Whether a kitchen/bath design firm owner correctly charges sales tax or use tax in their client contracts has long been a source of confusion and frustration in this industry. And it seems that every state would like to keep it a mystery because the tax codes are written so ambiguously.
Indeed, a dealer – or his representative such as an accountant – could probably call his state tax department three different times over a span of a few months, speak with three different bureaucrats and receive three different interpretations of how his firm should be collecting tax from his clients.
THE USE OF A TAX
The only instance of clarity and uniformity in the state tax codes around the country seems to be for those of us just selling design and product. We have to charge the prevailing sales tax percentage on the selling price of the materials, and that tax must clearly be disclosed on the face of the agreement.
It starts getting murky when there is an installation involved. With respect to these kind of projects in general, and remodeling projects in particular, most states see the kitchen/bath firm as the “end user” of the products because he is altering the room.
Therefore, dealers should apply for a resale certificate from their state and give their resale number to suppliers when buying product from them. An NKBA survey of the states in the mid-1970s confirmed that 38 of them would see the remodeling firm as the “end user” of the kitchen and bath products.
This procedure exempts them from paying sales tax to the supplier on the cost of the materials being purchased for a specific job. However, owners must collect this sum – the sales tax percentage on the purchased materials – from their client and include the figure in the signed agreement. This “use tax” must be paid to the state within 30 days of the sale (cash accounting) or within 30 days of substantial completion (accrual accounting). If you don’t know the differences between the two accounting methodologies, please see my April 2006 column in Kitchen & Bath Design News. All firms in this industry should be on accrual accounting.
PROFITING WITH USE TAX
Unaware of this resale provision in most of the state tax codes, many dealers erroneously charge a sales tax on the selling price of the materials. In these instances, the state ultimately comes out a big winner because the dealer is collecting more revenue for it (i.e. the difference between the % on the cost of materials and the same % on the marked up selling price of the materials).
Other dealers calculate the correct use tax figure, but just tack the sum on after the materials, labor and subcontract costs have been marked up. They are missing a big profit opportunity.
Savvy dealers treat the use tax like any other cost in a project. They mark it up and make a profit on it, knowing full well that the amount of the use tax does not have to be separately disclosed in a contract.
STIPULATIONS, INTERPRETATIONS & VARIATIONS
When I operated four showrooms in Connecticut back in the 1980s, we also did some business on occasion in Rhode Island, Massachusetts, Vermont, New York and New Hampshire. These states (except New Hampshire, which does not have any sales tax) all permitted us to charge use tax to our clients provided that (1) installation was part of the contract, (2) the price on the contract was presented as a “lump sum,” and (3) the use tax amount was not disclosed separately on the front of the contract. As a result, we enjoyed a healthy profit on the cost of use tax in tens of millions of dollars in signed agreements.
Connecticut had one quirky stipulation, however. Our firm needed to break out the selling price for appliances in a project contract, charging sales tax only on their total. Because there were so many appliance stores selling their products “over the counter” (i.e. without installation), the state wanted kitchen design firms to treat the tax on appliances the same way.
On the other hand, North Carolina allows dealers to calculate use tax on appliances in a lump sum contract, but only if the firm does most of its business in remodeling. If the majority of a company’s kitchens and baths go into new houses, North Carolina requires the firm to use two contracts. The first is for the sale of materials, so a 7% sales tax applies on that total. The second is for the installation, much like what they require of flooring stores.
USE TAX DOESN’T COST MORE
A simple comparison between Use Tax and Sales Tax on the same project reveals that your client would pay about the same overall price regardless which calculation procedure is applied. The main difference is that your firm becomes a winner in the sense that it is picking up dollars for profit that would ordinarily be paid to the state in sales tax.
In the example below, where the objective is a 50% Gross Profit, those extra gross profit dollars equal the tidy sum of $1,596.
Use Tax Sales Tax
Cabinet Cost $20,000 Cabinet Sell Price ($21,800 x 2.0) $43,600
Freight 1,000 Freight (included in $21,800 cost)
Company Raw Materials 800 Co. Raw Materials (in $21,800 cost)
Use Tax (7% on $20,800) 1,456 Sales Tax (7% on $43,600) 3,052
Installation 2,000 Installation 4,000
Markup ($25,256 x 2.0) $25,256
Total Selling Price $50,512 Total Selling Price $50,652
APPROPRIATE ACTION PLAN
When it comes to use tax and sales tax, there’s no doubt that many states have quirky applications or stipulations written into their tax codes. Since the profit opportunity in marking up use tax is considerable, it would behoove kitchen/design firm owners who aren’t earning these profit dollars now to do a little homework. Remember, you are likely to run across a number of interpretations depending upon to whom you speak with in the state tax department.
If possible, get a letter from the state tax office that confirms how your firm should be collecting the tax in your contracts. That way, when auditors target small businesspeople – in a year where there is a significant budget shortfall – from whom to collect underpaid sales taxes, you can provide proof that your firm has been collecting taxes in compliance with official state guidelines.
Ken Peterson, CKD, LPBC, is president of the Chapel Hill, NC-based SEN Design Group and an instructor for the “Road to Recovery: Best Business Strategies for 2011” seminar, co-produced by KBDN. Peterson can be reached at 1-800-991-1711 or firstname.lastname@example.org.