Texas conducts thousands of sales tax audits every year, and their audits have a reputation for being among the toughest. Texas tax rules are notoriously complicated. And their sales tax auditors are known for being aggressive. To survive a Texas sales tax audit, you’ll need to be at the top of your game.
Data from the Texas Comptroller indicates that one-third of their 4,252 audits in progress are being conducted out of state. Research also shows that Texas has a total of 595 auditors. 78 of those auditors are permanently based out of state.
The Statute of Limitations in Texas is four years, which is above the average of three years. That means that your audit period and potential liability is 33% higher than in most other states.
Why is Texas auditing you?
One of the first questions most business owners ask is, “Why my business?” While it’s common to think you did something wrong, this usually isn’t the case. There are number of reasons Texas could decide to audit a business.
Higher reported sales
Gross sales reported is the single biggest driving factor in the audit selection process. It is simple math: the higher your reported sales, the higher your potential tax exposure. The Comptroller knows this, so they audit larger businesses on a more regular basis.
Texas may have selected you for an audit because someone reported your business to the Texas Comptroller. This is called an Audit Lead. They come from former employees, competitors and from Texas auditors directly.
A possible reason your business was selected for audit is just bad luck. In other words, your tax identification number was selected at random. It is also possible that your business is in an industry the Comptroller is targeting due to poor compliance.
Some businesses are selected for audit because their reporting history throws up a “red flag.”
Prior productive audits
If your business owes more than $10,000 in additional taxes due to an audit then you will automatically be audited again in three to four years.
Additional reasons for audit selection
- Certificate of NTD (No Tax Due) request
- Leads from newspaper articles or internet news sites
- Security release request
- Leads resulting from bankruptcy action
- Insolvency investigation
- Refund request
- Amended returns
Texas sales tax audit process
Texas’s audit process is structured similar to other states, though you can expect the regulations to be more complex and the auditor to be more aggressive. (Review our guide on other states here.) However, one area that will be unique is the audit appeals process.
Texas audit appeals process
Preliminary Notice and Initial Discussions
Once the field work is completed, the Texas auditor is required to provide and explain the audit schedules to the taxpayer. The auditor’s write-up should include a sufficient explanation to allow the taxpayer to determine the legal basis for the proposed assessment. The taxpayer also may request a meeting with the auditor’s supervisor.
If you disagree with the proposed assessment and you desire an informal conference, a reviewer outside the Comptroller’s Audit Division will grant you an independent review.
Important Note: This “independent reviewer” may be “outside the Audit Division” but they are still employees of the Comptroller’s Office.
When the review is completed, a final version of the audit will be provided to the taxpayer, and a Notification of Audit Results will be issued. If there are remaining disagreements, the taxpayer should file a written request for a Redetermination Hearing within 30 days of the date of the Notification.
Assessment and Protest
The request for a Redetermination Hearing should include a statement of grounds that lists the protested items (either individually or by category) and explains the taxpayer’s reasons for disagreeing with each. Any disagreement with the agency’s interpretation of the law or regulations must be supported by legal citations. Copies of supporting documents should be included with the petition, and schedules and work papers should be provided as needed to clarify the taxpayer’s position.
The audit staff will schedule a pre-hearing conference on or about the 61st day after it receives the request for redetermination. The staff is expected to expedite the process. If the taxpayer does not provide all records deemed necessary, the audit will be returned to the hearing section without adjustment.
Extensions of time may be granted in increments of 30 days or less. Requests for extension and the staff’s responses must be in writing. If you have to obtain resale or other exemption certificates, extensions for doing so may not be granted beyond the statutory 60-day requirement.
If the pre-hearing conference does not produce a resolution, a hearings attorney will schedule an informal meeting with the taxpayer. Following the meeting, the attorney will issue a letter explaining the state’s position. The taxpayer should respond to the letter, including an explanation of any remaining disagreements and any additional documentation if applicable.
As the final step before a formal hearing, the state will offer an optional mediation with an Attorney/Mediator before proceeding to a formal hearing.
Appeal to Second Level
The State Office of Administrative Hearings (SOAH) holds all formal hearings of contested sales and use tax cases. The hearing process is quasi-judicial. The administrative law judge (ALJ) may examine witnesses, rule on motions and the admissibility of evidence and determine what goes into the record.
After the hearing, the ALJ will issue a proposal for decision to the Comptroller or their designee that includes findings of fact and conclusions of law. They’ll also support this with a description of the judge’s legal analysis and reasoning.
Either the taxpayer or the Administrative Hearing Section may file exceptions to the SOAH’s proposal for decision. Once exceptions are filed, the other side has 15 days to respond. The Comptroller or her designee must rule on the exceptions, and either side may file a Motion for Rehearing. If the Motion for Rehearing is denied, the decision becomes final on the denial date. Note that the Comptroller may change a judge’s finding of fact or conclusion of law, or vacate or modify an order, if they find specified types of errors.
Missing Resale Certificates and the 60-Day Rule in Texas
One of the unique rules in Texas sales tax audits involves how they treat missing resale certificates. Recall that if you make a sale of taxable items to a customer in Texas, you must either collect the tax, or a valid resale or other exemption certificate.
If you don’t have a valid certificate on file, then the Texas auditor will simply assess you the tax on the transaction. This is not unique to Texas. What is unique is that Texas gives you a specified time period to locate missing certificates. If you can get them in that time, you’re in the clear. If not, then the assessment sticks even if you get a valid certificate later.
The 60-Day Letter from Texas
Texas law requires that properly executed resale or exemption certificates should be in the possession of the seller at the time of the nontaxable transaction. Agency policy requires Texas auditors to allow the taxpayer a reasonable amount of time (depending on the circumstances of the audit) to obtain the missing certificates relating to unsupported tax-free sales before the audit is finalized.
If the taxpayer did not acquire all certificates needed within the time period allowed by the auditor, Texas Tax Code §151.0054(e) allows taxpayers sixty days to obtain the missing certificates from the date the Comptroller gives written notification requiring them. A sixty-day letter will be sent by the Audit Processing Section of Audit HQ in Austin. All certificates acquired during this time are subject to verification by the auditor.
The Sixty-Day Letter does not apply to:
- The United States government (Sec. §151.309(1)(2)(3)
- The State of Texas and its political subdivisions (Sec. §151.309(4)(5)
- Sales which are exempt by statute, such as water
- Sales which qualify for a resale or other exemption, such as bales of cotton
If you are missing resale certificates and haven’t been able to get them for the auditor by the time they submit the audit, all is not lost. But you must protest the audit by requesting a redetermination hearing. Once you make that request, the state will issue the “60-day Letter”. The 60-day deadline is fixed and unchangeable. You must absolutely furnish any missing certificates by that deadline.
Example of a typical 60-day letter
COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
September 25, 2006
Mr. Allen B. Clark, President
ABC Services, Inc.
P.O. Box 2468
Houston, Texas 77043-2468
Dear Mr. Clark:
I have received your request for a redetermination hearing on the limited sales, excise, and use tax audit performed on ABC Services, Inc., Taxpayer No. 12345678903, for the audit period April 1, 2004 through March 31, 2006. You have sixty (60) days from the date of this letter in which to submit any additional documentation to support your statement of grounds. An Auditor from Houston South Audit will contact you to make arrangements to review this documentation on the 61st day.
Your case will be reviewed by Houston South Audit, and if any relief can be granted at this initial stage you will be advised.
If we determine the issues in dispute cannot resolved by the audit office, you have the right to meet with an Independent Audit Reviewer (IAR), if you have not met with one previously. This can be initiated by notifying the auditor on or before the 61st day. If you previously met with a IAR or choose not to exercise this option, your request will be forwarded to the Comptroller’s General Counsel Division. You will be notified by letter of the name and telephone number of the hearings attorney assigned to your case.
Please do not hesitate to call Jennifer Hernandez in the Houston South Audit Office if your have any questions. You can contact the audit office by calling 713/314-5700.
1.800.531.5441 – Ext. 65872
Texas sales tax audits: The verdict
Navigating a Texas audit is tough, more so than any other state. If you want to get through one with a positive outcome, you’ll need to be prepared and know exactly what you’re up against. Because Texas audits can be so challenging, many businesses choose to work with consultants who specialize in Texas tax audits.