Reverse sales and use tax audits.

• Author: Kisscorni, Edward S.

The reverse sales and use tax audit is identical in many respects to the sales and use tax audits conducted by state auditors, except the reverse auditor looks for overpayment of tax.

Several factors may cause sales and use tax overpayments. In many states, the field auditors have become very aggressive in assessing taxes, penalties and interest. This environment has caused retailers to be aggressive in charging tax, because of the fear of a state audit deficiency. Often, tax is charged even when the sale would be exempt.

In many cases, suppliers and distributors are aggressive in charging sales tax on every sale, even when the sale may be exempt. Usually, their motivation is to avoid the responsibility for tax, because most state laws will hold the seller responsible for the tax if not paid. Other times, they will inappropriately charge the tax because there is no (or an invalid) exemption claim. Either way, the purchaser may pay tax not due.

Finally, an inadequate sales and use tax compliance system may allow tax to be paid in error. Normally, it is the responsibility of the purchasing function to make a claim for exemption (industrial processing or agricultural production). If this is not done (either through miscommunication or negligence), the supplier will normally charge the tax. A second line of defense is the accounts payable function. If an invoice that includes tax is presented for payment, the accounts payable department should omit the tax if the purchase is exempt. Inadequate compliance in the purchasing and accounts payable areas can cause the overpayment of tax.

Performing a Reverse Audit

The first step in a reverse audit is to perform a complete study of the taxpayer's business activities. It is important to identify what line of business the taxpayer is in and how it is taxed. More important is the determination of which exemptions may apply. In the case of manufacturing or industrial processing, it is important to identify when the exemption starts and ends.

The second step is a complete study and evaluation of the sales and use tax compliance system. The acquisition of property is traced from the purchasing function through the payment and accounting for the acquisition. Particular attention should be paid to the sales tax and use tax compliance function. Reverse auditors look for weaknesses in the system that would allow for the overpayment of tax. Often, a sample review of invoices will be made to identify adherence to...