Managing sales tax and usage tax audits is a difficult process. There are certain steps and processes that you should consider before the audit notification reaches your desk. Similarly, there are options available that can affect the outcome of the audit. Finally, you will have the option to negotiate your assessment after the final audit assessment has been provided. This document is based on more than 50 years of partner experience in managing sales tax and usage tax audits in virtually all states in the country.
• In many cases, jurisdictions audit specific industries. In these industries, there are usually new or complex taxing rules, and as a result, you are more likely to make mistakes along the way. Examples of recent targets are the service industry and Internet companies.
• As a result of auditing one of the customers, it may be determined that the invoice has been reviewed and not properly taxed. The auditor returns to you and follows the breadcrumb trail.
• Disappointing employees who know that they are not properly taxed within their jurisdiction may report to the tip line.
• A random drive-through past one of your locations, or an auditor's recognition of a delivery truck or employee at a trade show in their jurisdiction, may lead to an audit.
• Unfortunately, sometimes audits are a result of chance.
• Jurisdictions discuss each other, which may lead to additional audits.
Once identified, regular audit cycles should be expected, especially if the first audit results are favorable to the jurisdiction.
Compliance documents should be maintained in a way that is easy for the auditor to interpret. Many companies are audited without proper documentation. In this case, the auditor assumes that the transaction is taxable, and if there is no appropriate invoice or sales data, the auditor performs historical predictions or an arbitrary assessment of taxable sales. The documents that an auditor usually needs in order to conduct an appropriate review include:
1. Expect an audit:
One of the first questions that may come to mind is why your company was chosen for the audit. There are many reasons to identify a company, but here are some of the more common ones.• In many cases, jurisdictions audit specific industries. In these industries, there are usually new or complex taxing rules, and as a result, you are more likely to make mistakes along the way. Examples of recent targets are the service industry and Internet companies.
• As a result of auditing one of the customers, it may be determined that the invoice has been reviewed and not properly taxed. The auditor returns to you and follows the breadcrumb trail.
• Disappointing employees who know that they are not properly taxed within their jurisdiction may report to the tip line.
• A random drive-through past one of your locations, or an auditor's recognition of a delivery truck or employee at a trade show in their jurisdiction, may lead to an audit.
• Unfortunately, sometimes audits are a result of chance.
• Jurisdictions discuss each other, which may lead to additional audits.
Once identified, regular audit cycles should be expected, especially if the first audit results are favorable to the jurisdiction.
2. Maintain compliance documents:
Compliance documents should be maintained in a way that is easy for the auditor to interpret. Many companies are audited without proper documentation. In this case, the auditor assumes that the transaction is taxable, and if there is no appropriate invoice or sales data, the auditor performs historical predictions or an arbitrary assessment of taxable sales. The documents that an auditor usually needs in order to conduct an appropriate review include:
• Sales tax payable-Sales tax should be listed as a separate general ledger number in the general ledger.
• Invoice-from both a sales perspective and a purchase perspective.
• Returns / Credits-Make sure that these are clearly identified in the accounting system and properly billed.
• Exemption Certificate-Maintain an accurate and complete exemption certificate for each customer being exempted.
• Bad Debts-Most states allow deductions of bad debts written off for federal income tax purposes. Again, make sure that this is clearly identified or documented in your accounting system.
• Other Adjustments-Adjustments made on return require additional documentation. Most companies keep this document with a copy of the declaration.
• Consumer use tax payables-these must be associated with a specific purchase invoice.
• Summary Report-Summary financial and tax reports need to be coordinated with the tax returns submitted.
• Declarations-Although all audits start with a review of sales and usage tax declarations, most auditors also require income tax returns. The gross income needs to be adjusted between income tax and sales tax and usage tax return.
3. Evaluate your records:
When notified of an audit, you evaluate your records to determine where there are gaps. You should make every attempt to identify your exposure prior to the audit. For example, you may be aware that the file does not have an appropriate exemption certificate. By proactively identifying this issue, you can provide the customer with the time needed to protect the missing certificates. Other exposed areas not found may lead you to manage the audit in a specific way. For example, if you find that there is a problem with your accounting system or that there is a large gap in your taxable actions during an audit statute, we recommend that you avoid sampling that period if possible. If the period is identified by the auditor and considered in detail, it can be isolated as an outlier from any sample.
4. Process review / overview:
Providing an auditor with an explanation of your business is always helpful. Be concise, but be specific in the way your business operates. Please be aware that exposed areas change frequently during facility visits. In the facility visit, the auditor looks at the movements inside your warehouse and manufacturing facility. They may ask how long the forklift will spend moving raw materials from the receiving dock to the first step of the manufacturing process or how long it will take to move the finished goods in the warehouse.
