Documenting Spoilage in a Sales Tax Audit
If you purchased items that cannot be sold due to spoilage or damage, you need to document it properly. Otherwise, you might be liable for the sales tax.
Important:
Always maintain clear records of spoilage to protect yourself during a sales tax audit.
Transcript
Markups, Spoilage, and Sales Tax Audits
I’m Mansoor Ansari with Nexus Tax Defense.
The reason why we’re going to discuss markups today is because that’s just an estimate of what the sales tax auditor believes you should have made.
Example:
If you bought $100,000 of merchandise in a specific month, the sales tax auditor might say that you should have had a profit of $25,000 because your markup is 25%.
But that’s not always true.
Understanding Spoilage
Let’s assume you have spoilage.
What spoilage really means is that something you purchased could no longer be sold.
If on your tax return it states that the gross purchases were $100,000 and the auditor says that you should have had a 25% markup, but you weren’t able to sell all of your product, what’s going to end up happening is that you’re going to end up paying sales tax on products that you never sold.
Why Documentation is Critical
It is really important for you to document all the spoilage — whether it’s:
- Food
- Drinks
- Other perishable or damaged items
Make sure the auditor gets this information prior to your audit.
Frequently Asked Questions
What is spoilage in the context of a sales tax audit?
Spoilage refers to products that you purchased for resale but could not sell due to being damaged, expired, or otherwise unsellable. These items should not be included in taxable sales, but must be properly documented.
Why is it important to document spoilage for a sales tax audit?
Without clear records of spoilage, auditors may assume all purchases were sold and tax you on unsold goods. Proper documentation ensures you’re not unfairly taxed on losses.
What kind of documentation should I keep for spoiled or damaged items?
Maintain dated records such as photos, disposal logs, inventory write-offs, or supplier return notes. The more detailed the documentation, the better your defense during an audit.
Can spoilage affect how an auditor calculates my sales tax liability?
Yes. Auditors often estimate sales based on your markup. If spoilage isn’t accounted for, they might overestimate your taxable revenue, resulting in higher tax liability.
When should I present spoilage documentation to an auditor?
Provide spoilage documentation before or at the beginning of the audit. Waiting too long can limit your ability to challenge inaccurate tax assumptions.