U.S. Sales Tax Audits
Content provided by tax veteran Greg Anderson
No sales tax audit is fun, but, with some understanding of the process and proper planning, the experience can be more efficient and less costly for your organization (the taxpayer). In addition, using the audit results to improve the accuracy of the use tax accrual can help reduce any tax inefficiencies in the current process. The content below explains four points to consider as you prepare for the next sales tax audit of your P-Card program:
Understand the auditor’s job
Explain your [tax compliance] process to the auditor
No assessment does not mean your work is done
Do not make the same mistakes twice
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About Greg Anderson
Greg Anderson is a partner with Application Design Resource, LLP (ADR) and has over 20 years’ experience assisting clients implement tax management processes in P-Card programs.
1. Understand the Auditor’s Job
The auditor’s job is to make sure your organization accrues the correct amount of use tax on taxable purchases for which the supplier has not collected sales tax. (Access the tax introduction page for background about the requirements.)
Determining the Audit Time Frame
The auditor will begin by establishing the time period for which P-Card transactions will be subject to review—generally the state’s statute of limitations period. While each state is different, most range from three to five years.
Selecting a Sample to Audit
Given there will likely be thousands of purchases made during the audit period, the auditor will select a sample of transactions to review. This may be a block sample from a fixed period (e.g., one month) or a random sample.
Reviewing Purchase Documentation
For each purchase in the sample, the auditor will review your documents or reports to substantiate the collection of sales tax by the supplier or your organization’s accrual of use tax. Most commonly, documentation is either the original receipt or an imaged copy.
Calculating and Assessing Unpaid Tax
A tax assessment to your organization will occur if the auditor cannot find documentation of either the payment of sales tax or the accrual of use tax; for example, if receipts or images are not available/missing or no longer legible because of mishandling or fading.
To calculate the assessment amount for the sample, the auditor will multiply the applicable rate by the transaction/purchase amount. Then the auditor will calculate and apply the error rate to the entire population of purchases; this is what your organization will owe. The auditor may also apply interest and penalties, thereby increasing the amount owed.
2. Explain Your Process to the Auditor
Organizations with a Process
If your organization has a process, whether automated or manual, to regularly and consistently initiate the use tax accrual, the auditor can justify taking a smaller sample of purchases over a smaller, more recent period. The auditor will review how your organization makes the tax determinations and the tax reporting generated by the process. If the auditor is satisfied with your process and reporting, he or she will take a small sample to confirm the adequacy of the documentation.
Organizations without a Process
The sales tax audit will be more difficult if your organization does not have an established tax compliance process for the P-Card program. The auditor’s only option is to work with a larger sample and request hundreds of receipts for the full statutory period. This can be frustrating and time consuming for both the auditor and your organization. Receipts from earlier periods may be stored offsite; physical receipts may have faded; the older the transaction, the more likely a receipt will be missing; and the volume of receipts requested can significantly increase the time required to complete the audit. Larger samples may also include more errors, which increase the amount of the assessment.
Not having a regular, consistent process for managing sales tax compliance for your P-Card program takes your organization down a slippery route.
3. No Assessment Does Not Mean Your Work is Done
If the auditor does not issue any assessment, it is likely that your organization is overpaying tax and unnecessarily increasing the cost of the P-Card program. Tax over-payments can occur for a variety of reasons; for example, if an organization excludes transactions with in-state suppliers, but pays use tax on the rest. While this approach sounds logical, suppliers are increasingly collecting sales tax in more states, so you might be overpaying. To check for this, take a sample of transactions and compare the documentation of sales tax collected by the supplier with your use tax accrual documentation.
4. Do Not Make the Same Mistakes Twice
While very few people enjoy a tax audit, the audit results can be a valuable contribution toward making your program more tax efficient. When the audit is over, take some extra time to review the findings and make corrections to your process. If assessments were made, make sure accruals are made on those purchases going forward. If over-payments were found and your organization was accruing use tax on transactions where the supplier was already collecting sales tax, make sure those over-payments are not being made in the future.