Learn how long it takes for the state to issue a formal audit assessment and how to check interest and penalty calculations. We’ve also included a sample penalty abatement letter and a checklist of what to do as the sales tax audit is finalized.
Protesting the sales tax audit
Many auditors view themselves as the final authority on the audit results. Because of this, they often push taxpayers to pay the tax assessment, interest and penalties. But you might not have to. You have rights.
Before making any protest decisions, you should verify that the assessment is correct. Even if you agree with the items assessed and the calculations, you should consider protesting if you received a penalty.
At the completion of the fieldwork, the auditor should have given you copies of all audit work papers and schedules. Review these documents to verify that they’re correct and that they reflect any agreements reached in your negotiations.
You should bring any errors in the assessment to the auditor’s attention immediately. Pay particular attention to any last-minute adjustments that were agreed upon. Make sure they were carried forward to the auditor’s final worksheets.
After all the required adjustments have been made, some states will issue a preliminary assessment while others will issue a final assessment. An assessment is a formal request for payment that imposes certain obligations on the taxpayer for payment or appeal of the audit results.
Formal assessment timeline
It can take anywhere from four to twelve weeks after completion of fieldwork to issue a preliminary or final assessment. Most states issue their assessments six to eight weeks after the auditor turns in the necessary papers.
It takes this long because the auditor’s work has to go through a review process before the formal assessment can be issued. Most states rely upon the auditor’s supervisor to perform the review. But some states have a formal committee or department that reviews and processes all assessments. The level of review can vary with the magnitude of the assessment — larger assessments generally receive closer scrutiny.
Check the interest and penalty calculations
You should verify the accuracy of the interest or penalty calculations. Many states use simple interest, which makes the verification process relatively easy. If a penalty has been included in the assessment, you should consider asking for a waiver. These actions can reduce the total amount you owe.
The deadline for filing an appeal is usually thirty or sixty days after the date the notice was mailed or received. If the taxpayer fails to file an appeal or protest by the deadline, the assessment becomes final and the results cannot be appealed. If the taxpayer does not make payment or file an appeal by the deadline, an additional penalty may be assessed, and additional interest will be assessed.
Making preliminary payments
States often allow the taxpayer to make a payment from the preliminary assessment to avoid incurring additional interest costs. If the audit is agreed upon, the taxpayer may wish to consider this alternative. In some states, if the audit is only partially agreed upon, the taxpayer may pay the undisputed portion to reduce interest costs on the overall settlement.
Checklist: Action items to finalize the audit
- Meet with the auditor at a concluding conference and verify the timetable and tasks to be completed to finalize the audit.
- Discuss the assessment process and clarify your rights and responsibilities. Take particular note of your appeal rights if you are planning to appeal.
- Confirm your appeal and payment rights through analysis of the state’s law.
- If the auditor provides you with copies of the audit work papers, verify that all agreed-upon adjustments are reflected in the final work papers.
- When you receive the assessment, verify all amounts against the final work sheets provided by the auditor.
- Verify that the interest calculation is correct.
- Note deadlines for payment or appeal and plan accordingly so you don’t miss them.
- If an appeal or litigation is contemplated, discuss the probability of success with outside counsel.
- If the state allows partial payment on agreed-upon issues, consider paying that portion of the assessment to reduce interest costs during an appeal.
- Make sure the audit deficiency is properly accounted for on the company’s books.
- Promptly notify the auditor of any errors or discrepancies in the final audit work papers or assessment.
Appeals procedures and processes
If you don’t agree with an aspect of the audit, there are many levels of review and appeal that you can pursue. As you would expect, protest procedures vary from state to state. A few agencies allow only one level of administrative appeal before requiring taxpayers to pursue their cases in court.
Most tax agencies provide two levels of appeal, although one is generally an optional informal conference. A few states provide three levels (again including an initial informal conference), and some also offer alternative dispute resolution or settlement programs outside the usual administrative appeal process.
If you don’t agree with any aspect of the audit, there are many levels of review and appeal that you can pursue. As you would expect, protest procedures vary from state to state. A few agencies allow only one level of administrative appeal before requiring taxpayers to pursue their cases in court.
During this phase of the audit, you need to be careful that you don’t compromise your rights to sue in court at a later date. Many states require you “to exhaust all administrative remedies” before proceeding to court. So you have to know what your “administrative remedies” are.
Typically the auditor will hold an “Exit Conference” with you at the end of an audit. You may not be aware that this meeting is an exit conference because the auditors usually don’t call it anything specific.
In that meeting, they tell you your options as far as appealing the audit. These can become quite involved depending on the circumstances of the audit. We won’t discuss all the available options. There are a number of them. But here are the most commonly used avenues.
Meeting with the audit supervisor or manager
Some states refer to an audit as a “Determination” of your tax liability. If you believe the tax assessed your company is overstated as a result of this “Determination” and you haven’t been able to persuade the auditor or his supervisor, then you must request a “Redetermination.” This is usually an appeal to the State Department of Revenue.
To request a redetermination you are usually required to file for one within 30 days of being notified of the official audit results. Typically, the request/appeal must contain a complete statement of the facts and the legal reasoning behind it. The deadline is critical.
At this point, the state will usually assign a state attorney to attempt to resolve the audit. (This often works in favor of the auditor/state).
There are many different avenues the appeals procedure could take depending on the circumstances. It is possible to handle it on your own. But to make sure you get the best results, it’s worth working with an attorney or CPA experienced in audit appeals.
Effective Strategies for Appealing a Penalty
If the state assessed you a penalty in any material amount, you should consider appealing it. Not only is the penalty an additional amount out of your pocket, but it’s also not deductible for federal income tax purposes.
Here’s how you should appeal the penalty.
First, make sure you understand why the penalty was assessed and how it was calculated.
When you get a satisfactory explanation of the penalty, formulate your arguments and assemble your evidence for waiving the penalty. Generally the penalty imposition laws state that penalties are imposed because the taxpayer failed to exercise “reasonable care”. This is what you will attempt to refute in your protest.
If the penalty relates to self-assessments of tax on fixed assets, explain your self-assessment procedure. Be sure to cite the dollar amounts self-assessed, the number of transactions reviewed and any other material fact that supports your argument.
Review department regulations, court cases and department of revenue publications to determine if there are any guidelines that support the State’s position.
The state may not always be specific in its reasons for assessing a penalty. For example, the State might indicate that you may have made errors in prior audits with self-assessments and that similar errors were found in the current audit. Or the State may cite the amount of the assessment or the number of errors in the audit as being greater than in the previous audit.
When the state provides general reasons for the imposition of penalty, you should also be prepared to respond in a broad manner. There are a number of general defenses you can use to justify a penalty waiver, if and when applicable.
Here are some of the defenses we use:
- The complexity of the tax law.
- The unsettled nature of the issues involved.
- Your demonstrated level of self-compliance. (You were correct on 99% of the transactions, for instance.)
- How much tax you voluntarily collected and paid compared to the audit deficiency.
- Your prior audit history and compliance record (if favorable).
- The staffing issues and turnover you’ve endured during the audit period.
- The degree of cooperation you exhibited with the auditor.
Sample sales tax penalty waiver request letter
December 10, 2018
State Department of Revenue
123 State Capitol Street
Capitol City, USA 77777
RE: Penalty Abatement for ABC Company Taxpayer ID 123-45-6789
Dear Madam or Sir:
We have completed our review of the audit and are in general agreement with the results. However, we are not in agreement with the penalty imposed. Per state statute, penalty is imposed in cases where the taxpayer failed to exercise “reasonable care”. We feel that a penalty on this audit is inappropriate for the following reasons:
- A review of tax remittances during our audit period shows that the audit deficiency comprises less than 10% of the total tax due for the period, when compared to voluntary self-assessments and payment of tax to vendors. The tax deficiency is $50,000, while the amount of self-assessments during the audit period totals $250,000, and the tax paid to vendors equals another $300,000. These figures indicate that we have made a diligent effort to comply.
- $40,000 of the audit deficiency is related to the sale of SaaS services which is a complicated area of the tax law that we did not fully understand until now.
- Our prior audit history of a less than 3% overall error rate shows that we have been diligent taxpayers over a long period of time.
- Throughout the entire audit period, all returns and payments were made in a timely manner. We accomplished this despite the fact that there was a 25% turnover of compliance personnel during the period.
- We cooperated fully with the auditor during the audit engagement and extended every courtesy to make the audit as efficient as possible for the state.
Based upon the facts presented above, we believe that we have established that we exercised the “reasonable care” required under the statute and as such, it would be inappropriate to impose a penalty. Therefore, we respectfully request a full abatement of penalty on the audit.
Please contact me if you have any questions.
Protesting the sales tax audit: The verdict
If you’ve been over-assessed sales tax in your audit in any material amount, then you should strongly consider protesting the assessment. Don’t be overly intimidated by the process and don’t be put off by the auditor who has a strong motivation to avoid the protest phase.
Every state has a defined process for protest. It starts with trying to resolve it with the auditor and the supervisor and goes all the way to an administrative law judge.
In our experience, it’s easiest and least costly when you try to get everything possible resolved before ever going to the official protest route.