Your company’s sales & use tax audit has been completed. You’ve worked diligently to provide the auditors the information they requested; you’ve responded to questions and provided additional supporting documentation; you’ve countered the auditor’s position, attempted to settle issues and did everything in your power to resolve the audit in a timely and efficient matter. However, at end the end of the day, the auditors still issued an assessment for additional tax due with interest and possibly penalties. (Due to state budget deficits, expect to see more interest and penalties added on to audit assessments, as states implement more stringent enforcement tactics to help offset these shortfalls).
What are the company’s options at this point? If the company is essentially satisfied with the assessment and believes it accurately reflects your company’s level of compliance, than it is best to pay the assessment within the time period allotted by the state and move on to implementing corrective procedures to improve compliance. Given the current state of the economy, many states are willing to discuss installment payment plans if a taxpayer is unable to pay the entire assessment at one time. One note of caution though: interest typically continues to accrue on the unpaid tax due; so be prepared to pay additional interest in exchange for extending the timeframe to pay to the assessment.
If the company is not satisfied with the audit assessment and believes there are unresolved issues, including differing interpretations of the tax law or errors made by the auditors, then the company typically has the opportunity to appeal to a higher authority within the state tax or revenue agency. If all appeals to the state tax or revenue agency are exhausted and unsuccessful, you can request a judicial review. Determining whether or not to appeal can be a very difficult decision. The following factors should be considered before moving forward:
- Appeals process. If you thought the audit process was daunting, an appeal can be much more so. Once the audit is finalized, it becomes extremely difficult to remove an item from the assessment. Most states send forms or instructions for appeals along with the assessment or billing statement. Carefully read these documents, as taxpayer companies have a limited amount of time to file paperwork requesting an appeal. Review the state’s “Taxpayer Bill of Rights” or other guidance explaining the levels of appeal, procedures, rules for presenting evidence, etc. Additionally, some states may require you to “pay to play” (i.e., post a bond or pay the assessment prior to the appeal) or require legal counsel at certain levels of appeal.
- Amount of tax in question. It can be very time consuming and costly to pursue an appeal, especially if the issues cannot be resolved within the lower levels of the tax or revenue agency. Therefore, the dollar amount at stake needs to justify the time, effort, and cost (especially if outside representation is required or needed) that will be expended on the appeal.
- Future impact on your industry or business. Unfortunately, the current dollar amount at stake isn’t the only factor to consider. What happens if the issue in question is a recurring matter that will likely be audited again in the future? Issues regarding interpretations of the tax law (i.e., real property vs. business fixture, where does production begin/end, selling property or performing a service, etc.) can have huge impact on future activities and need to be resolved in order to avoid future audit risk. Additionally, it’s critical to determine whether or not the end result of your company’s appeal establishes precedence for the future. In other words, if your company wins the appeal, will the auditors have to respect the results of the appeal for future audits, or can they still challenge your position?
- Level of assurance for your position. Given the time and cost associated with pursuing an appeal, what level of assurance do you have that the position your company is taking can be successfully argued or defended? Hopefully, you have more than a realistic possibility of winning the appeal before moving forward. Is there precedence in this matter or other authority in the tax law that supports your position? Your company may want to consult with a third party or request an opinion letter from the state’s office of counsel or technical assistance bureau before appealing.
Finally, the cost vs. benefit of appealing the audit assessment needs to be assessed. If, after considering the above factors and addressing other concerns (i.e., potential negative publicity, budget constraints, lack of resources, etc.), the perceived costs of appealing the assessment outweigh the current (and future) benefits of winning the appeal, then consideration should be given to forgoing the appeals process and paying the assessment.
One positive takeaway from a sales & use tax audit is that it provides the opportunity for some “teachable” moments for the taxpayer. Unfortunately, it’s the amount of the audit assessment that usually dictates how much teaching needs to be done to improve sales & use tax compliance. If your company’s audit assessment was relatively small, there may not be that much the company needs to do to improve its compliance process (that is, unless the assessment was minimal due to the large amount of overpayments that were identified during the audit). Implementing the following ideas will help your company’s well-oiled compliance process moving in the right direction:
- Schedule periodic (quarterly or monthly) meetings to review law changes, tax rate adjustments and other issues in a timely manner. Give your staff the opportunity to ask questions and address issues they’ve experienced problems with.
- Prepare/update tax matrices or guidelines used by staff for making sales & use tax decisions.
- Have questionable or large-dollar invoices reviewed by someone with more experience. Establish a process to identify these types of invoices and document to second-level review.
- Set guidelines for collecting resale or other types of exemption certificates from customers who are not being charged tax. Alleviate the scrambling for certificates that always occurs during an audit by implementing policies to improve the collection and retention of these documents.
On the other hand, if your company’s audit assessment was relatively large, it’s highly likely that your company’s compliance process is not working as it should. If this is the case, you may want to recommend the following ideas to your company’s executive team to get your compliance process back on track:
- Establish internal controls for sales & use tax compliance. Set up a process for preparing and reviewing sales & use tax returns, reviewing invoices for use tax, determining what sales to charge tax on, etc. and then make a commitment to adhering to these internal controls. Document the process and build in levels of review and sign-off procedures. Consulting with a third party to evaluate the internal controls process your company has developed or to propose internal controls ideas to you may prove to be the best insurance in maintaining compliance and making the most efficient use of your and your staff’s time.
- Consider outsourcing compliance with a third-party who will take your company’s sales & use tax-related data and prepare the returns or, through automation, utilize computer software to prepare sales & use tax returns. Upfront time would be needed to define parameters and build tax decision tables, etc.; but automation can free up resources to focus on other compliance issues, especially since preparing returns can be very time consuming.
- Determine whether or not the state will allow you to use a simplified method for calculating use tax on purchases. Applying a specific taxability percentage to your monthly accounts payable transactions and then calculating the tax due, takes decision making away from staff and streamlines this process.
- Staffing changes may be needed to match sales & use tax work to people who have the requisite skill-set to do the work. Sometimes additional resources or staff who specifically dedicate their time to sales & use tax compliance may be needed, especially for companies doing business in multiple states.
While this list doesn’t include all of the steps your company can take to improve its sales & use tax compliance, it does provide a number of ideas that can be implemented on both small and large scales, depending on your individual needs.
If you have any questions about this or other SALT issues, please email Tom Mazurek at . For additional State and Local Tax insights and resources, or to subscribe to our quarterly newsletter, visit tsacpa.com.