Managing sales and use tax audits.

AuthorYrjanson, Carla

Introduction

Even in the best economic times, businesses need to be vigilant against unnecessary costs and risks. In challenging times such as these, it is more important to avoid missteps, protect cash flow, and derive maximum value from people and processes. But it is not just businesses that need to maximize cash flow these days: States and other tax authorities are feeling the same economic pinch. State budget deficits are mounting into the tens of billions, income taxes are shrinking, and federal help is drying up, leading states to become more creative in targeting additional products and services to tax, and more aggressive in collecting that tax. The result is a flurry of new laws and rate changes, intensifying collaboration to catch the non-compliant, and an explosion of new tax auditors on the streets, each charged with bringing home revenue.

This is not welcome news for businesses already reeling from the pains of the recession. Not only do companies have to navigate through the recession recovery, but they also have to stay on top of new tax laws and trends, preserve cash in the face of proliferating audits, and figure out how to reduce operational costs while covering their audit risks. Tax audits require weeks of effort and distraction, and come with the potential for tens of thousands of dollars in penalties and fees biting into your company's bottom line, all at a time when you can least afford it.

This article outlines a survival guide to sales and use tax audits, based on knowledge collected from real-life past and present auditors who were asked about what they look for in an audit. It provides information to help you understand your company's exposure to audits and how to avoid them right from the start, coupled with proven strategies for minimizing their effect on your bottom line. At the end of the day, the best defense against being audited is a good offense. Each new tax law change, newly taxable item or service, launch of a new product, etc., increases your odds of being audited. Passive acceptance or turning a blind eye will get you nowhere. This article concludes with techniques, tips, and tools that will enable you effectively manage your sales and use tax compliance, cost-effectively scale your ability to survive audits, and help you emerge successfully from the present downturn.

The Top Ten Issues that Trigger Audits

To cash-hungry tax authorities, your business represents a revenue stream, plain and simple. Their job is to maximize that stream, and a sales and use tax audit is one of their primary tools. In a sales and use tax audit, an auditor reviews your business records over a period of days, weeks, months to determine whether you are underreporting or underpaying taxes that are legally due. In addition to the time, effort, and diversion of resources this takes on your part, the resulting penalties can be substantial. In a recent survey of 514 companies, the estimated annual cost of penalties owing to sales and use tax mistakes was $34,000 over and above the recovered taxes. To you, that is an unexpected hit to your profits; to the State, it is "found money."

Given this kind of return, it is no surprise that when states need more funds, as they increasingly do today, they send out more auditors. Case in point: In October 2010, the California Board of Equalization began hiring 98 new staff members to address the growth in the number of sales tax audit leads and to enhance tax collection efforts. The state expects the effort to bring in an additional $13.6 million to the State General Fund. The accelerated and new General Fund revenues are expected to be $62.2 million in 2011-2012 and $81.2 million in 2012-2013.

Also in California, auditors are literally going door to door to seek out businesses that are not properly paying sales taxes. In short, they are out there looking closer, more aggressively, and with greater frequency than ever before, and the more tax jurisdictions you do business in, the greater the likelihood that you will be audited.

How States Determine Whom to Audit

Most states use systematic methods and electronic data to evaluate and determine those taxpayers who are at potential risk for underreporting or underpaying sales, use, corporate, or withholding taxes. If you know what they are looking for, you can take steps to avoid being audited. But what are the triggers? According to current and former auditors, here are the top 10 issues that...

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