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magazine | Jul 20, 2022 |
Getting sales tax right is boring. Getting it wrong can be a disaster

Accounting is the boring part of interior design. Sales tax is the boring part of accounting. But designers take it lightly at their peril.

Late last year, Lisa Gilmore was confronted with the one word no designer wants to hear: audit. Gilmore’s St. Petersburg, Florida–based firm had been flagged by the state’s department of revenue for a thorough look at its books. Though the very term will send shivers down the back of any small business owner (accountants, only half-joking, call it “the A word”), Gilmore was surprisingly calm.

For one, it was a sales tax audit, not income tax. It’s far easier to demonstrate that you collected and passed on the required 6 percent on the sale of a sofa than it is to prove that a cocktail with dinner was a business expense. But more important, Gilmore knew her books were solid. “I was not worried because our bookkeeping is so buttoned up,” she says. “I was like, Nothing to hide here, let’s go!”

Her stress ratcheted up a notch when the auditor asked to come into the office and take a closer look—but still, nothing to worry about, right? Gilmore’s firm meticulously documented all of its purchases, collected tax dutifully and passed it to the state in a timely manner. It had a reputable CPA who specialized in the design industry. Things were in order. As the auditor ran the numbers, Gilmore went about her day, alert but not stressed.

Then, the mood changed. “My team and I were sitting in the office, and he was like, ‘Well, we have a few things,’” recalls Gilmore. The auditor informed her that she wasn’t charging sales tax on shipping—which surprised her, as she hadn’t known it was required. But that was nothing compared with what came next: “He said, ‘You’re also not charging sales tax on any of your design services.’ And at that, my staff member went white.”

Sales tax, in theory, is focused around, well, sales. You go into a store, you buy a product, you pay sales tax. Simple. Labor— things like haircuts, dermatology consultations and French lessons—is supposed to be exempt. At least, that was how Gilmore (and countless designers just like her) had been approaching it. “Every time we’ve been trained and mentored, we’ve always been told that labor and services aren’t taxable,” she says. “That’s how our design services qualify—as services.” But as it turns out, Florida’s tax code has a wrinkle in it: Design fees are exempt if they’re “only for advice.” But if the fee is “in conjunction with the sale of tangible personal property,” the designer is required to collect and remit sales tax to the state.

Florida’s Department of Revenue determined that Gilmore’s firm had failed to do so and sent her a bill—payable in eight business days. The amount? $140,000.

No one would call sales tax riveting. Perhaps that’s why it’s one of the most commonly overlooked, misunderstood and glossed-over corners of the industry. “No one goes into interior design to learn this kind of
thing,” says Monique Stemper, founder of Colorado-based consulting firm Stemper & Associates. “It’s a lot.” As I talked to design-industry accountants across the country for this piece, that attitude was reflected everywhere I turned. Most told me that when designers first hire them, the general level of education around sales tax in the industry is quite low. 

It’s ironic, because while sales tax may be one of the most mundane aspects of the design business, it’s one of the most dangerous. “It’s the third rail of the industry,” says accountant Justin Masonek. “It is the one part of design where you can go to jail if you don’t do your job properly.”

Truthfully, the number of interior designers who go to prison for sales tax violations is (quite) low. Of the millions of taxpayers, fewer than 1,000 are typically convicted of fraud each year, and very few face jail time. However, tax fraud is a serious crime, and it can have real consequences. In 2015, the owner of a furniture business in Rochester, New York, was sentenced to five years’ probation for violating tax laws, while two years later an Ohio designer was sentenced to four months in prison for tax evasion. These examples involved purposeful fraud, something the vast majority of firms don’t need to worry about. Still, the design industry is unique in that even the well intentioned can struggle to comply with the intricacy of the laws. “I can’t imagine there is another business that’s more impacted by sales tax laws than interior design,” says Stemper. “It’s so tricky.”

A lot of the complexity is a result of the profession itself, which combines an unwieldy variety of business models under one roof. By comparison, stores have it easy: They sell stuff, and people take it home. Even the most sprawling, wonky retail operation is simpler, from a sales tax perspective, than a bustling design firm, where purchasing is a multistage process stretching out weeks, months and even years, combining consultations, material costs, shipping, markups and installation.

As remote projects have become more common during the pandemic, navigating tax codes has only grown more complex. That’s because one of the most common sales tax conundrums is how to approach work that occurs outside of a designer’s home state. “People can work in Colorado and have clients in California,” says Angela Roork, a New York–based accountant. “The number one thing designers aren’t sure of these days is if they need a resale certificate in the state where their client is located.” However, while interior design is an inherently complicated profession, most of the confusion around interior design sales tax comes from—surprise—the government.

After breaking through the bewildered reaction from accountants when I told them I wanted to write about sales tax, we started to get into actual rules and regulations. There, another common theme emerged: “Don’t quote me on that.”

When speaking about the particularities of individual state laws, consultants would often share a weird little wrinkle of sales tax law, then almost immediately ask that I not print their comment in this article, at least until they had double-checked it. At first, that surprised me. Shouldn’t the experts feel comfortable talking off the cuff about their area of expertise? But when I started to look into the actual laws themselves, I immediately understood. Sales tax for designers is a sprawling, disorienting labyrinth, even for the pros. For one, sales tax is collected by state governments. That means there are 50 sets of regulations (more if you include county or city taxes, but let’s ignore that for now), which are all slightly different. Some states collect taxes on shipping; others don’t. For some, painting is a taxable expense; for others, that’s between you and your contractor.

To be sure, most designers only need to learn the rules of their home state, and maybe one or two neighbors. But even those rules are subject to change on a quarterly basis—the ground is constantly shifting under the industry’s feet. “Every time a client asks me about sales tax, I say, ‘This is what I know as of this moment,’” says Roork. “This is why I have a sales tax compliance team to keep track of these laws.”

Depending on the state, the level of detail around interior design sales tax guidance can vary wildly. California, for example, issues a 22-page booklet on how designers should and shouldn’t collect taxes on their services. Florida’s is three pages long. South Dakota doesn’t appear to have one at all.

In theory, more detail is better. But breaking down every component of the design process by taxability can lead to weird places. Take, for example, California’s sales tax guidance for interior designers. The pamphlet—known as “Publication 35,” or simply “35”—details with incredible specificity a variety of situations that designers may encounter. A representative sample: “You may contract with a client to install cabinets in a home, store, office or other building. For sales and use tax purposes, some cabinets are considered materials and others are considered fixtures. Each cabinet in a project must be evaluated individually,” the document reads. Among the long list of things most people aren’t taught at design school: evaluating every cabinet individually for its sales tax exposure.

It’s not like I can go back to a client I worked with three years ago and say, ‘You owe me $15,000 in sales tax.’
Lisa Gilmore

Elsewhere, California’s exhaustive pamphlet goes down some almost philosophical rabbit holes. “Fixtures” and “materials” are taxed differently in the state, so it’s of utmost importance to know the difference between the two. How to tell? When installed, “fixtures are accessories to a building that do not lose their identity,” says California’s tax authority, sounding a bit like Kafka. Should designers really be tasked with contemplating whether wallpaper loses its sense of self when installed? (It does, at least for tax purposes in California.)

Draperies? Taking measurements, cutting and sewing the fabric: taxable. Hanging the draperies? Not taxable. The fabric itself: taxable. After the fact, if the client wants them resized? Not taxable. It goes on and on. The convolutions of some states’ tax laws creates a confusing maze for designers to navigate as they go about their normal course of business.

When the guidance is more open-ended, it can create other problems. That’s especially true for the most murky area of sales tax law: design fees. In some states, under some circumstances, design fees are subject to sales tax—though there is usually a caveat that limits the exposure to fees that are directly related to the sale of a tangible good. That sounds simple, in theory, and some scenarios are cut and dried. An assistant spending an hour to specify a custom chair is clearly related to the sale of a tangible good. Having a vibey, “what are your dreams”–type session with the client is clearly not. But in an industry where the personal, the professional, the artistic and the practical are all happening at once, confusion abounds. How to categorize charging for a phone call with a client that begins as a therapy session for their fears about moving into a larger home, transitions into a discussion of art deco, detours into some idle chitchat about the weather and ends with the purchase of a chandelier?

Getting sales tax right is boring. Getting it wrong can be a disaster
A playful wallcovering is an ebullient backdrop in a primary bedroom by Lisa Gilmore.Amy Lamb, Native House Photography

What the best designers can do, say the experts, is keep track of their time as thoroughly as possible. “A lot of designers want to know: ‘What if it starts as consulting but it turns into a purchase? Do I break it down and say this much time was spent on this, this much time was spent on that, for a 45-minute meeting with the client? That’s crazy!’” says Stemper. “It is crazy. But all you can do is document.”

Because of the complexity of the sales tax system, I had assumed that there would be countless ways that accountants could wield the rules to their clients’ advantage. But according to the experts, there’s not really any sales tax “strategy.” A designer’s job is to learn the rules and follow them. Despite all of its fragmentation, the idea behind sales tax is simple. “Sales tax is really just a pass-through. The designer is collecting money on behalf of the government and passing it on to the government,” says Jennifer Vick, the financial services manager for The Dove Agency, a Texas-based consulting firm for designers. “Designers shouldn’t be making or losing money on sales tax.”

There is one sales tax maneuver I encountered, but it comes with a big caveat: It’s potentially illegal. In states where design fees are not taxable, there’s a built-in incentive to orient a firm’s charging strategy away from markups and toward a bigger design fee. In simple terms, with made-up numbers, here’s why: Imagine procuring a sofa for a client that costs $9,000 net. With a 30 percent markup—$2,700—the client’s price is $11,700. Now add sales tax of 8 percent (that’s $946) for a total of $12,636. In that setup, the client pays $12,636, you’d pocket $2,700 and the state makes $946.

Now imagine that you charged no markup and simply added $2,700 to your design fee. In that scenario, the client pays sales tax on $9,000 instead of $11,700, for a total of $12,420. The client gets a cheaper price, you get paid the same $2,700 and the state pockets slightly less: $720 instead of $946. Amortized over the budget of a large project, such a setup could, in theory, save the client thousands of dollars. The problem is, if you’re adding money to your nontaxable design fee that’s explicitly related to the purchase of a sofa, you’re likely breaking the law.

When I mentioned this particular maneuver to Masonek, he was emphatic in his reply. “The worst thing you can do is collect tax on behalf of a state and not give it to them in a timely fashion,” he says. “The second worst thing you can do—and it’s still very bad and criminal—is circumventing sales tax on a markup by calling it a design fee. I go through the books with a fine-tooth comb and say, ‘That entry on March 1 looks like it was related to the purchase of a sofa.’ If you’re charging to source a sofa and selling them the sofa, then it’s not a design fee; it’s a markup.”

The legal, in-the-clear version of the above is simply charging a mega-size flat fee that isn’t explicitly related to purchasing. In other words, telling clients: I don’t charge a markup, but you’re going to pay me $150,000 for my creativity. Ironic, because on some level there’s not much of a difference between folding markups into a design fee one by one and simply coming up with a big number that gets you to roughly the same price. Both circumvent sales tax, but only one is technically against the rules.

There are a few basic pointers to follow when you’re setting up a sales tax system. The simplest is making sure that you know what your state laws actually say. That sounds obvious, but accountants say it is not uncommon for clients to come in with only a loose understanding of what is on the books, cobbled together from secondhand advice or misinformed online articles. “The number one thing I’d tell designers is, when you’re researching sales tax, you need to be looking in the right place,” says Masonek. “You want to see that .gov at the end of the URL.”

If any of the information online is unclear, call and ask for clarification. Most states have a hotline to provide help on sales tax issues. (If you do call, it’s not a bad idea to take notes and write down who told you what.)

There are little things designers can do to work around the annoyance of sales tax. One of the regular challenges of working in states where design fees are taxable is avoiding the sticker shock. It’s hard enough to present clients with a big bill early on in the process—getting them to pay tax on it is another hurdle. To get around that, consultant Christine Froelich says that some of her clients charge a retainer upfront and then bill against their design fee monthly. “That way, clients won’t be like, ‘Wait, what’s all this tax here?’ right at the beginning,” she says.

As always, a good contract is never a bad idea—especially one that lays out in clear terms what will and won’t be taxable. It sets clear expectations for the client, and it protects designers too, because you’ll have a paper trail in the event of an audit. “A lot of our clients have contracts that specify that when you’re being charged for design time, you’re being charged tax,” says Froelich. “For others, if the firm has multiple employees, sometimes they’ll have only their project managers do the taxable work so it’s easy to flag their hours as taxable.”

In general, though, most of the advice around sales tax is simply: Be meticulous, pay it on time and, if you can, hire someone else to do it for you. Just make sure it’s someone who knows what they’re doing. “There are a lot of not-so-great bookkeepers who don't understand the rules of interior design,” says Stemper. “Don’t assume that your bookkeeper is doing it right!”

All of that brings us back to Lisa Gilmore, the Florida designer who ran afoul of her state’s tax authority. Gilmore did have a CPA working on her books, one who, frustratingly, had been unaware of Florida’s rule on design fees. The result was a staggering tax bill: $140,000. “It’d be different if I’d collected this money and didn’t turn it in,” says Gilmore. “But it’s not like I can go back to a client I worked with three years ago and say, ‘You owe me $15,000 in sales tax.’”

Gilmore has been fighting back. She’s hired a tax attorney and is reviewing her firm’s records in search of ways to rebut the state’s charges. However, even if she’s successful, it’ll be a costly win. Gilmore estimates that she and her staff have thus far spent at least 40 very unbillable hours dealing with the audit, to say nothing of the expense of hiring a lawyer.

Gilmore is considering a novel solution to tax confusion going forward: splitting her firm into two companies. One would solely advise clients on design (nontaxable labor) and the other would handle all aspects of purchasing product (taxable labor). The strategy would, in theory, get rid of the tax ambiguity. It would also require her clients to sign two separate contracts with two separate businesses. “It’s crazy we have to do this,” she says.

Gilmore has found she’s not alone. Nicole White, another Florida designer, spent thousands to combat an audit from the state government, and Gilmore says her tax attorney was dealing with another audit related to a designer. Others may be next. Polling her colleagues, Gilmore found that none were charging sales tax on design fees: “They were all like, ‘Oh, my god, I’m going to lose sleep over this.’”

Homepage image: A moody dining space by Gilmore is designed to catch the light, from illuminated displays amid wine storage to gilded cork wallpaper on the ceiling and a chandelier dappled with crystals. | Amy Lamb, Native House Photography

This article originally appeared in Summer 2022 issue of Business of Home. Subscribe or become a BOH Insider for more.

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