Deftly Navigating an MTC Audit: Considerations for Taxpayers; Check out this stat: In the last three years, the MTC Audit Program has recommended state tax assessments in excess of $45 million annually.

Author:Friedman, Jeffrey A.
 
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As recently recognized by Tax Analysts, the Multistate Tax Commission (MTC) has been gaining in prominence and, arguably, effectiveness. (1) One of the MTC's several activities is to administer audits on behalf of states. The MTC's Joint Audit Program (Audit Program) is authorized by the Multistate Tax Compact and was initiated in 1971. (2) The MTC does not have the authority to assess tax. Rather, following an audit the MTC transmits its audit report and proposed adjustments to participating states. Over the last three years, the Audit Program has recommended state tax assessments in excess of $45 million annually.

The Audit Program includes the MTC's Compact members, Sovereignty members, and Associate/Project members. (3) Currently, of the twenty-eight member states in the Audit Program, twenty-seven participate in the MTC's Income and Franchise Tax Joint Audit Program, and seventeen participate in the MTC's Sales and Use Tax Joint Audit Program. (4) The MTC has developed audit manuals, for both income tax and sales tax, which set forth the procedures that MTC auditors follow when performing a multistate joint audit on behalf of the states. These audit manuals are publicly available. (5)

Because a single MTC audit is intended to take the place of separate and duplicative audits, it provides economies of scale to the states. The Audit Program is also intended to promote uniformity among states with similar laws and regulations and to provide states with expertise on new issues and business practices. However, unique challenges arise with an MTC audit. For instance, the notion of state tax uniformity is aspirational at best, in that states that adopt identical tax provisions often interpret them differently.

Available data reveals that during fiscal years ended 2000 through 2009, the Audit Program completed or partially completed an average of 8.3 corporate income tax audits and an average of 11.7 sales tax audits annually. (6) Over the subsequent ten years--fiscal years ended 2010 through 2019--the Audit Program completed or partially completed an average of 12.4 corporate income tax audits and an average of 15.6 sales tax audits annually. (7)

For fiscal year 2019 alone, the Audit Program completed or partially completed 18 corporate income tax audits and 35 sales tax audits. (8) As Table 1 shows, this uptick indicates that the number of audits completed each year is rising, with 2019 being an especially busy year for the Audit Program.

Although the MTC has reported assessment amounts only since fiscal year 2009, the annual assessment amounts vary widely and do not appear to be directly related to the number of audits completed in any given year. For instance, in 2019 the Audit Program recommended $61,704,365 in corporate income tax assessments and $6,470,763 in sales tax assessments. (9) For fiscal year 2016, the Audit Program completed or partially completed far fewer audits than in 2019 (11 corporate income tax audits and 17 sales tax audits). (10) Yet, in that year, the Audit Program recommended corporate income tax assessments of $175,106,740 and sales tax assessments of $5,610,324. (11)

Interestingly, despite advances in technology and the MTC's use of electronic records, the Audit Program has actually increased the time spent doing its audit work in the past two decades. For example, in 2000 an MTC audit required sixty-three hours of staff time per audit per state. (12) By 2018, that number had grown to 154 hours of staff time per audit per state. (13) A number of reasons may explain this increase, including the increase in the number of states participating, the rise of combined reporting (and the challenges of auditing a unitary group), and more frequent and disparate state tax law changes.

MTC Audit Selection Process

The MTC's Audit Committee consists of representatives of member states' tax agencies. The Committee is responsible for MTC audit selection and overseeing the audit program. (14) The audit selection process begins every July, when the MTC Audit Director distributes audit nomination forms to the states. A state may nominate up to two lucky candidates for audit by the MTC, and the nomination form must describe the reasons for the nomination. The MTC provides that the state should consider certain criteria when nominating a taxpayer:

  1. Does the taxpayer's consolidated federal income per line 28 exceed $250,000?

  2. Does the taxpayer have substantial business activities in a number of states so that apportionment is more than de minimis in most states where the taxpayer files?

  3. Is there a good chance that nexus may be established in the states where the taxpayer does not currently file?

  4. Is the taxpayer filing a combined return where required?

  5. Does the taxpayer have large intercompany transactions?

  6. Do the taxpayer's apportionment factors fluctuate from...

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