State & Local Taxes
Many states now allow their residents to report a liability for state use taxes on their individual income tax returns. The rules vary by state, but using the individual income tax return to report a use tax liability is usually a convenience and not a requirement. As more states adopt this approach, practitioners will have to explain to clients their obligations in reporting any use tax liability and address the professional standards for reporting use tax on a state income tax return.
While this item focuses solely on the application of the AICPA’s Statements on Standards for Tax Services (SSTS) to state use tax reporting, CPAs should be aware of any applicable state professional standards that might apply in the states in which their clients file returns. Note that some states require all CPAs to follow the SSTS, regardless of whether they are members of the AICPA.
The SSTS are a set of enforceable ethical standards that members of the AICPA must follow when providing tax services to clients. Under SSTS No. 1, Tax Return Positions, a CPA is precluded from signing a state income tax return reporting a use tax liability unless there is at least a reasonable basis for the amount of use tax reported on the return (SSTS No. 1, ¶5). Though a CPA can rely in good faith and without verification on use tax liability information furnished to him by the client, the CPA must make reasonable inquiries if the information or documentation appears to be incorrect, incomplete, or inconsistent either on its face or on the basis of facts known to the CPA (SSTS No. 3, Certain Procedural Aspects of Preparing Returns, ¶2).
When it is impractical to obtain exact data, a CPA can also use client estimates when preparing a tax return reporting use tax if the CPA believes (based on professional judgment) the use tax estimates are reasonable in light of the known facts and circumstances (SSTS No. 4, Use of Estimates, ¶2). A CPA should inform a taxpayer promptly when he or she becomes aware of a taxpayer’s failure to file a required return, including a use tax return (SSTS No. 6, Knowledge of Error: Return Preparation and Administrative Proceedings, ¶4). If an unreported use tax liability is insignificant, it is not considered an error for purposes of SSTS No. 6, paragraph 1.
A CPA’s obligations under these standards when reporting a client’s use tax will depend on (1) whether the reporting is either optional or required on the state income tax return and (2) whether the client will report a use tax liability on his or her individual income tax return (regardless of whether the reporting is optional or required). Even if the taxpayer wishes to report his or her use tax liability on an income tax return in optional reporting states, some states may require the taxpayer to file a separate use tax return. For example, an Illinois use tax liability greater than $600 requires the taxpayer to file Form ST-44, Illinois Use Tax Return.
For states in which the taxpayer is not required to report use tax liability on his or her income tax return, such as in Illinois and New York, a CPA may prepare and sign the state income tax return if the client chooses not to report any use tax liability on the return (SSTS No. 1, Tax Return Positions , ¶5). If the CPA is unaware of a client’s possible use tax liability and is not engaged to prepare any separate use tax return for the client, he or she is not required under the SSTS to conduct any due diligence into the client’s possible use tax liability (SSTS No. 6, ¶¶1(c) and 4). If, however, the CPA is aware that the client has an unreported use tax liability, the CPA is obligated to inform the client that he or she should file a separate use tax return. Notwithstanding a CPA’s obligations under the SSTS, discussing with the client the nature of the use tax and his or her options for complying with use tax obligations provides value to the client and represents a sound risk-management practice.
For states in which the taxpayer is required to report his or her use tax liability on an income tax return if not previously reported on a use tax return, the CPA may prepare and sign the return only if he or she either obtains the information from the client necessary to report the correct use tax liability or obtains the client’s confirmation that no use tax liability is due. A CPA must exercise due diligence in determining whether the client has a reportable use tax liability, but the CPA can rely on a client’s confirmation that no use tax is due unless he or she is aware of facts inconsistent with that confirmation (see SSTS No. 3, Certain Procedural Aspects of Preparing Returns). If, for example, a CPA knew his or her client purchased an automobile out of state and paid no sales tax, he or she could not rely on the client’s confirmation that no use tax is due.
If the client will report a use tax liability on his or her individual income tax return (whether reporting is optional or required), how does the CPA navigate the SSTS?
- To calculate and report use taxes on an income tax return, the CPA must be provided by the client with information regarding purchases to which the use tax applies.
- The CPA can rely in good faith and without verification on information furnished to him by the client; however, he or she must make reasonable inquiries if the information or documentation appears to be incorrect, incomplete, or inconsistent either on its face or on the basis of facts known to him (see SSTS No. 3).
- CPAs can also use client estimates of purchases subject to use tax if it is not practical to obtain exact data and if they believe the estimates are reasonable based on the facts and circumstances known to them (see SSTS No. 4).
- Reasonable estimates might be obtained from client’s credit card statements showing vendors not likely to have collected sales tax (e.g., internet retailers).
Some states, including Illinois and New York, will allow a taxpayer to estimate his or her use tax liability based on the taxpayer’s adjusted gross income, although certain restrictions may apply. Illinois only allows this method if the taxpayer had no “major purchases” during the tax year. New York will allow this method provided the taxpayer did not purchase any items costing $1,000 or more.
Once the amount of the use tax to be recorded on the income tax return has been determined, the CPA’s obligations under the SSTS will depend, again, on whether the reporting is required or optional. If use tax reporting is required, a CPA should not prepare or sign the tax return unless he or she has a good-faith belief that the position has at least a realistic possibility of being sustained on its merits if challenged (SSTS No. 1, ¶5(a)). Notwithstanding this requirement, however, a CPA may prepare or sign a return that reflects a position if the CPA concludes that there is a reasonable basis for the position and the position is adequately disclosed (SSTS No. 1, ¶5(b)).
If use tax reporting on the income tax return is optional, professional standards regarding errors and omissions may come into play. If the use tax is understated and the amount of that understatement is significant, the CPA must inform the client of the correct use tax liability and the potential consequences of a failure to pay (e.g., tax penalties and interest) and recommend that the client file a separate use tax return (see SSTS No. 6). A client’s refusal to report and pay a significant amount of use tax should cause a CPA to reevaluate whether to continue representing the client (SSTS No. 6, ¶5).
Mindy Tyson Cozewith is a director, Washington National Tax in Atlanta, and Sean Fox is a director, Washington National Tax in Washington, DC, for McGladrey & Pullen LLP.
For additional information about these items, contact Ms. Cozewith at (404) 751-9089 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with McGladrey & Pullen LLP.