Ohio to Conduct Business Use Tax Audits; Options to Reduce Your Liability


February 1, 2011

Early in 2011, the Ohio Department of Taxation will begin investigating all businesses that are registered with the Ohio Secretary of State but do not have a use tax account. Whether or not your business is actually subject to the use tax does not matter. Even having tax-exempt status does not matter. If you do not have an account, you may be audited and could face significant tax liabilities, interest and penalties.

What is the Use Tax?
Closely related to state sales tax, use tax comes into play in two different scenarios. The first scenario is when an individual or business buys tangible personal property or taxable services—such as computers, software or office supplies—from out-of-state or online vendors and the seller does not charge any sales tax. It is the responsibility of the purchaser to remit the tax to the state in the form of a "use tax."

The second scenario that generates a use tax liability is when a vendor collects Ohio tax from a purchaser, but the tax collected is at a rate lesser than the rate of the county in which the purchaser is located. The amount of the tax paid must equal the sales tax rate for the county in which the goods or services are used. For example, if your county sales tax is 7.5% and the seller charges 5.5% on the purchase, you must proactively pay 2% in use tax to the state.

Even for those businesses with an exemption, such as the resale or manufacturing exemption, use tax may apply if the exemptions are used incorrectly. As an example, the manufacturing exemption only covers items used in the manufacturing process. Using this exemption to avoid sales/use tax on other purchases, such as office supplies and furniture, results in exposure to use tax.

Minimize Risk and Reduce Potential Liabilities
The state is aggressively looking to fill budget holes, so it is likely they will cast a wide net in their investigations. If the state contacts you about a use tax audit, they generally will go back four to seven years into your records, regardless if you are actually subject to use tax or not. However, they can go back as long as they want since a use tax return has never been filed. If unreported use tax is discovered, you may incur significant tax liabilities and be subject to interest and penalties.

If you currently do not file use tax returns with the state, you may want to consider completing a voluntary disclosure agreement (VDA). A VDA will limit your audit exposure to three years versus the typical range of four to seven. Completing the VDA also will excuse you from any penalties assessed after the audit is complete. You cannot take advantage of the VDA option once the state contacts you about an audit.

For example, a manufacturer purchases office supplies and software, not to be used in the manufacturing process, online or from out-of-state vendors. The manufacturer does not have a use tax account (so never files a use tax return) with the State of Ohio. The manufacturer did not fill out a VDA and is selected for a use tax audit. The audit will look back four to seven years into the manufacturer’s purchases to determine how much use tax, if any, is owed (and may in the process uncover other tax liabilities). Unless the manufacturer has all of its past invoices stored on site, the company will have to go through the effort and cost of pulling years of purchase histories from offsite locations. The ending assessment could result in tens of thousands to even hundreds of thousands of dollars after interest and penalties. The amount owed may have been reduced if a VDA had been filled out, limiting the scope of the audit to the previous three years only and eliminating any penalties.

Even if your business does not believe it is subject to use tax, it may be a best practice to file a “zero return” each year. At a minimum, filing each year will place you in the state’s system. Record of filing prior use tax returns will limit the number of years a future audit could encompass.

Next Steps
Make it a priority to determine if your business has a use tax account and if it is consistently filing use tax returns with the state. If you do not have an account or are not regularly filing, contact a member of your service team or Jenny Tapia at 440.250.8515 (jtapia@cohencpa.com) in our State and Local Tax Group. We will work with you and your legal advisors to determine the best course of action to help you minimize your liabilities.

Notwithstanding that these materials do not constitute legal, accounting or other professional advice, as may be required by United States Treasury Regulations and IRS Circular 230, you should be advised that these materials are not intended or written to be used, and cannot be used by you or any other person, for the purpose of avoiding penalties that may be imposed under federal tax laws. No written statement contained in these materials may be used by any person to support the promotion or marketing of or to recommend any federal tax transaction(s) or matter(s) addressed in these materials, and any taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor with respect to any such federal tax transaction matter.