A Sales Tax Audit? What!
Be prepared to answer the door when the IRS comes knocking.
By Lisa Mackell, PT, MPT
Imagine yourself sitting at your desk one day, and your telephone rings, and it is your state tax department calling, informing you that you have been randomly selected for a sales tax audit! “A sales tax audit?” I asked. “We barely sell any products at all.” Well, this happened to us one early spring day in 2013. Now, I am not an accountant, and tax laws vary in all states, but there are things that we learned throughout this process that will be valuable to all practice owners and save you time if this ever happens to you.
First and foremost, a “sales, use, and occupancy tax audit,” as it was formally called, is not to verify that you charge sales tax on any items that you may sell to your patients. In fact, that was a very small part of this audit. The bulk of this tedious audit was to verify that we, as a business, paid sales tax on everything that we purchased through the business for the last three tax years. So, we set up an appointment with the auditor, and for a solid week, this auditor was in my office, going through boxes and files of invoices, receipts, Quickbooks, and reports, to verify that we could show and prove that we had paid sales tax when we were required by the state to pay it. Here are some tips, based on our experience, that we suggest you put in place at your practice:
- Keep all receipts and invoices for all purchases made, not just for income tax purposes, but also for potential sales tax audits. Our audit went back three years, but seven years should be a safe timeframe based on the Internal Revenue Service (IRS) recommendations for keeping records.
- We had always believed that a lot of our supplies—and suppliers—were not subject to sales tax because they were for “medical use.” We learned that this was not true. The tax law in Pennsylvania stated that the only time an item was not taxable was when that item was purchased for the sole use of one and only one patient, purchased for that patient at the time, and only used by that patient. In other words, if you purchase kinesiotape in bulk, and then sell to patients, this is taxable, because you did not order that specifically for that particular patient at the time of purchase. This would also apply to crutches, electrodes, braces, etc. If you purchase an ultrasound machine, that is also taxable because it is not used solely for the use of one particular patient.
- When a vendor does not charge you sales tax, it is your responsibility to pay that sales tax, to your state, in a return that you file. We have learned which of our vendors were not charging us sales tax, and we now pay the tax for all of the invoices from those vendors on a quarterly basis.
- Sales tax is also applied to certain services you receive. Our Information Technology (IT) service technician was not charging us sales tax on any of his service calls for computer repairs—as he was also unaware that any of his work was taxable. We now know that certain computer repair work is taxable and certain work is nontaxable. All of our invoices for the last three years had to be revised.
- Capital equipment was a large part of our audit. We are right next to the state of Delaware, which does not charge sales tax. Regardless, we are responsible for paying sales tax as a Pennsylvania company. Keep this in mind as you purchase large equipment from out-of-state vendors that may not charge you sales tax as a cost savings benefit to you.
- Be very involved in the process if you are audited. There were many items that our auditor was incorrect on, which we were able to debate and prove we were correct. Your state should have a booklet or guide that will itemize every possible item and whether or not it is taxable. This will help you be prepared in the event of an audit so that you can understand what your tax liabilities truly are.
I am sure you are wondering—what was the damage? At first, the auditor estimated that we would owe about $15,000 in back taxes. After we went through the itemized list, debating things that the auditor did not understand how they were used in our business, the final outcome of our tax liability was $4,694.03. Since this was our first audit, we also had to pay the interest and a failure to file fee, but we were able to appeal the major penalty. The total amount that this audit cost us to the state was $6,338.36. Keep in mind, additional costs to the company included some accountant costs, and I lost about a week of work while I sat with this auditor finding files, invoices, and receipts, and reviewed these with her.
Be prepared—keep your records, receipts, and invoices. We all hate to pay taxes, but I hope this personal experience at least arms you with some proactive tips to prepare your business for better protection against a sales, use, and occupancy tax audit.
Lisa Mackell, PT, MPT, is the founder and owner of Theraplay, Inc., a pediatric therapy company that provides physical, occupational, and speech therapy services. Theraplay currently has seven outpatient centers, as well as contracts providing early intervention and school-based services throughout Pennsylvania and Delaware. Lisa can be reached at email@example.com.