More Sales Tax Audits - Be Prepared

Thursday, October 27, 2011

Regardless of the outcome, increased audits are inevitable.

Michael Miller, CPA
HoganTaylor
State and Local Sales Tax (SALT) Practice

Oklahoma businesses are now more likely to experience a sales and use tax audit, particularly those in the Tulsa area. Why? Recent changes in Oklahoma law and subsequent actions at the state and city level have driven significant changes in the manner and frequency with which these audits are conducted. Like the Boy Scout motto, businesses should be prepared! Steps to follow in this article address some basic steps to take.

What Has Changed?

On June 1, 2010, the City of Tulsa engaged Revenue Discovery Systems (RDS) to collect sales and use taxes. This contract came on the heels of House Bill 2359, which was passed on the last day of the legislative session. The RDS contract was signed after the bill was passed but before it was signed into law.

The bill made several revisions to existing law. In particular, it implements a new “independent audit program.” This allows cities to contract outside parties to conduct sales and use tax audits. However, the Oklahoma Tax Commission (OTC) retains authority to approve and train auditors, oversight on audit selection, review of taxes assessed and enforcement. Under the program, OTC will waive the 1 percent fee that is charged for administering sale and use tax.

More Auditors Coming

The auditor engaged by the city would be an employee or contractor of the jurisdiction and not a state employee. According to the OTC, contract auditors will have to meet the same minimal requirements of an OTC auditor. This includes a bachelor’s degree in accounting, finance or business administration, and the completion of a two-week training course. An OTC employee is required to initially conduct audits under the supervision of an experienced examiner. A contract auditor will not have the same oversight. According to the Commission, any person that meets the minimal requirements can complete the OTC training and then work to secure a contract with a city as an independent auditor.

According to sources, there are several issues that have to be worked out before the program will be fully implemented. These include audit selection and how to coordinate audits between multiple independent auditors. A distinction will be made by the OTC between jurisdictions that are participating and those that are not. The Commission will continue to audit taxpayers that are conducting business statewide. This process will be ongoing, but increased audits will likely be initiated in the near future. Currently at least 20 cities have expressed interest.

Lawsuit — More Changes On The Way

The bill also changed the language that a city “may” engage the OTC, to “shall.” This change prompted Tulsa and several surrounding jurisdictions to file suit against the OTC and the State of Oklahoma. In the suit, filed in Oklahoma County District Court, Tulsa asked the Judge to rule the law change as unconstitutional because “Tulsa no longer has a choice regarding how its taxes are collected and enforced.” The suit is being contested by the OTC, and one of their concerns is that if Tulsa prevails, Oklahoma will effectively become a “home rule” state like Louisiana and that this will jeopardize the State’s “single point of administration” in regards to the Streamlined Sales Tax Initiative.

The OTC also contends that the main reason for the suit — that the OTC is understaffed and unable to effectively administer taxes — is now mitigated by additional sales and use tax resources. Increased funding has authorized the hire of an additional 10 collection agents, 10 auditors who are CPAs and new analytical tools. This funding effectively tripled the size of the OTC’s audit manpower. In comparison, Texas fields an audit force of about 400. Regardless of the suite’s outcome, increased audits are inevitable. As a preview of things to come, a Tulsa World article in late 2010 reported more than $1 million in additional sales and use tax collected were due to increased audits during the previous month.

What Should Companies Do?

Since this is a preview of things to come in Oklahoma, how can companies deal with this more aggressive audit environment? Are there measures that business can implement to more effectively respond to audits and mitigate risk? As a practical matter, there are some measures that can be implemented which will prepare taxpayers to manage future audits.

1. Taxpayers should ensure that all non-taxed sales of tangible personal property are supported with a valid resale or exemption certificate. Certificates should be periodically updated
2. Taxpayers should identify business acquisitions made and confirm that the appropriate sales or use tax was remitted.
3. Companies should ensure that they have either a use tax permit in place and are reporting taxable purchases, or that they are reporting use tax on their sales tax returns.
4. Direct pay permit holders should ensure that they are filing returns and that the returns are complete. A red flag can result when a direct pay permit holder does not file or files zero returns for an extended period.
5. Manufacturers should ensure that they have a current Manufacturer’s Service Exemption Permit (MSEP).
6. Retailers that make deliveries into multiple jurisdictions should ensure that they are sourcing those sales correctly. Many cities are focusing on this issue to increase revenue.
7. Small business owners should take care to endure that Schedule C reported income is comparable to sales tax returns.
8. Contractors are going to experience greater scrutiny as consumers of materials used in their jrojects. Contractors that attempt to avail themselves of a customer’s exemption will be examined more closely than in the past.
9. Hospitals and non-profits that deal with large amounts of tangible personal property are going to be subject to more intense examination. Most non-profits are subject to sales and use tax in Oklahoma.
10. Distribution facilities are going to receive closer attention. The OTC believes that many taxpayers are not properly self assessing use tax on tangible personal property stored in the state.
11. Taxpayers should take care to ensure that disposed property and intercompany transfers of assets are addressed for sales and use tax implications.
12. Finally, if exposure is known, taxpayers should take advantage of the state’s voluntary disclosure program. This program allows taxpayers to remit tax under more favorable terms, but it must be sought before notice of an audit is received.

By looking closely at these potential areas of risk and proactively addressing them, businesses can effectively deal with these new, more aggressive sales and use tax compliance environment.

To contact HoganTaylor’s SALT practice, click here to email Tom Smith, the leader of HoganTaylor’s 12-member SALT team.