A sales tax audit can be a dream or a nightmare. The deciding factor is the nature of your compliance efforts.
I recently came across a recording of Wizard of Oz in my DVR and I immediately started drawing parallels between those characters and the state tax world. Some clients are like Dorothy, i.e. thrown into a strange world (state and local tax), but willing to follow the yellow brick road on what can be a harrowing journey. Others are like the Lion, praying for courage or like The Wizard, hiding behind a curtain and making up stories to keep everything running smoothly. Let’s explore Glinda, The Wizard, and The Lion.
Glinda: The sales tax audit liaison that appears after an audit is generated
One character some customers want me to be is Glinda, the Good Witch. Yes, she isn’t as endearing as Dorothy, or as cuddly as Toto or delightfully campy like the Wicked Witch. But Glenda has her good points, including a great sense of fashion and the ability to perform magic at just the wave of her glitter-coated wand.
Even Glinda can’t make a valid audit deficiency go away. Once the tax man comes, you should be proactive to make sure the audit is conducted fairly and accurately. But if a tax bill is valid, the deficiency will not just disappear–no matter how many times you wish upon a star. The liaison makes sure the auditor has data required to perform the audit, reviews audit methodology, advocates for your tax position, let you know when there are issues, and keeps the audit moving as dictated by the circumstances of your audit.
The goal is to understand and comply with tax rules BEFORE you participate in an audit. The Wizard is actually all-powerful.
The Wizard: The person who addresses compliance before a sales tax audit is generated
Again, the key to a happy audit result is understanding your responsibilities before the auditor knocks on your door. Understanding when you should charge sales tax, when you should accrue use tax, and how contract types and invoicing affect your business is imperative. Maintaining the appropriate records is also important. Copies of your general ledger, exemption certificates, customer or job listings, sales invoices, shipping documents, contracts, purchase invoices, federal income tax returns, and bank statements are some of the records that you should retain in case you are ever audited. These documents should be clear and must be retained for entire applicable statute of limitations.
Each taxing authority has their own statute of limitations. In Texas, the statute of limitations (unless there is fraud) is four years. That means, keep your records at least that long. The normal range nationwide is three to four years. Keep that in mind as your business activities expand. Your filing status, i.e. monthly, quarterly, yearly, etc., impacts the calculation of your document retention.
The Lion: The danger of running away from the sales tax audit
One character that you NEVER want to emulate is the adorable lion. You cannot run from sales tax compliance responsibilities or an audit. There is nothing sadder than a taxpayer who receives a final bill that they cannot challenge because they chose to ignore an audit notice. If you do not give an auditor access to records and participate in the audit process, the refusal to address the situation is NOT rewarded.
The tax authority can estimate your liability. If you do not respond timely to the assessment, the estimate can become final. You can deny yourself the opportunity to mitigate an error or prove that an estimate is overstated. NEVER do this to yourself! When you get an audit notice, be sure that you understand what is happening with your audit.
While your CPA and sales tax consultant are resources, we cannot work miracles. If something is taxable, we cannot wave a wand and make it nontaxable. As business owners, you must be proactive in understanding your business and how a jurisdiction’s sales and use tax laws affect you. Your sales tax audit result, in large part, reflects compliance efforts that occur long before you receive an audit notice.
When you are adding to your lines of business, expanding into different states online, making large dollar purchases, opening locations or making renovations, remember there are sales/use tax consequences. Plan and consult with your advisors when making material purchases or changing your business. Even participation in a trade show may merit a call.
Act now! Don’t wait until a house falls on you.
For more information, visit Know if You Have A Sales Tax Issue.
For online class on completing a Texas sales and use tax return, visit Understanding Your Texas Sales and Use Tax Return.
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