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Bad Debts – An Overlooked Sales Tax Exemption

Bad debts are often carefully considered for federal tax purposes but overlooked when it comes to sales tax. It is common for businesses to fail to collect the total balance of their sales. These bad debts are generally remembered when it comes to calculating income for federal returns and even state income tax returns. However, they are often overlooked for sales tax purposes.

In most states, sales tax is due at the time of sale. For example, if a customer purchases a car with the agreement to make equal payments over five years, sales tax on the full purchase price of the vehicle is still due to the state upon purchase. That means you paid the full amount of sales tax on your sales even when you never collected the full amount from your customer. Fortunately, you may be able to get that money back.

States take substantially different approaches when it comes to the scope of their sales tax exemptions for bad debts. This article will focus on the five big states: California, Florida, Illinois, New York, and Texas.

Credit of Refund

Taxpayers generally can obtain either a credit or a refund for sales tax paid on accounts that ultimately became bad debts. Most businesses opt for the credit because it is more convenient to roll it into the next month of taxes due. In addition, taking the credit on the next return resolves the issue faster than applying for the refund. State taxing authorities are much more likely to allow a credit than to hand back money to taxpayers from their own pocket. The refund application process can be tedious. In addition, the state can stall them for long periods of time, especially if they are for high dollar amounts.

However, there are situations in which a refund is the best way to recover sales tax relating to bad debts. When a business has closed, for example, and no future returns will be filed, a refund may be the only option. Similarly, if a business has ceased or reduced operations in state, the credit they are seeking may exceed any tax due in that state in the foreseeable future. Finally, a change in ownership may mean that a separate and distinct party would receive the benefit of a bad debt sales tax credit for which they are not entitled. In these and other circumstances, it may be beneficial for taxpayers to consult a sales tax professional who can walk you through the application for refund process.

State Differences

If you’ve just realized you never took your credit or obtained your refund for sales tax paid on bad debts, don’t expect a windfall now going back to the beginning of your business. Each state has different policies, any one of which could prevent your business from the overpaid sales tax it’s entitled to. 

In California, taxpayers are relieved from liability for sales tax or from liability to collect use tax when the origination of the sales tax is an account found worthless and charged off for income tax purposes. If the taxpayer is not required to file a federal return, the account must be charged off under generally accepted accounting principles.

Meanwhile, Florida restricts bad debt sales tax refunds to the following scenarios: (a) within 12 months following the month in which the bad debt has been charged off for federal income tax purposes, or (b) if the dealer is not required to file federal income tax returns, within 12 months following the month in which the bad debt has been charged off in accordance with generally accepted accounting principles.

Illinois provides three requirements for the recoupment of sales tax paid on bad debts. First, a retailer is relieved from liability for any tax that becomes due and payable if the tax is represented by amounts that are found to be worthless or uncollectible. Next, the accounts must have been charged off as bad debt on the retailer’s books and records in accordance with generally accepted accounting principles. Finally, the bad debts must have been claimed as a deduction pursuant to section 166 of the Internal Revenue Code on the income tax return filed by the retailer.

In New York, the law specifically includes bad debts from a variety of sales. Specifically, receipts, amusement charges or hotel rents, which have been ascertained to be uncollectible (either in whole or in part), can be taken as credit or a refund. Taxpayers must apply with the Department of Taxation and Finance within three years from the date on which the tax was payable.

Like Illinois, Texas has three requirements for the recovery of sales taxes paid on bad debts. Specifically, a seller may withhold the payment of the tax on a portion of the sales price of a taxable item that remains unpaid by the purchaser if: (1) during the reporting period in which the item was sold, leased, or rented the seller determines that the unpaid portion will remain unpaid; (2) the seller enters the unpaid portion of the sales price in the seller’s books as a bad debt;  and (3) the bad debt is claimed as a deduction for federal tax purposes during the same or a subsequent reporting period. Texas also limits deductions and refunds due to bad debts to four years from the date the account is entered in the retailer’s books as a bad debt.

States take different approaches to returning overpaid sales tax on bad debts. Taxpayers generally can take a credit going forward or apply through the taxing authority for a refund. While taking a credit on your next return is likely the simpler way, there are specific circumstances in which applying for a refund is preferable. States take varying positions on what types of bad debts can be considered for a sales tax refund or credit. It is especially important for taxpayers to know how much time they have to recoup their overpaid taxes after they have been paid or the account has become delinquent. These timelines are not to be confused with refund statute of limitations, which may be conflicting to those provided by bad debt statutes. Taxpayers should consult a state and local tax attorney if they believe they have remitted sales tax on bad debts and have not properly been credited or refunded those amounts.

Jeanette Moffa is an attorney who concentrates on state and local taxes at Moffa, Sutton, & Donnini, P.A. She is an executive council member of the American Bar Association Tax Section State and Local Tax Committee and the Florida Bar Tax Section. Ms. Moffa is an author of both the CCH’s Expert Treatise Library: Sales and Use Tax as well the ABA’s Sales and Use Tax Deskbook. In addition, her regular columns on state and local tax issues can be found in State Tax Notes and Actionline, a publication from the Florida Bar’s Real Property, Probate, and Trust Law Section. She also serves as assistant editor to the Sales and Use Tax Deskbook and Actionline. Ms. Moffa is a regular speaker at the American Bar Association Tax Section conferences, the Institute of Professionals in Taxation, the Florida Bar Tax Section, the Florida Bar Real Property, Probate, and Trust Law Section, and the FICPA. In her free time, she teaches as an adjunct professor at Broward College.

At the Law Office of Moffa, Sutton, & Donnini, PA, our primary practice area is Florida taxes, with a very heavy emphasis in Florida sales and use tax. We have defended Florida businesses against the Florida Department of Revenue since 1991 and have over 100 years of cumulative sales tax experience within our firm. Our partners are both CPAs/Accountants and Attorneys, so we understand both the accounting side of the situation as well as the legal side. We represent taxpayers and business owners from the entire state of Florida. Call our offices today for a FREE INITIAL CONSULTATION to confidentially discuss how we can help put this nightmare behind you.’

Additional Resources

Overlooked Exemptions – Shipping, Freight, and Packaging, Published September 12, 2019, by Jeanette Moffa
Shipping – An Overlooked Florida Sales Tax Exemption, Published September 12, 2019, by Jeanette Moffa
Overlooked Exemptions – Technology, Published September 10, 2019, by Jeanette Moffa
Technology – Overlooked Florida Sales Tax Exemption, Published September 10, 2019, by Jeanette Moffa
Bad Debts – Florida Sales Tax Exemption, Published August 23, 2019, by Jeanette Moffa
Manufacturing – An Overlooked Sales and Use Tax Exemption, Published August 20, 2019, by Jeanette Moffa
Manufacturing – Florida Sales and Use Tax Exemption, Published August 23, 2019, by Jeanette Moffa

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