advocate -- 1-888-324-2798 If you have been unable to resolve a disagreement with the Board, or if you would like to know more about your rights under the law

Taxpayer Educational Consultation Program Designed to provide sales & use tax info. to new taxpayers during 1st year. Eligible if: A new business (<1 yr), Filed at least two BOE returns, You report monthly, quarterly or quarterly prepay. No annual filers. He is here if you would like more information about this program

THANK YOU FOR COMING