Sales and Use Tax Return Filings: Understanding and Avoiding the Impact of Negligence Penalties

To encourage on-time filing and payment of sales and use taxes, states impose negligence penalties on any sales and use tax returns filed or paid late. The penalty amount can vary greatly from state to state and can be quite costly, with the penalty rate ranging from 1% to 30% of the tax due. For example, Minnesota imposes a penalty of 5% of the tax due on a return filed late, while Wisconsin imposes a penalty of 5% per month of the amount due up to 25% plus a $20 late filing fee. These penalties can add up quickly and can be very costly for a business.

Field audits of companies can often result in assessed penalties when additional sales or use tax that was not properly paid is discovered by the auditor. In more serious cases, when non-filing is intended to defraud the state, the penalties are even higher. In many situations, the penalties imposed can be 50% or even 100% of the tax due. More states are offering limited amnesty programs that allow a company to come forward and pay additional taxes due for all unfiled periods but generally waive interest and penalties. In 2015 alone, approximately 10 states offered some type of limited-basis amnesty program. An increasing number of states are implementing statutory provisions within their amnesty offering to assess negligence penalties on unpaid tax obligations for tax later discovered by an auditor or reported on an amended return filed in a period that was covered under the amnesty program.

Late-Filing Penalty

While it’s best to file your returns and pay your taxes on time, there may be circumstances that make filing on time difficult. When a state imposes a penalty for not filing and paying on time, a period of time for the taxpayer to request a waiver of the penalty is allowed. Generally, the time period to request a waiver of the penalties is 30 to 60 days. During this time, a written appeal should be submitted to the state, explaining the circumstances that led to the late filing. If the reason for filing late indicates reasonable cause and was something out of the taxpayer’s control, the state will likely consider waiving the penalties. Examples of reasonable cause may include a change in the person responsible for filing the company’s sales and use tax return (i.e., employee turnover), a natural disaster that caused a loss of records, or the sudden death of the person responsible for filing. Having a strong history of on-time filing also increases the likelihood that the state will consider and grant a one-time waiver request.

Audit Negligence Penalty

In addition to late-filing penalties, penalties can be imposed in an audit situation. The penalty can be imposed for negligence related to failure to report the correct tax due, failure to keep adequate records, or failure to provide records when requested; for example, when a company purchases a large amount of property (computer hardware or software) and the vendor is not required to charge the state sales tax based on where the customer is located. In that situation, it is the purchaser’s responsibility to self-assess and remit use tax to the state. Failure to have a system in place to detect and remit the use tax to the state can often lead to the imposition of a negligence penalty. The amount of these penalties varies from state to state. These penalties may be either automatically imposed or imposed based on the circumstances such as prior audit results or filing history. Whenever a state agency imposes a negligence penalty in an audit situation, it is best to ask the auditor the reason(s) a penalty is being imposed and whether the penalty imposition was approved by someone other than the auditor. In certain situations, penalties imposed by a state revenue auditor may be abated partially or in full to get the taxpayer’s full agreement with the audit results.

Fraud Penalty

When there is intent to evade or not report the correct state tax due, a state can impose a penalty equivalent up to 100% of the additional tax due; for example, a company that charges and collects state sales tax from a customer but does not remit the collected tax to the state. This does happen from time to time when a company unknowingly has set its sales tax system to charge and collect state sales tax from customers but fails to report the collected tax to the proper jurisdiction. Sometimes a simple reconciliation of the sales tax accrual account by the auditor reveals tax collected from a customer but not reported to a state. The majority of states impose at least a 50% penalty on the amount of tax assessed by the state or the amount of tax due. However, the penalty can be even higher than 50%. Colorado, for example, imposes a penalty of 100% of the tax due plus an additional 3% per month when there is intent to defraud the state.

Post-Amnesty-Period Penalties

As mentioned above, a company can be assessed automatic penalties if additional sales and use tax is discovered during an audit, and the additional tax due was for periods covered under a state amnesty program, and the company did not come forward to participate in the program. These penalties can range from 20% to even 50% of the additional sales and use tax due when later discovered by an auditor.

Whenever a notice with penalties owed is received from a state taxing agency, it is important to try to resolve the situation immediately. It is extremely important to understand what the penalties are for, what the procedures are for getting them abated (if any), and how to avoid incurring them in the future.

Wipfli’s State and Local Tax group has significant experience in favorably resolving penalty impositions in different states. In addition, we can help you implement a proactive approach to your company’s sales and use tax program to help you optimize exemptions and limit your exposure.