State Audits - What You Need to Know

Over the past couple of years I’ve noticed that several local businesses have been seized by New York State due to non-payment of taxes.  Some have “survived” the process but still suffered financially, causing them to reduce their inventories in order to pay for the audit findings. All business owners should be aware of their rights in the case of a state tax audit. First and foremost you have the right to representation. Your accountant should absolutely be present for the audit. If for some reason that isn’t possible, at the very least have your accountant organize your paperwork prior to the audit. Your books of record should be organized in a way that will quickly provide the auditor with the information they are seeking in order to expedite the audit process.

Once the audit begins, be wary of the auditor overstepping their authority. Three specific things to be watchful for are:

1.  The request for information to which the auditor is not entitled

2.  The misuse of vendor information

3.  The use of data from outside the business to calculate sales tax

Point number three is particularly key. Sales tax auditors have been known to make an early determination that the sales records maintained by a business are inadequate. The auditors do this so that they can use data from outside the business to calculate a sales tax deficiency. For example your business’ sales might be 75 percent credit and 25 percent cash while a “typical” business’ sales might be 50 percent credit and 50 percent cash. Using this outside data, the auditor might assume that your total cash sales were unreported and that you owe more money in taxes.

Sales tax case law has upheld that a taxpayer who maintains adequate sales records should expect that these records will be used in an audit to determine any tax liability. Very few business owners are aware of the laws that differentiate adequate sales records from inadequate sales records, especially as the records pertain to sales tax liability. Follow these rules for purposes of sales tax calculation and substantiation:

• Sales records must provide sufficient detail to independently determine the taxable status of each sale and the amount of tax both due and collected.
• Sales records should be reconciled to bank deposits.
• Cash register tapes that indicate whether each sale is in a taxable or exempt category, but which do not identify the individual item(s) sold, are sufficient to prove gross sales but are insufficient to independently determine the taxable status of each sale.
• For deliveries out of state, records must substantiate points of delivery. These documents must be referenced to specific sales transactions.
• For sales that are exempt from sales tax, an exempt sales certificate must be on file for the customer.

The list above establishes the minimum requirements for ensuring that the auditor accepts your books of record as adequate. If you have met at least these criteria, the proprietary markup information mentioned above cannot be used by the auditor in calculating your assessment. And, if you’ve paid your taxes timely and accurately, the auditor will not be able to assess a sales tax deficiency.

If you are already facing a large audit assessment there may still be time to fight it. Depending on the procedures followed by the auditor, a mediation conference or an appeal may still be available. Act quickly before the State attempts to seize your business.

As my old boss Marty used to say, “Failing to plan is planning to fail.” You need a good set of books and a good accountant to maintain a successful and secure business. Without one or both you could be asking for trouble.