Managing sales and use tax compliance and administration with self-audits and managed compliance agreements.

• Author: Boucher, Karen J.

State tax administrators and corporate America face the same challenge: how to do more with limited resources. Sales and use tax compliance and administration are prime examples of this challenge. In general, state tax administrators target their limited resources toward major taxpayers to get the highest return on the audit dollar. As a result, administrators expend significant resources auditing compliant taxpayers, missing the opportunity to identify nonfilers and educate other taxpayers about their tax compliance requirements. To further complicate the issue, a taxpayer's professional staff, who may not be tax savvy (such as purchasing and operations personnel), continually make important decisions about the taxability of many types of purchases, creating the potential for overpayment of taxes as well as understatement of use tax liabilities.

State tax administrators and taxpayers increasingly rely on managed self-audits and managed compliance agreements to streamline sales and use tax compliance and administrative functions. These programs ensure that states collect no more or no less than they are due, and that taxpayers pay no more or no less than they owe. Tax administrators benefit from them by being able to efficiently reallocate resources, reduce audit costs by cutting travel costs and customize taxpayer education. Administrators also enjoy greater assurance that use tax is being accurately reported and taxpayers are being uniformly treated. Self-audits and managed compliance agreements also give administrators the opportunity to work in partnership with taxpayers.

Taxpayers enjoy reduced disruption of day-to-day operations, an ability to schedule detail review work during slow periods, better awareness of sales and use tax laws, better understanding of internal control strengths and weaknesses, simplified reporting procedures, reduced errors and reduced assessments (as a result of errors and understatements), as well as an opportunity to identify areas of overpayment and of potential refund. Both parties benefit from reduced litigation costs, with fewer audits subject to administrative appeals.

Tools to Manage Sales and Use Tax Compliance

A managed self-audit is an agreement between a tax administrator and a taxpayer that allows the taxpayer to perform a physical audit using procedures written by (or in conjunction with) the tax administrator and agreed to by the taxpayer. In general, agreements specify periods to be covered, accounts to be reviewed, sampling techniques to be used and time period within which an audit review must be finalized and a tax liability calculated. The administrator reserves the right to review the taxpayer's findings and adjust the results. A formal assessment may be issued at the close of an audit, or a taxpayer may be allowed to make a voluntary payment in an amount equal to the taxes and interest due. Most states abate penalties on outstanding liabilities; however, a few states offer an additional incentive by reducing interest on outstanding liabilities. Agreements can be tailored to meet the needs of both parties (e.g., determining how overpayments identified during a review will be handled).

A managed compliance agreement or effective rate agreement is a written agreement, generally entered into following the completion of an audit. It requires a taxpayer to self-assess a use tax liability for a specified time period, using an agreed-on effective rate. The agreement period may last anywhere from one to three years, and may be renewed if both parties agree to do so.

States Adopt Managed Self-Audit Programs

Approximately 30 states have some form of managed compliance agreement procedure in place or are in the process of implementing a similar type of program.

Ohio

In 1993, Ohio was the first state to formally adopt a managed self-audit program. Under Ohio's program, taxpayers perform their own detail work according to the terms of their agreements with the Ohio Department of Revenue. The program was originally designed for small- to mid-sized taxpayers, in market segments too costly to audit on a consistent basis; it has expanded to include major companies with established audit histories and few complex issues. The department estimates that approximately 40% of all sales and use audits are managed self-audits.

In general, Ohio's auditors determine if a taxpayer is a good candidate for the...