As an audit proceeds, there are numerous items and conditions that the auditor will commonly look for. Here are the top ten pitfalls that are most likely to trip you up, and what you need to do to avoid them:
Pitfall #1: Use Tax – Use tax is the tax you pay on purchases of everything from office supplies to large fixed assets. If the vendor that you purchase from doesn’t charge you the correct sales tax, you have the responsibility of accruing and remitting use tax directly to the State of Texas on your Sales and Use Tax Return. Unfortunately, many people do not know this until it is too late and they are assessed the tax, interest and penalties in an audit. The only way to ensure that you are compliant in payment of use tax is to implement an accrual process to capture those purchases that should be reported, report them and keep very good documentation. Did you know that if you report use tax but can’t explain to the auditor exactly which vendors and invoices you were accruing and remitting; the auditor will tell you “thank you very much for the use tax” and then assess you on your purchases again? Maintaining the appropriate support and documentation are extremely important.
Pitfall #2: Exemption and Resale Certificates – If you do not have the proper certificates to support your non-taxed sales, you will be allowed to get them during the fieldwork and appeal phases of your audit but as discussed below in the section about “good faith” this can be a slippery slope and it’s best to have a process to ensure exemption and resale certificate compliance at all times.
Pitfall #3: Unreported Sales – Mistakes happen and sales can go unreported. Understanding your businesses’ taxing responsibility is critical and you should have a good accounting system that is set up properly to automatically determine and calculate the tax.
Pitfall #4: Charging the Wrong Tax Rate – Understanding how the “local” part of “state and local tax rates” work is vitally important. In Texas, there is a State rate of 6.25% and then there are county rates, city rates, mass transit authority rates (MTA); special purpose district rates (SPD) and advanced transportation district rates (ATD) and some cities have all of these and multiples of each. It’s important to understand how the rates apply to you and how they apply in each circumstance. For example, did you know that the rate changes if you deliver versus the customer picks up at your location? Did you know that the rate can change if you install versus just selling to the customer? Some rates are dependent on your location and some are dependent on your customer’s location.
Pitfall #5: History of Audits and Assessments – Once you have been audited, you are now a target for future audits and if the State continues to find significant dollars by auditing your company, they will continue to do so. The best thing that you can do is to know your taxing responsibilities inside and out and put processes and procedures into place and have good documentation to ensure that you are complying with the rules. Adequate documentation makes an audit go much more smoothly, while poor record keeping will prolong an audit and may ultimately cost you thousands of dollars.
Pitfall #6: Unique Rules and Regulations – Some rules are difficult to understand. Taxpayers and auditors alike struggle to determine how to apply specific rules to specific industries. As an example, landscapers mow lawns, they plant trees and flowers, and they build retaining walls and other permanent structures. It’s possible for three different rules to apply to one invoice. As with the pitfalls noted above, knowing how the rules apply to your business along with adequate documentation and processes are necessary to keep you out of trouble.
Pitfall #7: Sales Tax Accruals – Many companies do not properly remit the sales taxes they have collected. The auditor will look at your bank statements, federal income tax returns, general ledgers, invoice registers, invoices, sales journals and summaries to identify and reconcile any discrepancies and assess tax on those discrepancies. The best advice here is to make sure that you are using a good accounting system, set up properly to track your sales and reconcile your sales each month before you report and remit.
Pitfall #8: Acquisitions – A business acquisition can really muddy the waters when it comes to sales and use tax compliance. An acquisition can take you into new markets where you are unfamiliar with the tax rules and then there is the issue of previous liability. When you acquire a company, there are certain steps that must be taken or you automatically assume all previous tax liabilities. Consulting with an attorney and professional tax consultant can help you structure the acquisition so that you avoid or at least minimize future audit liabilities due to the acquisition.
Pitfall #9: Internet Purchases – Many taxpayers are unaware that the purchases that they make online most likely aren’t taxed. That is beginning to change with the recent rules regarding internet sales however, it’s important for you to take note and make sure that you are accruing and remitting use tax due on purchases made over the internet.
Pitfall #10: Audit Questionnaire – The questionnaire that the auditor sends you at the beginning of the audit can seem innocuous at first but beware. There are questions on the questionnaire designed to uncover unregistered businesses and businesses engaged in fraudulent activities. Consulting with an experienced and professional tax consultant before you complete the questionnaire can save you headache down the road.