In this chapter, we will highlight the statute of limitations for various states and how long you should retain your sales tax records.
A statute of limitations is a law that sets forth the maximum time after an event that legal proceedings based on that event may be initiated. When applied in a sales and use tax context, there are time limits established by state laws. They govern how long a taxpayer has to file a refund claim after paying tax erroneously and how long taxing jurisdictions have to assess your tax.
Your first contact with the auditor will be an official letter. Accompanying the letter will be a questionnaire requesting information about the company. This document will reference the statute of limitations in some way.
Most states have adopted the federal statute of limitations. That means they have a three year limitation. However, if the tax liability is understated by 25% or more, the state can go back six years to go back.
Some states don’t follow the federal statute. The most common alternative time limit is four years, but some states use a five or six year statute.
(Have questions about the statue of limitations in a particular state? Consult this chart from the CCH to see a state-by-state breakdown.)
Tolling is a legal doctrine that means “paused” or “stopped” while a certain condition exists. For example, if a company does not file sales tax returns when required to do so, the statute of limitations is tolled or paused and does not run out. Frequently, people will say that the statute of limitations is not tolled in this scenario. But that is an incorrect usage that leads to confusion. However you use the tolling word, the reality is, under certain conditions, a state can go back much further than the statute of limitations would seem to indicate.
Often audit fieldwork takes longer than the auditor initially estimates. There are a number of reasons this could happen. The auditor could run over schedule. Or may things got too hectic at your office and you had to ask for more time.
When a delay happens, the auditor will request a waiver of the statute of limitations. This is because the delay causes some of the months under audit to fall out of the statute of limitations. If your company files its sales tax returns on a monthly basis, that means every month that passes, another month (that happened 48 months ago) is no longer accessible to an auditor.
The auditor can ask you to sign a “waiver” to remedy this. A statute waiver agreement is just that — you agree to extend the statute of limitations on the earliest months in an audit to allow the auditor to complete the audit.
If you refuse to sign the agreement, a number of things might happen. Most of them are bad.
The auditor will often just estimate the audit using available records. Most auditors will be conservative (from their viewpoint) and not risk understating the tax liability. They will usually overstate it by a significant amount. This can cost you a lot of money.
The auditor may see your refusal to sign a waiver as unreasonable. This will lead them to to spend many hours in a short time frame getting all the paperwork completed before the statute expires. When it comes time for that auditor to make a reasonable compromise later on, you can be sure they will remember this part of the audit.
We generally recommend that our clients go ahead and sign the agreement to waive the statute of limitations. The auditor will usually not miss a deadline and you will have succeeded only in alienating the person who has the most leeway in whether to tax certain purchases.
On the other hand, we have seen instances where refusing to sign a waiver actually worked in the taxpayer’s favor.
In one case, records were so sparse and the client knew even if they were found it would mean bad news. So, the assessment calculated by the auditor was actually less than the amount projected by the client. The benefits of not signing the waiver outweighed the risks for this client.
Signing the waiver can also delay the audit to a more convenient time and give a taxpayer time to locate requested documentation that was not initially available.
It is also beneficial to have the waiver allow for more time to find offsetting refunds or credits to reduce the assessment.
There’s one last possibility if you don’t sign. In the interim period in which you refuse to sign a waiver extension agreement, the auditor may quit or even forget about your audit. We have seen this happen. But it’s rare, and very difficult to predict.