Sales Tax Audit Penalty

[DouglasB12]

I was audited by the state of MN and it was determined that I should have been collecting sales tax. I ended up having to pay a total of about $2300 in tax  and penalties out of my pocket. How do I claim this as a deduction on my schedule C?

Additional Info: While I have always reported income from a pet breeding business, I did not realize that pet sales were subject to sales tax in the state of MN. I was audited by the sales tax division. Since I had never collected the sales tax from customers, I had to pay that amount out of my own pocket, plus interest and penalties.

[MaryK4]

Unfortunately, fines and penalties a person owes to the government for violating local, state, and federal laws are never deductible. 

You would not be able to deduct the state and local sales taxes because they were in fact imposed on the buyer- you had a duty to collect and pay over to the state government.  Normally, sales tax is not deducted but it is also not included in income (essentially it nets itself out),  Since you did not report the sales tax as income, you cannot deduct it separately.

[DouglasB12]

I appreciate your response. I can understand that fines and penalties are not able to be deducted. That would be like deducting traffic tickets.

When I was audited for the sales tax, it was determined that I owed $2000 for the sales of product.  Since I did not collect the sales tax from the buyers, I have had to cover that tax out of pocket. For simplicity sake, let's say the sales tax is 10%. If I sold my product for $100 the tax on that would be $10, which I'm now paying out of pocket. Effectively, doesn't that change the sale price of my product to $90 retroactively?

Since my products are now selling for 10% less my gross sales and net income is also affected during the audit period. Shouldn't there be a way to reflect that reduction on my taxes?  

[DianeW777 · Accepted solution]

Yes, if you are in business, filing Schedule C, you can take a deduction in the current year for the sales tax portion only, that you were required to pay after the audit.  You can also deduct any interest  portion paid.  As stated by @MaryK4, fines and penalties are never deductible as an expense.

[AmeliesUncle]

Sales tax is imposed on the buyer, not you.

So my first thought is that you need to amend your prior tax returns.  In your example (I'm from MN, so I now those numbers are not actually accurate), rather than reporting $100 of income, you should be reporting $90.91 of income ($90.91 +10% = $100).  But then in turn, the sales tax should be based on $90.91, not $100.

[LudwigVan_fan]

"

So my first thought is that you need to amend your prior tax returns.  In your example (I'm from MN, so I now those numbers are not actually accurate), rather than reporting $100 of income, you should be reporting $90.91 of income ($90.91 +10% = $100).  But then in turn, the sales tax should be based on $90.91, not $100."

I don't think that would be the correct way of handling it.  If you do handle it that way, the sales tax then paid to the state would not be deductible.

Since gross income reported was $100, then any amount paid in sales tax would be a deduction from the $100.  Any change to that would be considered a change in accounting method and would need to follow those rules.

Furthermore, since the remittance to the state didn't take place until several years after the fact, the deduction would take place in the year the amount was determined and paid.  Especially if the cash method of accounting was used.

[#7]

So my first thought is that you need to amend your prior tax returns.  In your example (I'm from MN, so I now those numbers are not actually accurate), rather than reporting $100 of income, you should be reporting $90.91 of income ($90.91 +10% = $100).  But then in turn, the sales tax should be based on $90.91, not $100."

I don't think that would be the correct way of handling it.  If you do handle it that way, the sales tax then paid to the state would not be deductible.

Since gross income reported was $100, then any amount paid in sales tax would be a deduction from the $100.  Any change to that would be considered a change in accounting method and would need to follow those rules.

Furthermore, since the remittance to the state didn't take place until several years after the fact, the deduction would take place in the year the amount was determined and paid.  Especially if the cash method of accounting was used.