From a tax revenue perspective, many states have done well during the pandemic. Now, however, with supply pressures and inflation concerns, states are anticipating a significant reduction in sales tax revenue.
States become aggressive
Sales and use (sales) tax audits are an easy way for states to address lost revenue. New York (which has experienced a revenue shortfall during the pandemic), California and Ohio are already increasing the number of sales tax audits. And these states are aggressive.
For example, in a decision handed down at the end of last year, In re LendingTree, Inc. (NY Div. of Tax App. ALJ Unit, DTA No. 829714, December 9, 2021), Upon audit, the New York Department of Tax and Finance (the Department) determined that the petitioner owed more than $3.7 million including taxes and interest. and penalties. The Department asserted that LendingTree sold taxable information services. On appeal, an administrative law judge (ALJ) ruled that LendingTree’s online loan marketplace service was not a taxable information service, but a service that connected a borrower and a lender leading to a loan . Simply put, it was a non-taxable service.
Why did the department pursue the case? Was it just aggressive? In two other recent ALJ rulings on New York sales tax related to information services, the department also lost. [See, In re Lender Consulting Servs., Inc. (N.Y. Div. of Tax App. DTA No. 829198, Dec. 2, 2021 and In re IT Works Marketing, Inc., N. Y. Div. of Tax App., ALJ Unit, DTA No. 829134, December 30, 2021.]
Another example is California’s decision to send letters to Amazon sellers saying they could owe years of uncollected sales taxes and could be subject to audits unless they come forward. of how aggressively states pursue tax collection.
Errors, errors, errors
States pass sales tax audits because businesses make mistakes in calculating sales tax by using incorrect rates. As many as 500 rate changes across the United States take place each year.
Moreover, the Wayfair The decision and its implications mean that businesses must now collect sales tax in several states where no previous obligation existed. For some, this has created an overwhelming burden of sales tax compliance. Another error-prone area for taxpayers is obtaining and tracking exemption certificates.
Booming Audit Areas
As the volume of state sales tax audits increases, the following areas are particularly sensitive:
- Information Services
- Office fittings
- Credit card purchases without invoice backup
- In-state commodity sales through market facilitators
- Link to Remote Seller Sales Tax
- Sales tax exemptions (missing, incomplete, inappropriate and overused)
How to Mitigate Sales Tax Exposure
How can your business reduce its exposure to sales tax? Here are some recommendations.
Before the Audit:
- Determine the states where your business is exposed. A study of the links is essential.
- Consider voluntary state tax disclosure programs available in states where the link exists but returns have not been filed. These programs allow taxpayers to report anonymously and eliminate certain prior year tax exposures and penalties.
- Assess the taxability of the products or services your business sells, especially if they relate to complex areas of sales tax. Prepare a tax matrix in the states in which you provide products or services.
- Compare the gross sales reported on your sales tax returns to the gross revenue reported on your federal tax returns. Be prepared to explain any discrepancies. Also, compare sales reported on sales tax returns to sales reported in the general ledger to determine if there are any discrepancies.
- Keep and have at hand all purchase invoices. If you use company credit cards to regularly purchase expenses, keep receipts for purchases made using the credit cards.
- Review the retention status of your company’s resale and exemption certificates. Obtain missing certificates and verify that those obtained are completed, dated, signed and valid. If not, contact reseller or exempt customers and request replacement certificates. Also, establish a policy to review these certificates on an ongoing basis, even when the company is unaudited.
- Don’t go alone. The experience and knowledge of a seasoned tax professional is invaluable. Negotiate the choice of trial period with the auditor, especially if your company has made improvements to its use of tax processes or record keeping. In these cases, ask the auditor to review the most recent periods. Remember that an error rate derived from the test period will be extrapolated over the entire audit period.
- When an auditor finds that use tax has not been paid on a large one-time purchase and includes that transaction as taxable within the sample period, requests that use tax be assessed on that large single transaction separately from the rest of the sample. This will potentially reduce the overall extrapolated sales/use tax liability.
- If taxes and penalties are imposed, request that the penalties be reduced. Most states require the taxpayer to request a penalty reduction in writing and show reasonable cause for underpaying sales tax.
Sandy Weinberg is a director at PKF O’Connor Davies LLP, where Jill Cantor and Nick Rochedieu are senior executives.