SBOE: Why am I Being Audited?
A government agency that business owners and operators are likely to be familiar with, but which may be wholly unknown to the average taxpayer, is the California State Board of Equalization. The State Board or BOE, as it is often called, has a variety of responsibilities which include monitoring of Property Taxes (in which it governs and regulates the rates and procedures by which property values are assessed and taxed), collecting Special Taxes and Fees (such as cigarette and tobacco sales licenses, waste disposal fees, e-waste and other taxes and fees designed to protect the environment), Tax Appeals (disputes between taxpayers and the BOE, as well as the Franchise Tax Board involving personal income tax matters), and likely its most pervasive role in that it is the reason that most often gives rise to audits, Sales and Use Taxes.
Sales and Use Taxes make up about 80% of the BOE’s collected revenue, so naturally this is an area of special contention for the Board. If you run a business and are being audited by the Board of Equalization, chances are it relates to this topic. The actual percentage of Sales Tax or Use Tax will vary by the district in which you conduct business in the state of California, but wherever that may be, the Sales Tax and Use Tax will be equivalent. The distinction between Sales versus Use Tax turns mostly on purchases within or outside of the state. Depending upon your type of business and volume of sales annually, the imposition of these taxes can become quite a large liability so it is important to know when you are obligated to pay.
Sales Tax is imposed upon merchants for selling tangible personal property at retail, to put it another way, any goods for final consumption and not for resale are subject to sales tax. (Interesting fact: Those “five dollar foot-longs” that everyone loves? They’re actually part of an exception to the rule, any food sold cold and to-go, doesn’t have a sales tax, same with hot-coffee to-go). A business is obligated to collect and provide a quarterly report on the sales taxes gathered based upon gross receipts. An important side note to all of this is that, depending upon the exchange, labor can be included in the taxable transaction as well. A general rule is that there are three types of labor: installation, repair, and fabrication (the creation of a new item). Installation and repair are not included in the taxable transaction and sales tax does not apply. Labor that involves the manufacturing or creation of new property is party of the taxable transaction as a whole and sales tax must be paid on this portion of the sale! When you take your car to a mechanic and purchase brake pads, this as a sale of goods, is taxable. When that mechanic then applies the brake pads to your car, and you are charged for labor, this is not a sale of goods and this portion is not taxable. An offshoot of this is “services” as part of a sale. Any services performed as part of a transaction, that is, any additional charge for additional work is included in the taxable transaction and subject to Sales Tax.
To help shed some light on the distinction consider going out to eat at a restaurant. You speak with the waiter, he takes your order, refills your drinks when necessary, all the while bringing and removing food from the table. It is true the waiter has performed a service for you, but not one outside the normal sale of the good “dining out”, his actions thus far have been part of a single transaction. In cases of large parties however, restaurants will often charge a required tip included in the bill. If the restaurant chooses to impose this charge, in effect saying that waiting upon a large party is above and beyond the usual sale of “dining out”, this is included in the taxable transaction. In essence, if a customer is being charged for service related to the sale of goods and not a separate and distinct charge for the labor required to provide that service, it becomes a part of that good and gets taxed as such. Mandatory tips, gift wrapping fees, and handling charges for shipping are all examples of taxable fees related to the sale of a good imposed upon the customer, which are not a separate labor charge. The distinction between labor and services, taxable and non, can be ambiguous, and it is for that reason businesses often run into trouble and end up underreporting and under paying liabilities owed.
The Use Tax is applicable to businesses and individuals that make purchases outside of the state to be used, sold, or stored within the state. Unlike Sales Tax, the obligation to pay Use Tax is upon the consumer. Use tax is not measured by gross receipts from sales, but rather the sales price of the property sold. Out of state sellers doing business within the state of California are required to collect Use Tax at the time of sale, but if they do not then the purchaser will need to pay the tax to the BOE directly. The Use Tax is not all that different from Sales Tax, it is merely the State’s effort to cash in on transactions in which its residents take part. “Handling” again is a service related to the sale of the goods and will be subject to Use Tax, however shipping will be exempt as long it is 1) direct to the purchaser by common carrier, contract carrier, or US Mail; 2) the invoice clearly lists shipping/delivery charges as separate from the purchase price of the good; and 3) the charges are not higher than actual costs for delivery. A general rule is that if Sales Tax would apply to a purchase of the good within the state, then Use Tax will apply to its purchase outside the state.
Although not confined to matters regarding Sales and Use Taxes, as stated before the SBOE has a lot to lose (80% of revenue!) in not properly collecting these taxes, so chances are if you’re a business and being audited, it involves one of the two. Knowing when you are or are not required to pay can be a complex and confusing dissection of the state’s regulations. RJS Law is a firm specializing in tax matters and has the expertise to help you avoid audits and reduce or eliminate liability should you be assessed a penalty.
Please keep in mind the information and advice presented in this blog is not intended to be used as formal legal advice. Contact a tax professional for personalized tax advice pertaining to your specific situation. While we try and answer all parts of the question when we write our blogs, sometimes there may be some left unanswered. If you have any questions about your problems with the IRS, SBOE, FTB, or BOE, or tax law in general, call RJS Law at (619) 595-1655.