Sales tax audits are on the rise in most states. This is due to budget shortfalls of states across the country. In fact, state auditors are much more aggressive than the auditors at the IRS. The state has the power to do massive damage to a business as a result of a sales tax audit, including arresting the owners of the business.
Fear the state, even more than the IRS.
What Triggers Sales Tax Audits?
Many businesses handle their own sales tax compliance. Most of them do it wrong, failing to match sales on the sales tax returns with receipts on the federal returns, bank deposits, or sales on their Point of Sale (POS) system. If the business fails the matching process that many states use, the resulting error message will automatically trigger a sale tax audit. That is how the states picks its audit targets.
CPA Tip: Show your sales tax returns to your CPA before the income tax returns are prepared, so that discrepancies can be corrected in advance, thereby avoiding a sales tax audit.
Sales tax auditors often calculate sales subject to sales tax based on a mark-up percentage applied to purchases. These percentages can be based on outdated purchase prices, or they can be totally fictitious. This can result in an enormous bill for under-reporting of sales tax, plus interest and penalties.
Alternatively, the auditor may use a mark-up percentage that is based on industry standards that may not reflect where the the business is located or the actual scope of the business. Or the industry standards used by the auditor could be out of date.
CPA Tip: In the event of a sales tax audit, confirm that the mark-up percentage used by the auditor is reasonable for the specific type of business, for every year under audit.
Statute of Limitations
To make matters worse, the state auditor can impose tax for many years, depending on the particulars of the state’s statute of limitations. Every state has its own rules.
In Georgia, the state has three years to audit, from either the sales tax return due date or the return filing date (whichever comes later). However, in the case of a false or fraudulent return, or a return filed with the intent to evade sales tax, or a failure to file a return, a sales tax assessment may begin at any time.
In Illinois, the state has three years to audit, from the time when the taxable gross receipts were received. However, there is no statute of limitations when there is failure to file a return or a fraudulent return.
This means that, in Georgia or Illinois, for example, a sales tax audit based on inflated mark-up percentages can cause the taxpayer to appear to be fraudulent, even if they are not, allowing the auditor to go back many years. This threat can destroy a business.
What to Do After the Audit?
Always appeal a sales tax audit. Photos and videos of the business and of what is being sold are often your best defense. By thinking both strategically and creatively, a sales tax audit can often be settled for a fraction of the original bill.
CPA Tip: It is easier to settle your case at Appeals. Generally, the Appeals Officer is more reasonable and open to re-evaluating evidence than the field auditor.
And while the case is in Appeals pending a settlement, it is often possible to negotiate an Offer in Compromise to further reduce the amount of the tax to be paid.
If you have an issue with the IRS or the state Department or Revenue, please contact us at (678) 235-5460 or (773) 828-0551. Or you can reach us by email at Gary.Massey@masseyandcompanyCPA.com. Our services include tax return preparation, tax planning, tax debts, past due returns, federal and state audits, sales taxes, offers in compromise, installment agreements, innocent spouse relief, accounting and bookkeeping. We make the tax nightmare go away.
Massey and Company CPA is a boutique accounting firm located in Atlanta and Chicago, providing tax and accounting services to small businesses and individuals in Georgia, Illinois and in states throughout the country.
Learn about us at Massey and Company CPA.