In most states, sales and use taxes are one of the most significant sources for funding public budgets. To combat the impact of the COVID-19 pandemic on various states’ economies, states are now looking for ways to increase their revenues. One approach is to increase the number of sales and use tax audits conducted. Unfortunately for many taxpayers, sales and use taxes can present significant areas of exposure, which can be avoided or reduced if taxpayers plan ahead.
In part 2 of CBIZ Marks Paneth’s two-part series on sales and use tax tips, we look at steps to consider during the sales and use tax audit to make the process smoother and also potentially reduce your liability. See article 1 for ways to plan in advance for a potential audit.
Read Article 1 Here
Waiver of Statute of Limitations
It has become a common practice for an auditor who is initiating an audit close to the expiration of a tax filing period to request that a taxpayer sign a statute of limitations waiver form as part of the onset of the audit. This will extend the statute of limitations and enable the auditor to complete their examination before the statute of limitations, for any portion of the audit period, expires.
TIP #1 – Taxpayers may be unsure whether they should choose to sign the waiver form requested by the auditor. A taxpayer may want to sign the waiver form if it believes there may be potential refunds that could offset the sales and use tax exposure. In addition, it may be a good idea to sign the waiver if the auditor indicates that the state will issue a jeopardy sales and use tax assessment if the waiver is not signed. A jeopardy assessment is an assessment estimating the sales and use tax that the state believes is due for the periods that will expire if the waiver is not signed. A taxpayer should avoid receiving a jeopardy assessment as these types of assessments rarely accurately reflect the taxpayer’s true sales and use tax liability.
Although auditors are supposed to determine both underpayments as well as overpayments of sales and use taxes in an audit, the auditor’s main focus is usually to determine underpayments and few auditors will isolate overpayments.
TIP #2 – Taxpayers should consider including refund areas in their sales and use tax audits if the state allows. This is advantageous since interest is typically calculated on the net sales and use tax due. An area of overpayment can be used to offset an area of underpayment within the same tax period in some states, which may reduce the amount of interest and penalty assessed by the auditor.
Note: A taxpayer may want to concentrate on determining use tax overpayments for refunds vs. sales tax overpayments to reduce the overall sales and use tax liability due on audit. This is because in most instances, overpaid sales tax will need to be refunded to the customer that was charged the sales tax in error. This can cause an administrative burden on the taxpayer.
At the end of the audit, an auditor will issue a Notice of Assessment. The Notice of Assessment will include the sales and use tax liability as well as penalties and interest assessed. Depending on the state, penalty rates can range from 5% to more than 50%.
TIP #3 – A taxpayer should request a waiver or abatement of the penalties. Most states require that the taxpayer request penalty abatement in writing and show reasonable cause for underpaying the sales and/or use tax. It may be a good idea to consult a tax advisor to determine what constitutes reasonable cause in a particular state.
TIP #4 – Develop a good working relationship with the auditor. Do not withhold information or cause unnecessary delays in responding to an audit request. The auditor will assume you are trying to hide something and dig deeper to find discrepancies and errors. It is a good idea to make the records easy for the auditor to follow and review. When penalties are asserted, auditors hold some influence over whether the assertion is upheld before the case is closed. A taxpayer who treats the auditor with respect and cooperates throughout the audit process stands a much better chance of having penalties abated.
TIP #5 – Maintain complete and accurate documentation in a manner that is easy for an auditor to follow and review. When a taxpayer cannot provide the appropriate documentation requested by the auditor or the documentation is incomplete, the auditor will assume the transactions are taxable. This will result in the auditor making historical projections or issuing an arbitrary assessment of taxable sales.
TIP #6 - Automate your sales and use tax process as much as possible. This will take human error out of the equation and improve efficiency as well as accuracy.
TIP #7 - Evaluate the taxability of the products and/or services that you sell. It may be a good idea to hire a tax advisor to prepare a taxability matrix if the taxability of the products and/or services you provide is complex.
Reverse Sales and Use Tax Audit
The goal of a reverse sales and use tax audit is to identify and recover overpayments of sales and/or use tax made to a particular state. Many auditors are so focused on finding underpayments throughout the audit process they do not focus significant time and effort on finding overpayments or refund opportunities. Therefore, it’s a good practice for a taxpayer to conduct a reverse sales and use tax audit on a routine basis either on their own or by enlisting the help of an experienced tax advisor.
The steps for completing a reverse sales and use tax audit are very similar to the steps taken in a traditional sales and use tax audit discussed above. A taxpayer should review purchase invoices for fixed assets and expenses and determine if sales tax was paid on items that are not subject to sales tax in a particular state. Once a taxpayer has identified overpayments, they can contact the vendor directly and request a refund of the sales tax paid to the vendor or apply for a refund with the applicable state taxing authority. Some states require the taxpayer to request the refund directly from the vendor while other states allow a taxpayer to request a refund directly from the tax authorities.
A reverse sales and use tax audit can be a useful tool for a taxpayer to obtain refunds on overpayments of sales and use tax. It can also help ensure that the taxpayer does not overpay sales and use tax on issues identified in the future, thereby improving cash flow.
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