You did not ask for it, but you have been selected to undergo a sales tax audit. You immediately ask yourself, “What should I do?”
Many organizations are not familiar with the sales and use tax audit progress since most are lucky enough to not have been audited by a state for sales and use tax. While the requested lists of records and documents that will be reviewed appear straightforward, there is much more to preparing for the sales tax audit process.
Here is a list of potential pitfalls that you should be aware of during your interaction with the auditors.
What you need to know about sales and use tax audit procedures
Each state is different in the way they conduct their audits so it is important to be aware of the audit procedures and scope of the audit from the very beginning.
Be prepared. Before the initial “kick off” meeting with the auditor, it is wise to review your company’s internal sales and use tax process, identify any potential areas of risk and assign a point person to lead communications throughout the audit. You can assign your CPA, a sales tax expert or other external advocate to represent your company as they should have a good understanding of the audit process and can help guide you through each step. During the auditor meeting, it is acceptable to respond with “I will need to get back to you” if you do not know the answer or do not feel comfortable responding. Some auditors are good at asking leading questions, so be confident in your responses and do not guess.
Understand the auditor’s role and set expectations. The auditor’s overall directive is to identify under-reported sales and use taxes, and close the audit as quickly as possible. But in reality, the audit could take several months because auditors are often handling multiple audits for various companies and also need to report to a senior auditor for guidance. Always question why an auditor is requesting a piece of documentation before you invest resources in the request. It may not be necessary. Make sure to thoroughly review the auditor’s work as they can frequently make mistakes in calculating the sales tax liabilities that could potentially be assessed to the company
Auditor or industry experience is beneficial. External advocates or sales tax experts have typically been involved in other sales tax audits and might have possibly worked with your assigned auditor. They can bring experience from an industry perspective and can quickly navigate through the gray areas by accessing relevant private letter rulings and/or updated case laws. Another advantage to engaging a sales tax expert is they can identify other areas not considered by the auditor to assist the company, such as potential tax overpayments. Credits can be used to offset the liability owed or ultimately result in a refund due to the company.
Settlement authority. A company may not be aware of internal policies establishing the amount of tax that can be conceded by the auditor or the supervisor to secure a fully agreed case.
How to handle proposed adjustments after sales and use tax audit
If the actual sales and use tax audit results in significant proposed liabilities, then you may be compelled to now engage an external professional representative. There are many potential challenges to overcome at this point in the audit:
- The auditor believes the audit is complete and may be reluctant to invest more time to address the issues.
- The auditor might have made concessions during the discussions about the questioned transactions that may not be documented in the report detail. The external representative may not be aware of those discussions.
- The external representative may identify new or additional facts that were not presented to the auditor or were not entirely accurate explanations.
- The auditor may not want or be allowed to include offsets at this stage in the audit. The auditor may want to refer those refunds to an office auditor for review. This can take more time, and there may be an interest rate differential between assessment interest and refund issues in some states.
Tips to manage your sales and use tax audit process
The following are some best practices to consider when going through the sales and use tax audit process:
- Communicate with your CPA, a sales tax expert or other external representative when you are identified for audit. They can discuss the audit process with you, provide some background on various sampling methods and provide insights on specific industry issues targeted by the state.
- Maintain documentation and records of communication should you need to refer back to prior correspondence and for audit integrity.
- Even if you are handling the initial audit preparation internally, communicate with the external representative as schedules are shared so they are aware of the initial schedules vs. revised schedules.
- Evaluate whether it is appropriate to perform a refund study/ reverse audit at the same time to identify potential opportunities for refunds.
- If you opt to use a third party for the preparation and actual audit, make sure you understand the scope of their work and how they will be compensated.
- Do not engage in contingent fee arrangements on questioned items by the auditor unless you have already made the first pass. Otherwise, you may be paying them on reductions for errors made by the auditor or obvious exempt transactions.
- If they are doing a refund study/reverse audit, the fee should not be based on savings in periods outside the audit period. Their fee should always be based on offsets actually granted by the state. Payment should be made at the end of the audit, or a provision should be included to reverse any offsets not allowed.
- Understand whether their services are included only at the audit level or whether services related to appeals or tax court are included.
- Understand their specific experience with your specific state and your industry. Ask for references.
How Wipfli can help
The sales and use tax audit process is not an ordinary occurrence. Our team has deep experience in assisting companies undergoing state sales and use tax audits as well as conducting overpayment reviews. Learn more about our sales and use tax audit services on our audit and accounting services web page.