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Do you collect sales tax on balance of contract payments after default
April 11,  2022
Do you collect sales tax on balance of contract payments after default
          We have been using your Residential All in One for our residential security customers for many years now. We need clarification on the best way to handle sales tax in the event a customer pays off their agreement early and wants their service terminated.  
          The scenario in question arises when the client resides in a state where we charge sales tax each month on the monitoring fee; a state like Arkansas for example. A customer paying $76.99 for monitoring would pay an additional $6.92 each month, making their total monthly fee $83.91. If this same customer wanted to cancel their service and had 12 months remaining of a 60-month agreement, would we be correct to charge the customer $76.99*12 = $923.88*.9 = $831.49 as a final payoff amount or would we need to include the sales tax in this equation? Including the sales tax would be $83.91*12 = $1,006.92*.9= $906.22. Keep in mind, in this scenario we would be cancelling the monitoring and not providing a service for the remaining 12 months of the agreement. 
          This situation is different than a customer who pre-pays for a year but does not want their services terminated. In that scenario, we would still be providing a monitoring service and the tax would be assessed.
          Thank you in advance for your reply. We want to ensure we are handling these scenarios correctly. 
Name withheld
          I am going to give you a simple, direct answer, which I think is correct.  However, nothing is easy about taxes and you are wise not to ignore the issues that can quickly become problems. 
          If you are recovering for future taxable revenue you should collect sales tax and remit to the taxing authority.  So if you charge $100 a month and there is 5% tax, so you invoice customer for $105 and remit $5 to state when you collect it, you should follow that rule.  So if customer wants to pay off early and terminate or defaults and you seek to recover 80% of the balance of the contract term, you should tack-on sales tax and remit when you collect it.  Since your recover includes legal fees and perhaps other non-taxable charges you won’t be paying a sales tax on the full recovery, only the taxable part. 
          I suppose there are ancillary questions. 
  *  if you don’t charge the sales tax and don’t collect it, do you still have to pay the sales tax on what you did  receive [my guess, yes]
  *  if you do charge sales tax and collect it, are you liable if you don’t remit [my guess is, yes]
          I asked Mitch Reitman to comment on the original question, not my questions.  Here is his response.
          Great question.   When charging off a customer tax should be collected and remitted on any liquidated monitoring charges for two reasons:
          Even though the amount could be considered liquidated damages, it is a payment for theoretical lost profits from future monitoring.  Although the service wasn’t provided, had it been provided, it would have been taxable.  This would be different if the Company sued the customer and obtained a judgment for damages as these types of damages might not be taxable.
          Secondly, and this is very important, a customer paying $76.99 per month is most certainly paying for more than just monitoring.  Monitoring rates this high typically reflect monitoring and deferred payment of install costs (equipment, labor, and commissions), that were not collected at the time of the sale.  This is becoming a huge issue in states in which monitoring is not subject to sales and/or use tax.  Quite a few of these states have taken the position that a fixed portion of the monthly payment is an Installment Sale and made a calculation of the Installment Sale portion and the monitoring portion of each payment.  If no tax is collected, and the State later concludes that part of this transaction was a sale of equipment (or prepayment of an installment sale), they could charge the Company with collecting sales tax from the former customer (good luck with that), and, if the Company isn’t able to, the State may assess the Company for the uncollected tax, penalties, and interest.  In one case that we researched for a client, the Alarm Company was charging $75 per account.  The State obtained their central station bill and noted that they were paying around $4 per month for monitoring, determined that a 100% markup was good, and allocated $8 to monitoring and $67 to installment sale.  Our client was a fire alarm company that sold the system in an outright sale, but charged $55 per month for fire monitoring.  We explained the situation to the State and obtained a Technical Ruling in which the State agreed that our client’s situation was indeed, purely monitoring.
          I believe that it best to charge the customer tax on the entire prepay amount and remit the tax to the State.  If you believe that the pre-pay is actually a settlement and shouldn’t be taxable because no services were actually rendered, the best course of action is to get a Technical Ruling from the State.  If you are charging over $50 for residential monitoring in a State in which monitoring is not taxable, you may also want to ask for a ruling from the State.  We do these on a regular basis for this type of situation and others.  Once your company has obtained the ruling, it serves as a “Get out of Jail Card” until it is rescinded, or the state law changes to clearly conflict with the ruling.  We do this a lot and can prepare the paperwork very efficiently. 
 Mitch Reitman
 Reitman Consulting Group
817-698-9999 ext 101

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Ken Kirschenbaum,Esq
Kirschenbaum & Kirschenbaum PC
Attorneys at Law
200 Garden City Plaza
Garden City, NY 11530
516 747 6700 x 301