If you’re a retail business subject to sales tax, you will want to be especially prepared for an audit, since many states are looking to sales tax audits to increase revenue. With the popularity of internet sales and multi-state commerce, it’s easy for a business to underpay sales tax or to miss something important. There are several ways businesses can reduce their costs and be prepared if they are selected for a sales tax audit.
AICPA outlines the sales audit process and offers tips in an article titled Sales Tax Audit Best Practices.
The Entrance Conference
If you are chosen for an audit, you’ll be notified and asked to schedule an initial conference. At that conference, you’ll be told why you’re being audited, what items are being audited, the methods they’ll use for the audit, what period is being audited, and the overall plan for the audit. Here are a few tips as you’re going through this first stage:
- The auditor isn’t the person to express frustration to (that’s what friends are for!). If you go in with a positive attitude and cooperate with the auditors requests, the process will be much smoother. Auditors are people who will react to their surroundings like anyone else, so if you are positive and friendly, the chances are high that the auditor will be positive and friendly as well.
- Keep a record of all the communications between you and the auditor. This is especially important for any agreements you’ve come to regarding sampling, taxability, and timing. If anyone later questions something, you’ll have a written record to show them.
- Related to the previous tip, ask the auditor to provide all questions and request in writing, allowing you to keep a written record.
- You can ask how long the auditor expects to be on-site at your business. He or she knows that the audit is an inconvenience and you are having to work around his or her being there.
- Set a preliminary date to receive the initial audit workpapers, and come to an agreement with the auditor on how much time you have to review them. Then, ask for a time frame on when the assessment will be final.
- Often, you will be asked to sign a statute of limitation waiver, which extends the time the auditor has to complete the audit beyond the statute of limitation. There may be reasons you need to refuse to sign the waiver, but there are many advantages to signing, including delaying the audit to a convenient time for you, to give you time to locate requested information, and to allow time to find offsetting refunds or credits to reduce the assessment. Also, if an auditor is pressed for time, he or she may issue a more aggressive assessment, resulting in a greater burden for you.
- You should review your records of all correspondence from the state tax office to ensure that there we no notices that were unresolved.
The Sampling Methodology
Because it would be cost-prohibitive for the state to audit all records, the auditor takes a representative sample of the records from the selected time period. The sample is examined for errors, misstatements, and omissions, and then projected for the entire audit period. If there are errors that are limited to the sample, they will be magnified over the entire period, so preventing even small errors will save you significant money. Here are a few tips to take you through the sampling stage:
- You should ask if you can select the sampling method that’s used. Your availability of records, sales season, and other factors may make some sampling methodologies less likely to hit errors than others. Block sampling, for example, can be particularly problematic for you if you have seasonal sales and the sample hits an extremely busy time period where more errors are likely.
- If a large nonrecurring item ends up in a sample, you should negotiate to have it removed.
- Auditors will often sample routine purchases for use tax assessment and extrapolate errors in that assessment as well. Negotiate to have fixed asset purchases excluded from this sampling and evaluated separately.
- Ask whether the auditor is focusing only on instances of underpayment or if he or she is also looking at overpayments. You should request that the auditor evaluate both.
The Performance of the Audit
Again, once the auditor arrives, it’s to your advantage to cooperate fully and to be pleasant. Here are some tips to help you as you deal with this stage of the audit:
- Offer the auditor helpful information. Create an opening audit guideline that includes standard office hours, office security protocol, a contact person, and a request for a concluding conference and copies of all workpapers, and send this to the auditor in advance.
- Ask that the auditor issue all questions and requests for documents in writing, and establish that you will either send files electronically or send copies of the originals.
- Schedule face-to-face meetings when possible. Communication is always easier face-to-face.
- Stay involved in the process. Ask questions, follow up quickly to requests, and notify the auditor immediately if there will be a delay.
- Address all questions and provide all documents requested. Don’t rush, and be sure everything you submit is accurate. If you feel the auditor is asking for more data than is necessary to answer a question, you can ask why the data is being requested and be sure that it is the most suitable data to answer the question.
- Request status reports throughout the audit that outline the results of the audit segments as they are completed. This will give you time to deal with any misconceptions.
- As for a complete copy of the workpapers and negotiate enough time for you to review them before agreeing or disagreeing with the findings. If you disagree, continue the conversation with the auditor to try to reach a resolution before the final assessment is issued or before you take your case to appeals or litigation.
- Take your CPA or financial adviser with you, or have him or her represent you. They bring expertise and experience, and they also help to remove emotion from negotiations.
The Post-Assessment Period
Once the auditor finishes his or her work, you will receive a copy of the assessment. If you agree with it, you can then remit payment and the audit is complete. If you don’t agree, you need to evaluate your rights to appeal. Here are some tips to help you determine whether and how to appeal:
- Consider all venues for appeal that are available in your state. Administrative forums, for example, may offer you an opportunity to argue issues that would not be considered in court.
- If your appeal receives a negative determination, you can request reconsideration or settlement through an offer in compromise, which often allows you to settle your liability for less than the full amount. This path is often safer than further litigation in court.
- After the audit, evaluate what drove the assessment and make the changes needed to insure that you won’t run into the same problem again.
There are also opportunities you can take advantage of if you are selected for a sales tax audit, including amnesty programs, voluntary disclosure agreements, bankruptcy, and managed compliance agreements. In addition to taking the steps mentioned above, I recommend that to talk to your CPA to find out if you would benefit from any of these opportunities.