Idaho – Taxpayer’s Misuse of Bad Debt Tax Credit Led to Assessment

SALT Report 1998 – The Idaho Tax Commission issued a ruling regarding a Taxpayer’s use of the bad debt sales tax deduction.  At issue in this case are unsecured credit transactions and the methods the Taxpayer used to account for the sales tax it charged its customers on certain retail sales when those transactions were later determined to be worthless.

During the time in question, the Taxpayer filed tax returns to report its sales activity and to remit sales tax.  On 36 of its monthly returns, the Taxpayer took a tax credit for sales tax related to bad debts, which is allowed under the Idaho Sales and Use Tax Act.  Initially, the Bureau allowed the deductions, however during a subsequent audit the auditor determined that most of the credits taken should not have been allowed.  The auditor disagreed with the Taxpayer’s method of first applying a customer’s payments to late fees and interest and then reducing the principal amount with the balance of the payment.

In the auditor’s opinion, the Taxpayer’s method resulted in an overstated principal amount at the time of default, which provided the Taxpayer with a sales tax refund greater than the amount calculated by the auditor.  The Bureau issued a Notice of assessment to recover the overpayment. The Taxpayer requested a hearing with the Tax Commission to appeal the assessment.

In their decision the Commission also rejected the method for calculating the credit, in which the Taxpayer first applied the customer’s payments to the late fees and punitive interest.  The Commission notes that the imposition of penalties and higher interest rates to late payments do not directly relate to the sales transactions in which the tax was initially charged.  Therefore, these events should not impact the state’s right to collect sales tax and they should not provide the retailer with a greater sales tax credit.

Further, the Commission ruled that when the Taxpayer computes a bad debt tax credit, each payment made by the customer must be divided between the principal, which includes the sales tax, and the accrued interest.  By using this allocation method, a percentage of the sales tax that was previously remitted to the state will be considered satisfied.  As more payments are made by the customer, additional sales tax will be considered paid, until the principal balance is zero. However, if the customer later defaults on its payments any remaining unpaid sales tax will be available as a credit or refund to the Taxpayer.

As a result of the Commission’s decision the original assessment of $43,354 was upheld.

For Further Information:

Idaho State Tax Commission – Decision Number 24529