State tax audits are on the rise. If you haven’t had this happen to you yet – just wait – and plan on it. Posted by Guest Contributor: Sam Hodges
Posted by Contributor on Apr 28, 2011 | 5 comments
You receive an inconspicuous-looking letter with your state’s seal, small but visible in the corner. Addressed to you. Oh – and you didn’t think anyone (let alone your home state) would be interested in you – but here it is: you are the lucky recipient of an audit notification. After your heart calms down a little, and your mind clears (a couple of good deep breaths do help) you read more, and realize they want this experience to take place in your office – IN BROAD DAYLIGHT! [At least your doctor has the decency to do it in private, with curtains and a paper gown.] AND it will cover several years!!! After you regain your composure (and dust yourself off if you fainted) you should call you accountant(s) and break the news.
All but a handful of states are running deficits – and not minor ones. So what exactly does that mean for everyone involved in an audit?
If you are an elected state official: We must provide services to the public (so I can get re-elected), so why should we allow our revenue numbers to go down? Why don’t we have all of OUR revenue? We must get all of the revenue owed to us!
If you are a seasoned auditor: Oh boy. Here comes company X again! Didn’t someone just audit them and find big $$$? I sure hope the previous auditor left something on the table for me to find. I’m ready… here they come… (smile) … blah blah blah blah blah… lies … lies … lies … lies …. lies…
If you are the taxpayer: Oh, I sure hope they don’t look under that rock. I thought we did it right when we first looked at it, but now my @#$% accountant says it was wrong. I just know they are going to find it and it is going to cost us. I wonder what the auditor meant by “extrapolate the results over 36 months”???
While the above thoughts may go through your mind, you must always go into the audit armed with facts and fully prepared. Here are our TOP 3 RECOMMENDATIONS, and examples of what not to do, based on some of our more recent audits.
1. You should not try to do the audit yourself. Too many times we have seen taxpayers try to save some money and handle an audit themselves only to find out they were in way over their head. The taxpayer has one chance to make a good impression, to explain something correctly and to gain the auditor’s trust. While you may think back-tracking or being vague is a way to protect yourself, it’s not. Any attempt to correct a previous statement that may have been in error or misunderstood will more than likely be interpreted to mean you changed your mind because you thought the auditor saw something that might be taxable, or the auditor’s posture or apparent increased interest or worse. You completely lose all credibility; the auditor thinks you may know your business but you don’t know what you’re doing regarding taxes, and will begin to question everything you said.
The auditor’s mind is like a train at the station. Based on what you say and what they hear and interpret, they start down a track of understanding. It is extremely hard, if not impossible, to back the train up and change tracks. Taxpayers MUST get professional help from the beginning. With this type of professional services, quality does not cost – it pays.
2. Get the auditor and the records out of your office and away from your business. You have a business to run. You don’t want the disruption and the distraction that will take place throughout your company. The rumor mill will be working overtime and you need to control both the information and the message being delivered. Taking the audit off-site will allow you to control the message and the ‘understanding’. If you let the auditor camp-out and have free reign, they will find something.
3. Treat the auditor with respect. We have been called into situations where the taxpayer tried to handle the audit himself. Problems arose when the owner meant one thing, but said the wrong thing. The auditor and the owner exchanged a few more words; the nervous owner unleashed some expletives that would make a sailor proud, but unfortunately didn’t impress the auditor. Subsequently, the owner threw the auditor out of the office and the auditor stated “I will be back with a jeopardy assessment just for you!” How hard do you think it was for us to back that train up? You can always respectfully agree to disagree and ask for the statutory or case law in support of one position or another. We have seen some of the most absurd positions being taken by States; some justifiable and some not, like one comment heard recently: “How do I know _ _ _ _ (a big three automaker) is a manufacturer?” If your discussions with the auditor get tense, requesting information requests and positions be in writing is always the wise answer.
There is only one Internal Revenue Code with the federal income tax. There are 50 states (not 57 states as some politicians might think) and each state has at least one tax (and some as many as seven different taxes, not to mention the local cities) and each and every week changes are made. There is absolutely no way someone can keep track of everything! So, do your best – get help, don’t make the same mistake twice and don’t lose sleep over it. Your next audit letter is already on its way…
Sam Hodges & Associates (it’s the ‘Associates’ that count!) is a consortium of former professionals from the Big 4 and national accounting firms, industry and State Departments of Revenue. We specialize in all areas of State and Local Tax (income/franchise, sales/use, real/personal property, credits/incentives), Transfer Pricing, Fraud/Fraud Prevention and more.
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It’s not just the States that are getting aggressive. It’s been my experience that local jurisdictions are even more aggressive that the States. Not only are they targeting the usual big dollar suspects (use tax on fixed asset purchases) but they are also targeting everything from making sure that you paid use tax on inserts you include in your bill.
The other issue is the “seasoned auditor” is becoming a rarity. Auditors with less experience are hitting the field and they spend hours on end chasing pennies rather than targeting the big dollars and moving on. We are in for some interesting times.
The CO local jurisdictions are extremely agressive with the LA parishes next in line.
I was in a CO city’s tax department in mid 2008 and we were informed in a meeting that we no longer were expected to audit for compliance and the goal from that point on was to generate as much revenue as we could.
We were encouraged to apply tax on anything we could especially if the taxpayer could not produce a receipt proving they paid any tax at all.
Thanks for sharing, Sarah and Michael. We have been hearing this across the jurisdictions. Cash hungry states and localities…
Thanks for the comments, Ed! We have been hearing similar feedback on the aggressive nature of localities. Also, we have a lot of clients who actually track Purchase Order information and attach the PO and other documentation associated with their fixed asset purchases for this very reason.
On the audit experience, there seems to be some resounding agreement that the lack of experience is dragging folks down and putting inordinant amounts of pressure on tax departments. There are many jurisdictions that are even using 1099′s to supplant their field agents. Quite interesting.