Understanding and Profiting from Use Tax

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 types 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.

Using a resale certificate exempts the kitchen design owner 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 clients and include the figures 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 are unsure of 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. By doing this, 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.

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.