Not understanding the sales tax audit process can add to the stress of the ordeal. But not knowing how (and when) to work with the auditor can lead to over-inflated assessments.
So, here’s everything you need to know about the audit process to reduce the cost to your business.
The audit process consists of 4 basic stages. We’ve already discussed the first two stages: the pre-audit and selection of sampling methodology phases. In this chapter, we’ll review the third and fourth. The third phase is when the actual fieldwork and auditing happens. The fourth, and final, phase is the post-assessment period where you decide if and how you will appeal the assessment.
Stage 1: The pre-audit
Stage 2: Selection of sampling methodology phases
In this chapter, we’ll review the third and fourth.
Stage 3: Fieldwork & auditing
Stage 4: Post Assessment Period
This fourth, and final phase is where you decide if and how you will appeal the assessment.
The audit actually starts before the fieldwork begins. Let’s review the PRE-audit process, and what you can expect.
The preparation stages of the audit are vital to ensuring your success during the fieldwork phase. The Audit Coordinator (AC) should have already had a pre-audit conference with the auditor as we discussed in Chapter 1. In that pre-audit conference, you set the date for the first on-site meeting when the field work begins. The auditor will have given you a list of records they will need to begin the audit. The AC should be there to make sure the records are available and answer the auditor’s questions promptly and accurately.
First on-site meeting with auditor
This first meeting is extremely important, as it sets the tone for the remainder of the audit. The goal in the early stages of the audit is to take steps that will help you gain some control over the audit process. Don’t expect to have complete control, but if you’re cooperative, professional and knowledgeable, things will go smoother. Taxpayers who appear disorganized or uninformed about state laws at the initial meeting can create a negative impression that persists throughout the audit.
Review resale certificates
If you are a seller of goods and you sell to exempt purchasers, you usually have to bill the tax or collect a certificate in lieu of the tax. An auditor will test your sales to see if you have the proper certificates on file.
A lack of exemption certificates often results in large assessments by tax authorities. Depending on the time period sampled, missing just one exemption certificate could result in thousands of dollars of taxes owed.
One way the AC can mitigate this is by coming to an agreement with the auditor about what to do if they discover missing exemption certificates. You should be granted a reasonable timeframe to collect the exemption certificates.
You can learn everything you need to know about Resale Certificates from this great guide by We Sell Cellular.
Be careful what you sign
During a sales tax audit, you can expect to sign a lot of forms. These include statute of limitation waivers, sample agreements, receipt of documents and agreements to proposed assessments.
These are complex legal documents. If you don’t know what you are signing, get help from someone who does. The auditor will do some minimal explaining, but they often don’t feel it’s their responsibility to tell you. They may not even know all of the possible implications and ramifications of these documents.
In most cases, once the document is signed, it can’t be rescinded.
Signing a sampling agreement without knowing what it means or what the outcome could produce may end up costing you thousands of dollars in tax. You can minimize your exposure by conducting due diligence before you sign every document.
Negotiating with sales tax auditors
We’ve seen two extremes when it comes to dealing with auditors. Some people are overly intimidated while others are ready to battle over every adjustment, no matter how minor. Neither extreme will result in successful negotiations for the taxpayer. The best approach is to adopt a middle-of-the-road strategy.
To get a favorable audit, you have to be assertive in claiming the rights you do have. If an auditor senses you don’t know the procedures, they are likely to cut corners in performing the audit and you won’t get the best results. However, sometimes people get fixated on things that won’t make a bit of difference to the bottom-line result. There is a fine line there. Be tough about things that matter.
Finally, the auditor addresses the final scheduling items on which he/she feels tax should have been paid but was not. Often, there will be outstanding items that would be questionable if you could find the appropriate documentation. You may be missing some resale certificates or proof that tax was paid. You will have time to obtain this missing documentation before the auditor “turns in the audit for processing.”
An auditor is usually highly motivated to get the audit in for processing. This can be to your advantage. It may be that the State’s fiscal year-end is approaching, or their manager or supervisor is requiring that they turn it in soon.
Sometimes deadlines are good in that an auditor may be willing to accept less documentation if they feel it would help resolve everything sooner.
If you need extra time to obtain documentation, be sure to ask for it. An auditor will always tell you about the appeals procedure and will usually try to “just agree to disagree” on the remaining items. However, it is our experience that it’s best to get things solved before the audit is turned in.
Audit process FAQs
It is up to the AC to provide alternatives or ask questions concerning the necessity of requested documents. Most taxpayers usually share the following without too much protest:
- Federal and state income tax returns
- Sales and use tax returns
- Worksheets used to prepare returns (be careful about the depreciation schedule)
- Reconciliation schedules
- Source documentation such as invoices, register tapes, contracts and other records
- Exemption certificates, product descriptions, contracts and other information supporting an exemption
Auditors usually request more information than they actually need. There are some things you should not give them, especially at the beginning.
One of the documents you shouldn’t give to the auditor is the backup to the depreciation schedule. The reason for this is that schedule usually has rounded and combined figures. The auditor doesn’t need this document because they have the source documents that feed this schedule. If they get this schedule and start assessing the amounts there, it can be very difficult to get them removed later.
It’s also important to remember that the auditor shouldn’t have personal information about customers or proprietary information about the company. Similarly, an auditor rarely needs an entire contract. You typically only need to provide a limited portion of the contract.
Thinking through the necessity of each document before sharing will keep unfavorable figures off the record without impeding the audit.
Setting aside a dedicated office for the auditor isn’t necessary. But, in our opinion, the auditor should have a specific workspace. Preferably away from company employees other than the AC.
Larger companies sometimes have office space permanently set aside for auditors. This is because it is common for larger companies to have the IRS and one or two state auditors in the office on a nearly full-time basis.
For companies that don’t have a spare office, other possibilities include the auditor’s office, or the taxpayer’s CPA or attorney’s office.
It’s also worth noting that entertaining more than one auditor at a time should be discouraged, particularly among smaller companies that lack a large or sophisticated tax staff.
The auditor may request a tour of the premises, particularly if you are a manufacturer. Plant tours often clarify technical issues, and usually they are helpful. But they can also raise additional questions.
If the auditor asks for a tour, the AC should schedule a time, arrange for a guide (typically a technical person, such as an engineer) and the AC should take the tour in advance. This will allow the AC to educate the employee acting as the guide on potential tax issues. The same guide, and the AC, should then accompany the auditor for their tour.
The AC should have a preset schedule of meetings with the auditor. We do not advise that you position yourself as a “regularly available” person for the auditor to drop in and talk with. The AC’s schedule will dictate the meeting times. Typically, a scheduled meeting in the morning, early afternoon and end of day for 10 to 15 minutes per meeting will suffice.
Important meetings, like the initial onsite meeting and audit closing meeting should be attended by two company personnel if possible. It is important to have a second person there for purposes of verifying auditor comments, and for completeness in asking questions.
Audit process: Bottom line
The fieldwork stage of the audit is where your sales tax liability assessment happens. The decisions you make here could hurt or improve your verdict. If you’re not confident with your experience in dealing with this type of issue, we recommend bringing in an expert to help.