I’d like to talk next about how Sales Tax audits work. Sales tax audits are one of the areas that most practitioners and a lot of clients are probably most confused about. Whereas income tax audits are fairly precise, sales tax audits are based on variety of data and are calculated by much different means. What I mean by that is when you have a sales tax audit, there is a variety of data that you can use. It’s gross receipts, calculation from sales registers. You can use bank statements, you can use merchant accounts. All of those factors in the gross sales, plus you have the x-factor in a sales tax audit of potentially having unreported cash sales.
With the income tax audits, it’s fairly precise. As you earn money that money should appear on a bank statement and be deposited. There is the potential that you have under reported cash, but it’s not as great as in the sales tax in it. It’s usually less of a problem.
Briefly, I want to talk to you a little bit about the flow of how sales tax audits work on the state level. What happens is Sacramento designs that a group of cases are eligible for sales tax audit and they send those cases to the district level. The district then makes a determination on which cases it would like to audit. It assigns those cases to an audit supervisor who dishes them out to independent auditors. When the independent auditor gives the case, the first they do is review the case file to make sure that they have all the information and that the data that they are receiving is accurate.
The auditor does kind of pre-audit report, which is not seen by the taxpayer but it’s kind of a review of what information the board of auditors have on file. What information is attributable to other sources and how that sort of matches out. Your auditor then makes a phone call to the client or sends an initial letter saying, “Hey, congratulations you’ve been selected for a sales tax audit.”
At which point once the client make the return contact with the auditor, they decide on a plan for the audit. They have a pre-audit meeting to get any audit issues out of the way and discuss those issues prior to the case. Those can include the production of documents. It can include challenges in the client schedule or in the auditor schedule. It can include any other issues that need to be addressed prior to the audit actually starting.
After the pre-audit meeting, there is usually a gathering of documents of some sort or production. Although, occasionally you’ll have an initial meeting with just some questions or kind of an interview style, but then that kind of leaves away for the opening conference. The opening conference is kind of initial disclosure and production of information to the board.
The Department of Tax and Fee Administration will generally look at the information after the opening conference. The Department of Tax and Fee Administration will take the time to go through with the taxpayer. After the opening conference, they’re depending on the issues that are at stake, issues needing some follow up. Issues of some back up between the Department of Tax and Fee Administration and the clients or the representative. At that point, what happens is after the auditor has concluded their work after they get through the audit, they will create a report. They will schedule an exit interview with the client to go over the report and the determinations of their findings.
If the auditor and the client agree, then case closed, it goes to Sacramento for any billing. If the auditor and the client don’t agree, then it goes to an appeals or protest stage to get resolved. That’s kind of how audit work in a nutshell. At theDepartment of Tax and Fee Administration level. In reality, they’re actually much more complicated than this a bit more back and forth. But at least you have an idea how the general procedure goes.
With sales tax audit, one the key mistakes that people make is the over disclosure of documents. Sales tax audits, because they are so speculative so to speak, meaning there is a lot of different ways that you can arrive at the same conclusion. The auditor will have a general tendency to ask for more information than they actually need. This is a very important practical component for practitioners and clients like to be aware of. Whereas the typical play and income tax audit is to give the auditor everything under the sun in order to exonerate your client, with a sales tax audit, you need to be very careful about the information that the auditor is being provided.
The more information that the auditor has more likely that they are to find something that could potentially hang the client. You want to be careful number one, about the volume of information you’re producing and number two, how that information relates to other information you have on file. An example of that is if you file federal income tax returns that do not match your sales tax returns.
The auditor is going to catch the fact that the data that was reported to the IRS doesn’t match the data that was reported to the Department of Tax and Fee Administration and that’s going to create a discrepancy. Rather than having the auditor catch you in that discrepancy, the more prudent way to do it is to examine all the data, examine the federal income tax returns, the sales tax returns and make sure that information matches ahead of time. Speaking from a tactical level, there are two ways that an audit can go and this is going to seem really silly but it has a very important practical component in it.
When doing a sales tax audit there is going to be one of two resolves. You’re going to have a change whether that is an increase or decrease in the amount of liability that is owed or you’re going to have a no change. The border requisition like most agencies is under constraints and they have a limited amount of resources to handle the cases that they do. You have an auditor and the auditor is handling anywhere from 30 to 50 cases at any given time and the auditor is essentially charged with investigating the proper tax liability, making a determination and moving on.
In situations where you have a client with good records, you can facilitate the presumption that the audit is going to be no change quickly and easily. If you are organized and can steer the auditor in the direction of a no change and make sure that your initial document disclosure to the auditor alleviates the concerns of the auditor and that everything matches up and doesn’t open up any new concerns then what will happen is, you can usually end the audit pretty quickly. The best time to take the shot is right at the beginning.
In the initial audit meeting or the opening conference, you want to suss out any issues that the auditor is particularly skeptical of and then you want to address those issues as completely as you can, so that the auditor will then turn their attention to better cases. Silly as it seems, the job of a practitioner and a sales tax audit is not to fight back and forth with the auditor. Rather the job of the practitioner is to help the auditor write the report and get the result that the client wants.
Essentially, you are facilitating the auditor’s job at writing the report and getting the audit off their desk and the more information that you can provide to substantiate the auditor’s findings hopefully, in the favor of your client the better service you’re going to give your client.
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