Navigating sales tax bad debt is more important than ever
INSIGHT ARTICLE |
This article was originally published on May 28, 2020
The financial costs of the COVID-19 pandemic are unprecedented. Virtually every segment of the economy has suffered enormous losses and the problems are likely to persist. Stay-at-home orders and government mandated business closures remain in place. High unemployment and consumer uncertainty will likely keep demand for products and services low. Many economists believe the nation’s economic problems will linger long after the health crisis ebbs.
For businesses selling products and services subject to sales and use tax the financial crisis presents several unique issues. Many companies, especially in the retail and consumer product industries, remit significant amounts of sales tax collected from customers on a monthly basis to the states. Usually, the sales tax is remitted to revenue departments before actually collecting the payment from their customers because of payment terms.
For example, some businesses provide their own financing through ‘private-label’ credit cards. Customers make purchases on the cards while having extended periods to pay off the debt. Vendors will often remit the sales tax before that money is recouped through the credit or financing arrangement. If a customer subsequently defaults, the vendor has likely paid the tax to the state without receiving the corresponding amount from the customer. Essentially, bad debts may result whenever vendors extend credit to customers and are unable to collect on that debt. Bad debts also occur due to returned merchandise where the sales tax was remitted but now must be refunded to a customer.
While companies have always faced the problem of delinquent accounts, the problem is magnified during the pandemic. Many purchasers, both business and consumers, are unable to pay for products and services purchased. Vendors unable to collect payment may be able to claim a state sales tax bad debt deduction. Virtually all states imposing a sales tax permit businesses to claim a bad debt deduction as either a credit or deduction on a current sales tax return. Many states also allow vendors to file refund claims for sales tax remitted but uncollected.
The rules concerning claiming sales tax bad debt deductions are often complicated, For example, most but not all states, require that the sales tax bad debt meet the federal definition of a bad debt under section 166 and be included as a deduction on the seller's federal tax return. Some states are less stringent and require only the debt to be eligible for inclusion on the federal return. There are many other issues that affect the deduction for sales tax bad debt. Precise record keeping is important as the deduction or credits cannot exceed the original amount of tax on the sale. Moreover, changes in the tax law, while not common, can affect refund and credit amounts. Finally, in some financing transactions, the party with the right to claim the bad debt deduction is not always clear.
Many companies are ill-equipped to deal with the sheer number of tax related issues arising from the COVID-19 pandemic. Businesses may suddenly find themselves unable to collect on receivables that include sales taxes already remitted. There are opportunities for such companies to receive refunds on sales taxes remitted but uncollected. It is important to know what qualifies as bad debt, how to substantiate claims, and to develop practices to monitor and track uncollectable debts.