What To Do If You've Overpaid Sales Tax on a Purchase
Beware of little expenses. A small leak will sink a great ship.
This Benjamin Franklin axiom rings true for many companies regarding sales and use tax. If you suspect that sales or use taxes have been overpaid by your company, address the problem immediately, but also put practices in place to prevent future overpayments from sinking your ship. A money leak can quickly add up to a major hole in your company’s bottom line.
How to recover the overpayments, as with every answer regarding sales and use tax, depends on the state, and in this case, also depends on the type of tax. Let’s begin by breaking down the different scenarios.
Tax Paid Directly to A Vendor
In most states, if you overpay tax on purchases that qualify for exemption (for example, manufacturing machinery, production supplies, resale items, etc.), the typical course of action is to provide the supplier with a list of purchases that should have been exempt, as well as an explanation for the exemptions and copies of the exemption certificates covering those transactions.
Next your supplier should issue you a refund of the tax that they previously collected and remitted, while also making adjustments to their sales tax account to recover the credit issued on their next sales tax return. All this work is done behind the scenes without the Department of Revenue getting involved. It is a transaction between you and your supplier, and it usually happens pretty quickly.
Another possible scenario is that the supplier requests a refund directly from the Department of Revenue with the reason “sales tax refund issued to customer”. This refund claim will be reviewed and processed by the Department of Revenue before a refund is issued to your supplier. The supplier then issues a refund to you. In many states, interest is paid on these refund claims.
The third scenario is also very common. The supplier requests that you seek the refund directly from the Department of Revenue. Some states require this course of action while other states allow this option. But some states don’t allow this request, claiming that only the taxpayer who remitted the sales tax can seek the refund. Again, it all depends on the state.
Typically, with the third scenario an Assignment of Vendor’s Rights form is required to prevent two parties (the customer and the supplier) from seeking refunds on the same transactions. This form typically needs to be signed by your supplier, so if your supplier is out of business, you may be out of luck. Again, similar to the scenario above, the refund gets reviewed and processed by the Department of Revenue and a check will be issued directly to you, or perhaps jointly to both parties.
If use tax has been paid in error, you have three options. First, you can correct the error within your own use tax account and handle it within your own accounting recrods. This may be the easiest option if the overpayment is limited to a handful of transactions. Good documentation should be created in the event of an audit. You will need to substantiate the adjustments that were taken to your use tax account.
Another option is to file an amended return. This option often can be completed online and a refund or credit will be issued to your account.
A third option is to file a refund claim. This is often the best case scenario when a significant number of transactions are involved or you want an issue reviewed and approved by the audit department within the Department of Revenue. Depending on the size of the refund, it may be “desk audited” or assigned an auditor for review in the field (i.e. at your location). Questions may be asked about the specific exemption claimed to ensure the validity of the refunds. Typically, most states pay interest on refunds.
Things to Consider
All of these processes seem fairly straightforward, but should be taken with a note of caution. Any time a company files for a refund claim, the possibility of triggering a sales & use tax audit exists. For some companies, that’s no big deal – they are audited every year like clockwork. But, if you haven’t been audited in a while, or you are aware of potential exposure, consider the pros and the cons before filing for refunds.
What You Always Want to Do
Preventing overpayments is the best answer. But, mistakes do occasionally occur. When you discover that you have overpaid, look for the reasons why. Was your supplier not given a valid exemption certificate? Was your staff untrained to know the taxability of the products that they purchase? Did a tax law change, opening up this refund opportunity?
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The more you can analyze the root of the problem, the better chance you have to fix the problem AND put better processes in place for the future. After all, fixing the “leak” is a lot more work than preventing the crack. As Benjamin Franklin so aptly said, “An ounce of prevention is worth a pound of cure.” Well said Ben!