Holiday Returns and Sales Tax Burns: A Guide to Managing Santa’s Rejects

The holidays are the best of times and the worst of times for American retailers. After Black Friday mobs and Cyber Monday clickers inaugurate the annual shopping season, revenues do soar. But American consumers are not the easiest people to shop for. 11.2 percent of all holiday sales – $68.8 billion worth of goods – were returned in 2014. As many retailers have learned the hard way, holiday returns can cause some third degree sales tax burns. You thought you had a record year, and six months later, there’s a dour auditor knocking on your door.   

Yes, you could refuse returns altogether to avoid the conundrums of recalculating your sales tax burden. But that’s only a viable option if you’re willing to become a Yelp piñata. Instead, I say we talk about how to handle Santa’s rejects in a way that won’t get you beaten to shreds on social media. It’s time to make your returns and sales tax game plan.

The best way to do this is with some hypothetical examples. Let’s say that you own a cookware store in Chicago. On Black Friday, a woman buys a $300 skillet set for her husband, who claims that his new year’s resolution is to cook more often. Well, on Christmas Day, the husband unwraps the skillets. He wanted cast-iron, as all the food bloggers obviously advised, not non-stick pans. The woman returns the skillets on December 31. In this case, you apply the taxes you paid in December as a tax credit in your next filing. Nothing fancy.  

Now, let’s pretend that couple goes on a beach vacation to escape Chicago’s frigid winter. They leave on December 26, and the woman ultimately returns the skillets on January 5. Effective January 1, 2016, sales tax in Cook County, home to Chicago, will be raised from 9.25% to 10.25% (that part isn’t imaginary). In November, the woman paid $27.75 in sales tax on the skillets. Tax returns are based on the tax rate of the period in which you file. So were you to calculate the tax credit in January 2016, the result would show that the state owes you $30.75 instead of the $27.75 you remitted.

While that sounds like a nice business model, cash-strapped Illinois will not be happy. Instead, you need to file an amended return for November. In it, apply for a refund of the $27.75 that you paid.

If you file amended returns, you will never get burned. They are always a correct and legal way to manage returns and sales tax, but they come with several disadvantages. First, you do have to file an extra return, which takes time and costs money. Second, states are not fond of writing refund checks. To avoid doing so, they will create administrative hassles, like requiring you to submit a separate document requesting the refund. They will also take their sweet time processing your refund, meaning it might not arrive for five to seven months.

If the tax rate in your county doesn’t change between 2015 and 2016, avoid this bureaucratic imbroglio by applying a tax credit to your next filing. That said, there are two cases where you should never apply a credit.

First, if January is a slow month and returns were heavy, the state might owe you more money than you owe the state. You would have what is called a “negative tax return.” Most states will not allow you to file a negative return because their software can’t process it. In this scenario, either file the amended return or forward the tax credit to a future month with higher sales.

Second, be careful if your returns amount to an unusually high percentage of your monthly revenue. Thanks to uninitiated shoppers who don’t understand the superiority of cast-iron, etc., let’s say 35 percent of your sales are returned in January. Even if the tax rate remained the same, you would be wise to file an amended return for November.

Here’s why: when tax credits are unusually high relative to sales, auditors perk up. This red flag invites suspicion, even if you calculated your tax credits accurately. When the auditor goes hunting for other discrepancies in your filings, he or she might find an innocent mistake and trigger a full-blown audit.

So to recap your game plan for returns and sales tax: apply sales tax credits to your next filing when the year-to-year rate is the same, and use an amended return when rate changes or your returns-to-sales ratio is out of whack. When in doubt, always file the amended return. If you sell online and have nexus in multiple states (via virtual employees, warehouses, etc.), you must plan a separate course of action in each state and country where you owe taxes. If you have tax exposure in many jurisdictions, use tax automation software, an accountant, or preferably, both.

Expect about one in ten of the goods you sell to be returned this year. Returns and sales tax burns may seem like a corny rhyme, but if it keeps you out of trouble, I’ve done my job. There are no goods rhymes for the word “audit.”

Image Courtesy of Wikimedia Commons – https://commons.wikimedia.org/wiki/File:Black_Friday_by_Powhusku.jpg

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