If I charged sales tax on items that weren't actually taxable, can I get a credit for the extra tax I remitted, and can a first-time audit penalty be waived if I collected tax but didn't remit it?

Plain-English summary

A restaurant equipment maintenance company was audited for 2015-2018 and disputed several parts of the resulting assessment. Because the company's sales tax return filing history was inconsistent, the auditor built a sampling methodology to estimate use tax owed on general expense purchases, landing on 75% of such purchases being taxable. The company argued the real number should be 60%, but offered no objective evidence to back that figure — so the 75% stood, though because this was the company's first audit, it was given a further opportunity to submit documentation that could change the result.

Two other issues came out worse for the company. First, the audit confirmed the company had charged and collected sales tax on some items that weren't actually taxable — meaning it collected more from customers than it should have. Under Virginia law, a dealer who over-collects tax must remit that money to the state unless it can show the money was refunded or credited back to the customers who paid it. Since the company hadn't shown that, it wasn't entitled to a credit for the overcollection itself — the money had come from its customers, not from the company. Second, on a genuine win, several months of "non-filer" assessments the company had already paid turned out to be based on inflated gross sales figures; rather than a direct audit credit, the Department generated amended returns for those periods and applied the resulting refunds as internal offsets against the audit bill.

Finally, the company asked for penalty and interest relief. The Department found a narrow but important rule: first-generation audit penalties are generally waived — except specifically where a business collected sales tax from customers but failed to remit it, which is exactly what happened here for several months in 2017-2018. That carve-out meant the penalty stood despite the first-audit leniency that otherwise applied. Interest, meanwhile, was upheld across the board as a mandatory, non-punitive fee for the state's lost use of money.

What this means for you

Businesses that discover they over-collected sales tax

You generally can't simply keep a credit for tax you collected from customers on non-taxable items — the law treats that money as belonging to the customers unless you can show you refunded or credited it back to them. Reconcile and refund customers promptly if you discover an overcollection, and keep records of having done so.

First-time audit subjects

A first-generation audit typically comes with more lenient penalty treatment — but not across the board. If any part of your liability involves sales tax you actually collected from customers and simply didn't remit, expect the penalty to apply regardless of it being your first audit.

Businesses disputing an expense-purchase percentage from a sampling audit

Simply asserting a different percentage isn't enough — you need objective, documented evidence to move an auditor off an estimate built from a reasonable sampling methodology. If it's your first audit, ask about the opportunity to submit supplemental documentation before the final numbers are locked in.

Accountants and tax professionals

This is a useful reference for the specific "collected but not remitted" penalty carve-out under 23 VAC 10-210-2032 B 3 — a detail that can surprise clients who assume first-audit leniency is unconditional. It's also a clean illustration of how the Department handles genuine non-filer-assessment overpayments procedurally (via post-audit amended returns and internal offsets) rather than as a direct in-audit credit.

Common questions

Q: Can I keep a credit for sales tax I collected on items that weren't actually taxable?
A: Generally no — you must show the amount was refunded or credited to the customers who paid it, or you must remit it to the Department.

Q: Are penalties always waived on a first audit?
A: Not always. Penalty is still assessed on sales tax that was collected from customers but not remitted to the Department, even in a first-generation audit.

Q: What happened with the non-filer assessment overpayments in this case?
A: The Department confirmed the overpayments, but resolved them by generating amended returns for those periods after the audit and applying the refunds as internal offsets against the audit bill, rather than a direct credit within the audit itself.

Q: Can interest be waived if the audit process itself was slow?
A: Not automatically, especially where the taxpayer's own documentation delays contributed to the length of the audit; interest is treated as compensation for use of money, not a penalty.

Q: Does this ruling apply to my audit?
A: Not automatically. This is a published ruling based on this business's specific facts and the law as it stood in 2023; your documentation and the reasons for any assessment may differ.

Citations and references

• Va. Code § 58.1-625 C (remittance of erroneously collected tax)
• 23 VAC 10-210-2032 B 3 (first-generation audit penalty; collected-but-not-remitted carve-out)
• Va. Code § 58.1-1812 (mandatory interest, not a penalty)

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 23-100

Original ruling text

August 17, 2023

Re: § 58.1-1821 Application: Retail Sales and Use Tax

Dear:

This is in response to your letter submitted on behalf of * (the “Taxpayer”) in which you seek correction of the retail sales and use tax assessment issued for the period July 2015 through June 2018. I apologize for the delay in responding to your appeal.

FACTS

The Taxpayer provides restaurant equipment maintenance for its clients. As a result of the Department’s audit, the auditor assessed use tax on general expense purchases based on a methodology that adjusted for the Taxpayer’s return filing inconsistencies. Also assessed in the audit was sales tax collected by the Taxpayer that was not remitted to the Department.

The Taxpayer disputes the assessment and requests a reduction for the following reasons. First, the Taxpayer maintains, that after review of its records, 60% of the general expense purchases are subject to the use tax as opposed to 75% computed by the auditor. Second, the Taxpayer maintains that it charged sales tax on items that were not taxable, thus remitting more sales tax than applicable to the Department. Third, the Taxpayer contends that, during certain periods, sales tax returns were not filed and the Department issued non-filer assessments that overstated the Taxpayer’s gross sales and thus its sales tax liability. The non-flier assessments were paid in full by the Taxpayer prior to the commencement of the audit. Lastly, the Taxpayer requests relief from some of the penalty assessed for the periods August 2017 through June 2018, as well as the assessed interest.

DETERMINATION

General Expense Purchases

Due to the Taxpayer’s inconsistent sales tax return filing history, the auditor developed a sample methodology for computing the expense purchases liability that was adjusted for gross sales figures overstated in the non-filer assessments paid by the Taxpayer. This methodology resulted in applying 75% to calculate the use tax liability. While acknowledging estimates may result in less than accurate assessments, the Taxpayer has offered no objective evidence to support its claim that 60% of expense purchases is the correct amount that is subject to the use tax. However, because this is a first generation audit, the Taxpayer will be given the opportunity to work with audit staff in order to provide additional purchase documentation for additional consideration.

Erroneously Collected Tax

The Taxpayer maintains that it charged sales tax on some items that were not subject to the sales tax. As such, the Taxpayer maintains that the tax payments remitted to the Department were higher than applicable.

The audit confirms that the Taxpayer charged and collected sales tax on transactions that were not subject to the retail sales and use tax. This is considered erroneously collected tax and is addressed in Virginia Code § 58.1-625 C which states

Any dealer collecting the sales or use tax on transactions exempt or not taxable under this chapter shall transmit to the Tax Commissioner such erroneously or illegally collected tax unless or until it can affirmatively show that the tax has since been refunded to the purchaser or credited to its account.

The Taxpayer has not shown that the erroneously collected tax has been refunded to or credited to its customers. Reducing the Taxpayer’s audit assessment to reflect the erroneously collected tax is not warranted because the tax was paid by its customers and not the Taxpayer. Therefore, the Taxpayer is not entitled to a refund or credit for these tax payments in accordance with the cited statute.

Overpayment of Non-Filer Assessments

It is my understanding that the non-filer assessments for the periods September 2016, October 2016, December 2016, and January through April 2017 were found to be significantly higher than the actual liability due, and resulted in overpayments by the Taxpayer for the non-filer periods at issue. Instead of allowing a credit for the overpayments in the audit, amended returns for the periods at issue were generated after the audit was completed. The refunds resulting from the amended returns were then applied as internal offsets to reduce the Taxpayer’s audit bill. The Taxpayer may contact the auditor for a detailed explanation of the overpayment amounts applied to the audit assessment.

Penalty Waiver – Tax Collected But Not Remitted

Based on a review of the Taxpayer’s records, the auditor determined that the Taxpayer charged and collected sales tax on every type of repair or equipment regardless of whether the equipment remained tangible personal property after being installed. However, it was also determined that the Taxpayer did not always remit to the Department all of the sales tax that it collected. This issue was found in the periods August 2017 through April 2018 and June 2018, and is the only issue upon which the penalty was assessed in the audit.

Title 23 of the Virginia Administrative Code 10-210-2032 B 3 provides that, “Generally, penalty will be waived in first generation audits. First generation audit penalty cannot be waived if the taxpayer has collected the sales tax, but failed to remit it to the Department of Taxation.” Accordingly, the penalty was properly assessed in this first generation audit for sales tax collected but not remitted for the periods August 2017 through April 2018 and June 2018. In accordance with the cited authority, I do not find basis for waiver of this penalty.

Interest

Virginia Code § 58.1-1812 mandates the application of interest to any tax assessment. Interest is not assessed as a penalty for noncompliance with the tax laws. Rather, it simply represents a fee for the use of money over a period of time. In this case, the Taxpayer had the use of money that was properly due the Commonwealth. Therefore, I find no basis to waive the interest assessed as a result of the Department's audit.

CONCLUSION

Based on the facts as provided, the audit will be returned to the auditor to address the issue regarding the expense purchases assessment. The auditor will contact the Taxpayer to request additional documentation and the Taxpayer should provide such documentation within 60 days of the auditor’s request. Once the revisions are made, if warranted, the auditor will issue an updated audit report and revised assessment with interest accrued to date. In order to avoid the accrual of additional interest, the Taxpayer should remit payment within 60 days of the date of the bill. If documentation is not provided within the time allotted, the current audit assessment will be considered correct.

The Code of Virginia sections and regulation cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department’s web site. If you have any questions about this response, you may contact * in the Department’s Office of Tax Policy, Appeals and Rulings, at (804) ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/2225J