Use Tax Accrual: Manual and Automated Options to Keep You Compliant

Decisions your suppliers make as they react to changes in where they are required to collect sales tax can greatly impact your relationship with them as a customer. Will all your suppliers start collecting tax? Are they doing it correctly? Can you trust what they are doing? Accounts payable departments are the first line of defense in ensuring supplier tax responsibilities are being properly managed. If the AP department isn’t evaluating the taxes suppliers are charging, costs could increase, and sales tax overpayments are likely to occur.  

There are strategies to keep tabs on what your suppliers are doing when it comes to taxing your purchases and options such as direct pay authority and purchasing companies as possibilities to keep control. There are a variety of process options to consider from manual review to managed compliance agreements to interactive sophisticated solutions. Knowing the solutions available as well as what the right tool is for your needs is key to paying just the right amount of sales and use tax. 


Getting a Use Tax Process in Place 

Keeping up with responsibilities for consumer’s use tax, the tax that applies to purchases made outside the taxing jurisdiction but used within the state, requires a formal regular process of reviewing tax paid to vendors. Determination of taxability on purchases can be based on various parameters and can vary based on the type of transaction. As more vendors are required to register post-Wayfair, the risk of incorrect tax being charged is growing. As always in the indirect tax field, being thorough is key. When a vendor has charged tax on the transaction, the seller should validate that the tax is correct. This includes three important steps: 

  1. Jurisdiction Validation – Has the vendor taxed the correct jurisdiction? Make sure the destination state tax is charged and not the seller’s state. 
  2. Taxability Validation – Is the item subject to tax in the jurisdiction where it is delivered and used? Has the seller classified the items they are selling correctly based on state definitions?  Has the buyer provided an exemption certificate and has the seller applied it to the transaction? 
  3. Rate Validation – If the item is taxable, did the vendor use the right rate based on the item and jurisdiction? Is there a special rate for manufacturing, technology or an enterprise zone rate? 

Once you’ve taken these steps, it’s important to keep all parties in the know. For example, be sure to issue exemption certificates when applicable and communicate timely with vendors so they can fix any problems. If you short pay, be sure to send communication with reasons and documentation. If you file a refund claim, provide all necessary documentation and do it in a timely manner.  



Tax Automation and Other Solutions for You 

Tax automation makes dealing with your use tax responsibilities much easier, you just need to find the tool that works best for your company. There are many options out there that will help limit your risk for error. The key components that you need to look for in a tax automation tool are the following: 

  1. Taxability Determination 
  2. Rate Determination 
  3. Vendor Tax Validation 
  4. Tax calculation 
  5. Tax Accrual 
  6. Transaction Detail Reporting 

The more sophisticated and comprehensive tax automation solutions do come with a higher price tag, so there are few alternatives to them. If you choose manual review and identification, you need to provide taxability guidance and process directions to your purchasing and accounts payable teams.  To help identify the transactions requiring tax review and use tax accrual, identification by either vendors or GL Account can provide focus. At the least automated process, using an Excel spreadsheet or a use tax accrued GL account to track the transactions can provide the documentation needed for compliance and audit.  As you accrue tax, mark vendor invoices with stamp or use tax accrual account to help the auditor gain confidence in your process. 

For a middle ground, you can use a managed compliance agreement in lieu of specific transaction evaluation for use tax. This method includes determining a use tax accrual rate based on a sample review to report use tax. To limit risks, it’s recommended that you participate in a state approved program. Or lastly, you can use a simplified automated process where your AP inputs a simple code on AP Invoice. 

When evaluating which solution is best for your company, keep in mind these points…  

  1. Create a defined project plan with goals and objectives 
  2. Include a broad project team (AP, PO, Master Data, Finance, Tax, ERP) 
  3. Develop comprehensive requirements and definitions 
  4. Be open to creative solutions and change 
  5. Develop and conduct thorough testing 


In Summary 

Use tax is an area where companies often slip up. When tax decisions are made accurately, the company saves money, the vendors are satisfied, audits result in lower liabilities, and penalties and interest are minimized.

Posted on March 20, 2023