How to Make Sure Your Business Isn't Paying Too Much in Sales Tax

Consider taking these three steps to avoid overpaying the tax man. Plus, the best and the worst tax states for business owners.
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This story appears in the June 2011 issue of . Subscribe »

Dean Cycon was having an after-work beer with one of his suppliers and complaining about the high price of propane, which powers Dean's Beans Organic Coffee Company, his fair-trade wholesale and retail coffee company in Orange, Mass. The supplier, seeking a silver lining, said, "Well, at least you don't have to pay sales tax on it, because it's used in your manufacturing," Cycon recalls.

When he returned to his office, Cycon found that he had, in fact, been paying sales tax on propane--along with various other supplies used in creating his products.

The Best (and Worst) Tax States for 'Treps
The Small Business & Entrepreneurship Council's Business Tax Index 2011 ranks the 50 states and District of Columbia according to the impact of their tax systems on small businesses. States are ranked based on 18 different tax measures, including income, capital gains, property, unemployment and various consumption-based taxes like gas levies. Here's a look at the top--and the bottom--of the heap:

Best tax systems:
1) South Dakota
2) Texas
3) Nevada
4) Wyoming
5) Washington


Worst tax systems:
47) Iowa
48) New York
49) New Jersey
50) Minnesota
51) District of Columbia

Sales tax laws vary significantly from state to state, and even among various municipalities, says Gail Margolies Reid, a CPA and author of The Complete Idiot's Guide to Low-Cost Startups. In many areas, products and services purchased as part of a manufacturing or production process are not subject to sales tax. However, while Cycon was being charged sales tax erroneously, propane used in manufacturing may be taxable in other areas, she says. To protect yourself from paying extra sales tax, follow these steps:

Get an opinion. If the law is not clear about whether you'll owe sales tax, inquire with your state and, if applicable, municipal tax office, Reid says. Describe the situation in question and ask for an opinion on whether sales tax is due. Such an opinion can be an important factor in your favor if the issue is ever questioned. If you prefer to do so anonymously, have your accountant or attorney send the request.

Issue resale certificates. To obtain an exemption, you'll likely have to issue resale certificates to your suppliers to prove the product or service was purchased for resale and not subject to sales tax. These can be obtained from the taxation authority in your state or municipality, Reid says. Cycon found that some of his suppliers required their own versions as well.

Contact your suppliers. When Cycon contacted his propane supply company, they were aware of the issue and immediately credited his account for six months of sales tax. He is also eligible to petition the state to refund up to two years. He estimates that correcting erroneous sales tax billing will save his $4 million company about $5,000 per year.

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