Part III: Avoiding and Resolving Audits
Plan, Prepare and Prevent
State and local governments are in desperate budget straits, and they are aggressively looking at their tax bases to make up short falls. With sales and use tax making up about 31% of total revenue collected by state and local government, it’s no wonder that states are going to pick this low-hanging fruit. In fact, a report by the National Association of State Budget Officers shows that median growth rate for sales taxes, which represent about 31 percent of general fund revenues, was 2.5 percent in fiscal 2017. †
What are state tax authorities looking for?
Although there is certainly no one audit approach for every state, the audit guidelines in many states instruct their agents to pay close attention to certain “red flags”: (1) sloppy books and records, (2) lack of documentation, e.g., no resale and/or exemption certificates, (3) interstate tax liabilities, especially because of the nexus issues, (4) revenue mismatches between the gross receipts on income tax returns and sales tax returns; (5) the payment of other taxes but not sales tax, (6) cash-basis businesses; (7) markups or profits not in line with industry, (8) changes in inventory for personal use; and (8) the filing of sales tax returns but not use tax returns.
According to the latest California state statistics available (2015-16), key audit issues include:
- Untaxed purchases from out-of-state vendors
- Unsupported sales for resale
- Additional sales based on markup of cost
- Estimated sales due to inadequate records
- Recorded versus reported difference
- Resale certificate deficiencies
- Errors in compiling returns
- Difference between tax accrued and paid
- Withdrawal from resale inventory
- Cost of tax-paid purchases resold
And these same Californian statistics identify some industries as more audit prone than others:
- Food Service
The implementation of an expert sales tax solution would address these audit “red flags” in all industries and would therefore increase a company’s chances of avoiding audits altogether. However, should an audit of the company occur, this same expert solution would help to resolve audits more quickly and favorably with as little business disruption and cost as possible. It does so by being able to quickly and seamlessly provide the tax authorities with the records, reports and documentation needed to support a company’s tax positions. And if the tax authorities are impressed with the reliability of your compliance solution, this will also tend to reduce any “urge” for them to go on fishing expeditions looking for problems. Finally, it is important to note that it is also quite possible that a so-called “reverse sales tax audit” could show that your company is overpaying taxes, and so an audit could generate tax refunds.
Before any audit notice arrives, revisit your sales tax strategy and give attention to these three actions: plan, prepare and prevent. Recommit to fulfilling your fiduciary responsibility by seeing that your tax operation is the best it can be — no hidden traps, access to the tax expertise you need, and the right tools to do the job. Your business will be better off, and there won’t be any unwanted surprises.
† National Association of State Budget Officers, “The Fiscal Survey of States”, 2017.