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Sales and Use Tax Audits
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This manual was created for online viewing. State specific information in this manual is used for illustration and is an example only.
mail: P.O. Box 509 Eau Claire, WI 54702-0509 • telephone: 866-352-9539 • fax: 715-833-3953email: [email protected] • website: www.lorman.com • seminar id: 400363
Judy D. Harris, E.A. and Martin Joseph, CMICrowe Horwath LLP
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Sales and Use Tax Audits
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mail: P.O. Box 509 Eau Claire, WI 54702-0509 • telephone: 866-352-9539 • fax: 715-833-3953email: [email protected] • website: www.lorman.com • seminar id: 400363
Prepared By:Judy D. Harris, E.A. and Martin Joseph, CMI
Crowe Horwath LLP
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The Unique Alternative to the Big Four®
Managing Sales and Use Tax AuditsLorman Education Services
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The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2015 Crowe Horwath LLP 2
IntroductionsMartin A. Joseph, CMI
Managing Director
Direct (630) 575-4348
Mobile (815) 382-0458
Judy Harris, E.A.
Manager
Direct (630) 586-5177
Mobile (312) 342-8534
The Unique Alternative to the Big Four®
Audit | Tax | Advisory | Risk | Performance © 2015 Crowe Horwath LLP 3
Agenda
State’s Process for Selecting Sales and Use Tax Audits
How to Prepare for a Sales and Use Tax Audit
Initial Audit Meeting
Sampling Techniques
Finalizing the Audit
Appeals and Negotiations
Audit Tips
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Audit | Tax | Advisory | Risk | Performance © 2015 Crowe Horwath LLP 4
State’s Process for Selecting Sales and Use Tax Audits
Routine Audits for Large Taxpayers Generally Taxpayers that remit large sales tax dollars are routinely audited Small error can develop into large audit results
Retailers are popular targets due to large sales tax collections
Manufacturers that have high use tax amounts remitted to the state
Companies with Direct Pay Authority
Discovery from Audit Exceptions from Other Audits Popular where an exemption certificate is not allowed
Watch for duplicate collection of use tax assessed on audits where sales tax was also assessed by the Department of Revenue
Claims for Refund Common for states to audit companies after a claim for refund is filed Audit of the Claim for Refund
Audit of company sales and purchases to offset the claim for refund
If a state is commencing an audit, it is a good time to file a claim for refund
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State’s Process for Selecting Sales and Use Tax Audits
Industry Specific Very common
Gas Station Audits
Auto Dealer Audits
Banks with software purchases
Location Based Audits Popular with states that will send auditors to an area for several weeks
States that have no office or auditors in the area
3rd Party Audits Common for city audits
Examples include Louisiana parishes and cities and Colorado Cities
Multistate Tax Commission Audits MTC will perform an audit for a number of states at one time
Generally smaller states
Random
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Prepare for a Sales and Use Tax Audit
Notification of Audit States or cities may call to introduce themselves and inform you of an audit that was
assigned to the auditor on your company
Follow-up letter will be sent and should contain the following: Company to be audited
Audit Period
Auditor’s name
Supervisor’s Name
Date to start the Audit
Before the Audit Begins a pre-audit should be completed Identify sales and use tax exposure/overpayment areas
Advise management of pre-audit findings
Consult with outside tax professionals if assistance is needed
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Audit | Tax | Advisory | Risk | Performance © 2015 Crowe Horwath LLP 7
Prepare for a Sales and Use Tax Audit
Exam Areas Sales
Purchases
Capital Expenditures
Procurement Cards
Expense Reports
Retrieve Sales/Use Tax Returns Ensure all returns are available
Ensure all backup is attached Sales Reports
Use Tax Reports
Organize Exemption Certificates Test exempt sales to ensure exemptions certificates are available
Expand the test as needed
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Audit | Tax | Advisory | Risk | Performance © 2015 Crowe Horwath LLP 8
How to Prepare for a Sales and Use Tax Audit (Cont.)
Secure a capital asset report Establish a dollar threshold to retrieve supplier invoices
Significant use tax dollars are know to be collected in this area
Extraordinary events within the audit period Acquisition of a company
Divestiture of assets, division, or company
Change in ERP/other software systems
Discussion with Management Before the Initial Audit Meeting Sales/use tax exposure findings
Condition of exemption certificates
Are supplier invoices for capital assets found
How will sampling of sales and purchases be handled
Will outside assistance be needed
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Audit | Tax | Advisory | Risk | Performance © 2015 Crowe Horwath LLP 9
Initial Audit Meeting
The Day Auditor Arrives for the Initial Audit Meeting Decide who will attend the meeting An outside tax adviser may be recommended
An IT person may be necessary
The state will include the auditor, audit supervisor, and possible the audit sampling expert Many times the audit supervisor will be at the meeting of an inexperienced auditor
Audit Sampling Expert will appear when the Department of Revenue is determined to do a statistical sampled audit.
Establish Ground Rules for the Auditor A suitable workspace away from accounting/tax areas
Escort Around Building
Limitations to Certain Areas
Central Point of Contact
Establish Working Hours
Plant Tour
Dress Code
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Audit | Tax | Advisory | Risk | Performance © 2015 Crowe Horwath LLP 10
Initial Audit Meeting (Cont.)
• Discussion on the Audit• Verify the audit period
• Discuss the Statute of Limitation Waiver
• Discuss sampling methodology and sample selection
• Discuss the auditor’s approach to review sales invoices
• Discuss the auditor’s approach on purchase invoices
• Statute of Limitation Waivers• Allows time for both parties to conduct audit
• Both parties should still complete work in a timely manner
• Protects both assessments and refunds
• Refusal may lead to a jeopardy assessment
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Audit | Tax | Advisory | Risk | Performance © 2015 Crowe Horwath LLP 11
Initial Audit Meeting (Cont.) Discuss Sample Methodology Statistical
Block
Stratification
Actual Detail
Auditor should Provide Written Sample Plan Carefully review sample plan prior to signing the agreement
Ensure the tax manager working with the auditor is involved with the sample selection to ensure fair representation
Statistical Sampling Selection Process Reconciliation of control totals
Selection of GL accounts selected for testing
Statistical test of invoices for sales and purchases
Ensure the dollar strata are representative
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Audit in Process
Reconciliation of Sales State auditors will attempt to reconcile gross sales from the federal income tax return
to the gross sales on the sales/use tax returns
Will need to identify reason for the variance
Sales variance may be included as additional taxable sales
Review of Sales Invoices Auditor will use the stratified sample of sales invoices pulled for review to determine if
sales tax was properly invoiced
Auditor will create schedules of audit exceptions where sales tax was not charged on the invoices
Auditor will request exemption certificates to be provided to substantiate the exempt sales
May need to contact customers to request exemption certificates or XYZ Letters XYZ Letter is a document provided to customers asking the status of sales to the customer and
to indicate whether sales are exempt, taxable, use tax remitted, or any other situation
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Audit | Tax | Advisory | Risk | Performance © 2015 Crowe Horwath LLP 13
Audit in Process
Review of Purchases Traditional - Capital Asset Purchases Auditors will request a detail report of capital asset additions for the audit period
Auditor will request capital invoices to be retrieved and provided
Auditor will inquire on the capital asset purchases with no sales tax
Taxpayer will need to determine whether the capital asset purchases are exempt Qualify for the manufacturing exemption
Installed in another state
Labor component not taxable
Nontaxable software/license
Use tax self assessed
Auditor will provide schedules of capital asset purchases without tax and cannot be substantiated as an exempt purchase
Traditional – Consumable Supply Purchases Auditors will create a sample of Accounts Payable purchases
Auditor will pull invoices from the sample
Auditor will create schedules of the invoices found with no sales tax
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Audit in Process
Auditor will request and require Taxpayer to determine and substantiate the purchases without tax Qualify for the manufacturing exemption
Installed in another state
Labor component not taxable
Nontaxable software/license
Use tax self assessed
Auditor will provide schedules of capital asset purchases without tax and cannot be substantiated as an exempt purchase
Statistical Sample of Accounts Payable Purchases Auditor and state’s sampling expert will present a list of invoices to be retrieved that will be have
4 or 5 dollar strata
The strata with high dollar values will have lower projection factor
Invoices for each of the strata will need to be retrieved by either the auditor or Taxpayer
Auditor will request and require Taxpayer to determine and substantiate the purchases without tax Qualify for the manufacturing exemption
Installed in another state
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Labor component not taxable
Nontaxable software/license
How to handle extraordinary purchases
Use tax self assessed
Auditor will provide schedules of capital asset purchases without tax and cannot be substantiated as an exempt purchase
Audit Field Work is now completed Request a meeting with the auditor and audit supervisor , if necessary, secure hard and soft copies of the
audit schedules
Discuss the timing of response to the auditor to substantiate the audit exceptions for sales and purchases
Discuss and understand how the sample exceptions will be projected
Discuss how to handle missing invoices in the sample selection
Discuss how to handle missing exemption certificates
Determine if an outside tax consultant is required to secure exempt documentation and find approach to substantiate exempt transactions
Execute any necessary waivers to extend the Statute of Limitation
Set a final meeting date to present all final documentation
Audit in Process
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Audit in Process
Final meeting with audit Present exemption certificates on sales exceptions
Present use tax information on purchase exceptions
Present other documentation required by the auditor
Determine if the audit will be agreed or unagreed
Ensure all audit schedules are secured from the auditor
Ensure waivers to extend the statute of limitations are updated
Ensure Taxpayer understands the auditor’s position on the unagreed amounts.
Ensure auditor understands Taxpayer’s position on the unagreed amounts
Request penalty be waived at the audit level
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Appeals and Negotiations
Jeopardy Assessments
Using External Assistance
Protest
Informal Hearings
Board of Appeals
Formal Hearings
Circuit Court
Appellate Court
State Supreme Court
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Audit Tips
How to Handle Missing Invoices
Removing Extraordinary Items from Sample
Projecting Refunds by Including in Sample Procedures
Privilege Tax States – Purchaser Not Responsible if Vendor Did Not Charge
Speaking with Next Level Above Auditor on Gray Issues
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Audit | Tax | Advisory | Risk | Performance © 2015 Crowe Horwath LLP 19
Crowe Horwath LLP is an independent member of Crowe Horwath International, a Swiss verein. Each member firm of Crowe Horwath International is a separate and independent legal entity. Crowe Horwath LLP and its affiliates are not responsible or liable for any acts or omissions of Crowe Horwath International or any other member of Crowe Horwath International and specifically disclaim any and all responsibility or liability for acts or omissions of Crowe Horwath International or any other Crowe Horwath International member. Accountancy services in Kansas and North Carolina are rendered by Crowe Chizek LLP, which is not a member of Crowe Horwath International. © 2015 Crowe Horwath LLP
Sales and Use Tax Audits
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Notes