Illinois manufacturers often fall victim to "state tax surprises" that can come up during a state tax audit or a state questionnaire. Finding out you missed something during an audit can lead to a large amount of tax due since the error can cover a four-year period. Likewise, finding out you should have been filing tax returns in another state after they contact you can lead to a large tax liability. State tax laws are loaded with "pitfalls." I will point out some of the most common tax pitfalls for manufacturers and where to look for them.
Common state tax errors and omissions
• Customer Resale certificates: So you don't sell to end users -- It does not matter. Illinois will require that you have a resale certificate on file for every Illinois customer. Be sure to have a resale certificate to support every invoice with an Illinois "ship to" address. It's important that these certificates are no more than 3 years old.
• Blanket Resale Exemption: Your company issues a blanket resale certificate to its vendors because everything you buy from the vendor is for resale. This works well until the company purchases something that is taxable from the same vendor and no tax is charged. The company now has sale or use tax due on this transaction.
• Machinery and Equipment exemption: While equipment used to produce a product is generally exempt from sales tax, supplies, lubricants and small hand tools are generally taxable. . A company will often issue a blanket machinery exemption to a vendor and then later purchase taxable items from the same vendor with no tax charged. This is a common scenario that comes up in an audit and results in tax due to the state.
• Equipment purchases: Under audit, the state will audit all equipment purchases to see if sales tax was paid properly. Review all equipment purchases carefully for sales tax compliance. Be careful on equipment used in the shop. For example, packaging equipment and fork lifts are taxable in some cases, but in others, they are exempt from sales tax. You must find out how the equipment is used to determine if sales tax should be paid.
• Out of state purchases: The most common error during an audit is the purchase of taxable items from an out of state vendor who does not charge Illinois sales tax. A company must self-assess a use tax if the vendor does not properly charge sales tax to the company. Every audit tests for this in great detail. Since many manufacturers do not regularly file sales and use tax forms they completely miss this tax and are blindsided by a large tax liability. Common items include shop supplies, engineering supplies, office supplies, computer equipment, software, and equipment in the shop that is not machinery, etc.
• Installation service: Installing your product at a customer site generally creates a filing requirement in the state. This is certainly the case if your employees do the installation and can also be the case if a company uses a third-party to handle the installation. If your company installs and trains on-site you probably have an income tax filing requirement in the states that you provide these services.
• Delivery: Does your company have delivery trucks? Do you sometimes deliver to customers outside of Illinois? If the answers are "Yes", your company probably has an income tax filing requirement in every state you deliver to. The interstate commerce exemption only applies if you use an independent carrier.
• States with a Gross Receipts Tax: Did you know many states have taxes that are based on gross sales? For instance, a company that has no employees in a state and no contact with a state, but to their amazement may still have a filing requirement, and possibly a large amount of tax due!
• Ed Brooks, CPA, Principal, ebrooks@DHJJ.com