Credit transactions present some special complexities in the sales tax arena. When retailers make a direct credit sale, they are required to remit sales tax on the entire purchase price even though the tax was not collected. If a customer later defaults, the retailer can generally take a bad debt deduction for sales tax remitted but not received from the customer. Where the credit is directly issued and managed by the retailer, this system provides efficient and necessary relief. However, most retailers have moved away from directly issuing store credit, and instead have turned to private-label credit cards. These cards are branded with the name of the retailer but are issued and managed by a financial institution that processes the transactions and holds the portfolios. In the case of a default, the agreement between the retailer and the issuer controls to what extent each party is responsible for the economic fallout, and, generally, the retailer carries the burden. However, from a sales tax perspective, neither the retailer nor the financial institution can claim the bad debt deduction because the retailer did not directly experience the default and the credit issuer was not the retailer.
Nine states have moved to provide relief for this scenario by allowing a retailer to claim a sales tax bad debt deduction for amounts not ultimately collected in a private label credit card transaction: California, Florida, Idaho, Illinois, Hawaii, Michigan, Pennsylvania, Texas, and Wisconsin. Following prior proposed legislation in 2021, Ohio, seeks to become the tenth state to provide a bad debt deduction for retailers that recognizes the shift to private label credit cards through House Bill 223.
RSM state tax policy experts weigh in on this legislative proposal.
David Brunori
I am shocked - and disappointed - that only nine of the 45 states impose a sales tax allow retailers to deduct taxes collected on default transactions. Fairness is a principle of sound tax policy; disallowing the deduction is not fair. There is no tax or economic reason to allow sales tax refunds for retailer-issued cards but deny them for private label credit cards. That is neither fair nor neutral. Moreover, the current practice in Ohio and most states leads to the state keeping more sales tax revenue than it is legally owed. If the ultimate customer defaults, the state keeps the tax but the retailer is out the sales tax paid. And, the current system is contrary to sound sales tax policy – which unequivocally provides that the sales tax should fall on final consumption. In Ohio’s case, the consumer (who defaults) is not paying the sales tax. Rather Ohio law imposes the tax on the retailer. People concerned about sound state tax policy should be rooting for passage of House Bill 233.
Mo Bell-Jacobs
There is absolutely no reason not to pass House Bill 233, and it is unconscionable that there are only nine states that have previously properly addressed this issue. Set aside the fundamental unfairness of allowing a bad debt deduction for a default on a direct store credit transaction but not a private label credit transaction, which David has addressed. In my opinion, the worse problem here is that the economic result of Ohio’s current law is a windfall for the state at the expense of the parties that have been harmed by a default. The availability of credit and retail offerings help drive economic growth, and the shift to private-label credit cards has created significant efficiencies that ease the expansion of economic activity. Ohio benefits from this system through enhanced sales tax revenues and should find a way to provide relief when a debtor leaves a retailer high and dry, no matter who issues and manages the debt.
While we have previously written about bad debt deductions during the height of the pandemic, the reasons to continue due diligence are more important than ever as we navigate a less-than-certain economy.
