Washington Rules that Dentist Owes Use Tax Based on Purchase Price, Not Value
In a recent Washington case, the taxpayer owed use tax based on the value he paid for the property; the fact that he made a “bad bargain” did not constitute grounds for reducing the use tax owed.
By Jeff Glickman, SALT partner
Use tax continues to be one of the most confusing, and most often neglected, areas of state tax. Frankly, many taxpayers just aren’t aware of its existence, particularly among those who provide professional services, where sales taxes generally does not apply. However, a professional service provider has to self-assess and pay use tax on tangible property purchased for use in the business (i.e., items not purchased for resale) when the seller does not collect the tax at the time of the transaction.
One common issue that arises in the use tax area is whether use tax is measured based on the purchase price or the value of the item. On May 31, 2017, the state of Washington released a tax determination that concluded that a dentist’s purchase of tangible personal property in connection with the acquisition of another dentist’s business owed use tax based on the purchase price for the property, even if it turns out that the value of the property is lower. 
In 2012, the taxpayer purchased a small dental practice, and the agreement allocated a certain amount to the equipment, which was used by the taxpayer as a basis for depreciation on his federal income tax return.  The seller did not collect sales tax at the time of the transaction, and the taxpayer was unaware at the time that use tax was due. Following an audit for the period 2012-2015, the state issued an assessment that included use tax on the purchase of the equipment and a substantial understatement penalty. The taxpayer asserted that the seller misrepresented the office equipment, noting that of the 44 “major assets” listed by the seller, 21 were missing, and the dental chairs were 12 years old.  The taxpayer was successful in appealing its personal property tax assessment in 2015, stating that “original equipment on list of assets at point of sale does not reflect what is actually in the office.”
The taxpayer’s initial argument is that its use tax and penalties should be waived or reduced because he was unaware of his obligation. The tax review officer summarily dismissed that claim, pointing out that taxpayers are required to seek information about potential tax obligations. 
The taxpayer then argued that the use tax should be based on the lower fair market value of the property actually purchased. The tax review officer denied that claim as well. Under Washington’s use tax rules, use tax is due based on the “value of the article used,” which is defined to mean the purchase price, unless the property is sold under conditions where the purchase price does not represent the true value, in which case the use tax is measured based on the property’s fair market value.  The tax review officer concluded that since the sale at issue constituted an arm’s length transaction (i.e., between unrelated, educated parties), the use tax was correctly measured based on the purchase price.  The officer was persuaded by the fact that the price was negotiated and that the taxpayer used the purchase price allocation for depreciation purposes. Ultimately, the fact that the taxpayer later determined that it made a “bad bargain” and that the value of the property was reduced for property tax purposes were not relevant under the use tax.
The case highlights the need to be well informed about all of your tax obligations and to surround yourself with experienced advisors. The taxpayer in this case specifically noted that if he had been aware of the use tax, he would have borrowed more to cover the liability. As to the issue of the tax base for use tax, there are instances where fair market value, as opposed to purchase, is the correct measure, which may result in a lower use tax liability.
The Aprio SALT team has extensive experience in advising businesses about their state tax obligations when purchasing another business so that those obligations can be addressed and negotiated as part of the deal and do not come as a surprise following the closing. We continually monitor these and other important state tax issues, and we will include any significant developments in future issues of the Aprio SALT Newsletter.
This article was featured in the July 2017 SALT Newsletter. You can view the full newsletter here.
 Washington Tax Determination No. 16-0330, 36 WTD 296 (2017).
 The actual dollar amounts have been redacted in the published decision.
 The tax review officer is unclear how the discrepancy could have escaped the taxpayer’s notice at the time of sale.
 See Rev. Code Wash. 82.32A.030.
 Rev. Code Wash. 82.12.010(7)(a).
 See Wash. Admin. Code 458-020-178(4).
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