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Use tax exposure: The worst case scenario (and how to mitigate it)

March 11, 2015


Concerned that you haven’t been paying Ohio use tax consistently, to the full extent required by law? There’s good reason to be, as this has become a hot-button issue at the Ohio Department of Taxation, where they are actively looking for businesses with use tax exposure.

Purchases that incur use tax

When it comes to taxable purchases in Ohio, it’s a matter of pay me now, or pay me later. For transactions where Ohio sales tax was due but not collected by the seller, you must pay use tax in the amount equal to the uncollected sales tax. This situation most commonly – but not exclusively – occurs with out-of-state vendors, or through the internet.

The manufacturing industry enjoys an exemption from paying Ohio sales and use tax on the purchase of materials and equipment directly related to their manufacturing process. But misunderstanding this exemption has caused trouble for more than one business in recent years. Be sure you clearly understand which purchases qualify for the exemption, which don’t, and the proper way to interact with vendors who sell you either.

A red flag for the state

The Ohio Department of Taxation has become more aggressive in the auditing of manufacturers for use tax. They have recently cross-referenced records to identify over 300,000 companies in Ohio without active Consumers’ Use Tax accounts. And any organization that doesn’t have such an account may be subject to a state audit.

State audits are costly and time consuming

If the State of Ohio inquires about your use tax, you and your staff will have find and examine your receipts of business purchases from the past seven years. Not only will you have to remit the back use tax owed over that period, but you’ll face interest and penalties which can significantly add up.

Consider the case of one Ohio manufacturer who unknowingly abused blanket exemption certificates. For example, the business regularly purchased solvents used in the manufacturing process from a vendor, using a blanket exemption certificate. When the manufacturer later increased their order to include supplies used for other purposes (which were therefore not exempt), the blanket certificate allowed the transactions to erroneously take place without sales tax. This scenario was repeated with multiple vendors. When the manufacturer received an Ohio use tax audit, the oversight was discovered. Over seven years, the tax owed, combined with penalties and interest, was over $465,000.

Avoid the audit: disclose the issue now

If your company doesn’t have a Consumers’ Use Tax account, you might suddenly be feeling like you’re wearing a target on your back. But the state has offered an option to mitigate the impact of your situation: get ahead of the problem by proactively notifying them of your use tax exposure. You’ll avoid penalties and shorten your look-back period when you enter into a voluntary disclosure agreement (VDA) before the state contacts your company.

To enter into a VDA, you will need to review your business purchases for the previous 36 months to determine your outstanding use tax, a complicated and time-consuming process. The advantage is that your applicable penalties will be waived, and the state will be limited to looking at only the last three years, not the last seven. You will be assessed back use tax and interest for that period, but the consequences you incur will pale in comparison to enduring a state audit.

Consider the manufacturer who realized the company had use tax liability and entered into a VDA prior to hearing from the State of Ohio. The company’s look-back period was three years, not seven, and it saved it a substantial amount in interest and penalties. In the end, the company identified $230,000 in back taxes and penalties that it was not assessed, but could have been through a state audit.

Your support through the VDA process

Manufacturers have an added layer of complexity when submitting a VDA, as you may need to defend your application of the manufacturer’s exemption. As seen in this recent court case, determining which purchases are exempt from use tax is not always easy.

If it’s in your best interest to proactively contact the state about your use tax exposure, you don’t have to do it alone. Our compliance specialists can support your efforts every step of the way, helping position you in the best possible light, to save you time and money.

Is it the right time for you to enter into a VDA with the State of Ohio? A CSH advisor can help you explore the possibility.

Further resources for understanding the Ohio manufacturers’ sales and use tax exemption:

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.


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