In yesterday’s post, “Sales Tax Audits, Part 1: Why am I Getting Audited?” CPA Ned Lenhart talked about the many reasons you may be subject to a sales tax audit. Today we get down to the basics of what you need to do if you’re being audited.
Dealing with the Auditor
For companies that have not been audited for sales tax previously, there is often a misconception about the role the auditor plays. I’ve encountered several companies that thought the auditor would act more like a consultant and help them identify errors and find ways to minimize the tax they paid. Shockingly, they were not really expecting the auditor to give them a six-figure assessment for the tax errors that were identified!
To put it bluntly, the auditor is not your friend! The auditor works for the Department of Revenue. They are not a consultant and they will use any information you give them (whether it’s correct or not) to their advantage. There are exceptions, but the auditor’s goal is generally to separate your business from as much money as they can by identifying as many mistakes (in their opinion) that you have made.
Dealing with auditors is a delicate task. You must realize their job and appreciate their situation. You must also treat them with some degree of professional respect and courtesy. Your goal is to be to provide them with the information that will allow them to complete their work as quickly as possible. Having a good professional relationship with auditors can go a long way when it comes to penalty abatement and the tax treatment of unclear transactions.
Over the years I’ve had clients that took pride in the way the treated auditors. They put them in a small office where it was either too hot or too cold, they spoon fed them information and made the auditor ask multiple times for the same information, and they delayed and stalled on every issue of the audit. It was not surprising, then, that their audits always resulted in large tax assessments, full imposition of penalty, and a very poor success rate on audit appeals.
Treat the auditor as a professional. Keep it polite but remember they are not your tax advocate. They work for the state. It is not their job to provide consulting services to you or to point out areas where you have overpaid tax. Their job is to collect revenue.
Preparing for the Audit
In theory, your business should always be preparing for a sales tax audit. Your company should periodically review the sales tax procedures and policies it has and make sure that these policies are still valid and that they are being followed. In most cases, though, this does not happen! As such, once the notice for audit arrives, people panic and start to scramble to assemble the information requested by the auditor. This is the worst thing that can happen. If you need more time to pull the information together, then request and extension as quickly as you can. If the sales tax audit is set for the same time as your financial audit or is occurring during some other significant event, then move the audit. Nothing good will come from trying to deal with an auditor when you are distracted by other business matters.
As you review the audit request, make sure you understand what the auditor is asking for. The requests are usually generic and may not apply to your business. If that’s the case, call the auditor and develop an alternative. Also, don’t provide the auditor with items that they have not asked for. Anything you give the auditor is fair game for review. More is not always better.
I recently had a company that prepared a detailed analysis on its sales transactions that was not requested by the auditor. Their rationale for this was to make sure the auditor understood their business and accounting process. Once I saw the report, I instructed them to shred it and not to mention it to the auditor. The auditor had not asked for the report and the report only opened a “can of worms” and raised more questions than it answered. If the auditor had asked specific questions, we would have answered them, but there is no requirement that we divulge this type of information.
Also, have the information available when the auditor arrives. I’ve been in too many meetings where the auditor and the taxpayer meet for the first time, and my client says “what type of information do you want?” This is not what the auditor wants to hear and it’s not what needs to happen. Not only should you have the information assembled prior to the auditor arriving, you should also have it reviewed to make sure it’s complete. Ideally, you would have someone conduct a ‘pre-audit’ of the information to identify issues in advance of the auditor arriving. Once the information is turned over to the auditor, it’s too late to correct any errors or fill in any missing pieces of information.
During the Audit
Once the audit begins, there is a delicate balance between letting the auditor do their work and keeping tabs on the progress they are making. I always suggest and opening conference with the auditor to make sure they understand the business, the type or products and services provided, how your invoices are prepared, how your exemption certificates are filed, and the basics of your sales and use procedures. The last thing you want is for the auditor to complete their audit without a good understanding of your business. This can prevent questions and wasted time on the part of the auditor. I also recommending checking in with the auditor at the end of each day for questions they may have and to see what they are finding. Some auditors are forthcoming about what they are seeing and others like to surprise you when they have completed their fieldwork. Don’t abandon the auditor and leave them to their own devices. On the other hand, don’t hover over them and monitor their every move.
It is also important to monitor who the auditor communicates with and how they communicate. It should be made very clear to the auditor who they are to talk to and how they are to present their requests. Without some instruction, the auditor may strike up conversations with company employees who don’t really know anything about the business and then take what was learned as being truthful and complete, and make some very egregious errors in their audit based on incorrect or incomplete information.
What the Auditor Will Look at
For most sales tax audits, the auditor is looking for two things: taxable sales that were not property taxed and taxable purchases that were not taxed. The variations on this basic rule vary by business and industry. Here are a few of the common issues found in sales tax audits:
- Missing exemption certificates for untaxed sales
- Sales made to non-profit organizations that seller believed to be exempt but are not
- Not charging tax on shipping charges are required
- Not charging tax on other services as required by law
- Failure to tax bundled transactions according to state law
- Failure to pay use tax on untaxed purchases used by your business and not resold
- Payment of additional local tax when purchases are consumed in multiple local jurisdictions
- Failure to have proper documentation to support non-taxable purchases such as downloaded software and other digital products
- Failure to have receipts to support charges made on credit cards to show where purchase occurred and that tax was charged
- Improper or unclear invoices that don’t accurately portray the sales transaction
- Operating and capital leases that are not taxed properly
- Intercompany transactions that are not properly taxed or documented
- Asset sales or business disposition that are not properly taxed.
The list can be expanded based on the business involved. Restaurants have different sales tax issues than contractors and manufacturers have different issues than software companies.
Be Careful What You Sign
Audits contain a lot of forms to be signed by the taxpayer. These include statute of limitation waivers, sample agreements, receipt of documents, and agreements to proposed assessments. These are legal documents and if you don’t know what you are signing, get help from someone who does. In most cases, once the document is signed, it can’t be rescinded. Signing a sample agreement without knowing what it means or what the outcome could produce may end up costing you thousands of dollars in tax. It is not the auditor’s job to explain the implications and ramifications of these documents. It’s your responsibility to get help if you don’t understand.
Now that we’ve talked about what you’ll endure during and audit, stay tuned for tomorrow’s post on the aftermath of a sales tax audit.