Sales Tax FAQs #9: Audits
Michael J. Fleming is the founder and president of Sales Tax and More, a full-service consulting and solutions firm with a passion for state tax. He is one of the country's leading authorities on sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers.
Michael is a renowned writer and speaker, and he regularly presents on webinars. He is also the host of the Sales Tax and More Podcast, where he shares his wisdom and learnings with his audience in order to help them navigate the tricky world of taxes.
In this episode…
Mike Fleming and Ellie Moffat answer some of your frequently asked questions about sales tax.
Here’s a glimpse of what you’ll learn:
What red gas can trigger and audit? What are some big things someone should be paying attention to?
How can someone be proactive when it comes to preparing for a sales tax audit?
Who would STM’s audit defense service benefit? Who is not right for it? Who should be looking for this?
Connect with Michael
Episode Transcript - Audio Version
[00:00:00] Welcome to Sales Tax and More your go-to resource for all things state tax related. Now here is your host, Michael Fleming.
Michael Fleming: Hi, Mike Fleming here, founder of Sales Tax and More, and today's co-host of the Sales Tax and More Podcast where we talk about everybody's favorite topic, which is of course sales tax. And today we're gonna go over some of the questions we've been asked during our webinars. But before we do, let me introduce you to my co-host, Ellie Moffat.
Ellie Moffat: Hi everyone. It's great to be here. I'm excited for today's podcast. Maybe I say that every time, and it's because I'm excited for every one of these podcasts. Before we go ahead and
[00:01:00] get started here today, I'll do a quick introduction for Sales Tax and More. Sales Tax and More as a full service consulting and solutions firm.
We have a really great team here of experienced tax professionals who are very dedicated to fulfilling your state tax and related needs. So we do a lot of sales tax returns, sales tax registrations, consultations, research, audit defense, exemption certificate management, and like our name states more. If you have questions about our services or you'd like to work with us, please reach out.
We would love to hear from you and we would love to work with you as well. And we truly do have a great team. Shout out to our team. So that being said, Mike,
Michael Fleming: Hey team.
Ellie Moffat: Hey team, I'm gonna send them this one force everyone to listen and but let's get started. Mike, can you talk about red flags that can trigger an audit and what are some big things someone should be paying attention to? What a broad question. So I guess you are gonna take this
[00:02:00] whatever direction you want.
Michael Fleming: Yeah. Very broad question. I was just gonna ask you, how many days do we have to tape this thing? ' Cause I could speak forever about this. We'll try to narrow it down to a couple. Some of the more recent issues that I've seen.
Maybe it's not something you're doing personally except for the fact that you're following the crowd. And when a state finds out that. The crowd is doing it wrong. A whole industry is doing something wrong. They'll target that industry and where usually, if you're a small to mid-size company, you're chosen for audit based upon a lottery, and it's the type of lottery you don't wanna win. But if they realize, like in the state of Texas, a lot of marketing and website design companies are being chosen because a lot of those companies are just getting it wrong. In some states it may be contractors. When a law changes they'll target a specific industry. So if
[00:03:00] the whole industry is doing something incorrectly, then pretty much everyone in that industry is gonna be audited at some point or another.
Now, second part of that question, what are the big things I should be paying attention to? You may not be wrong by being part of the crowd. You may be. A lot of companies we talk to say this is the way everyone does it.
It doesn't matter how big a company is. There are huge companies out there that get it wrong all of the time. Sometimes, the bigger companies get it more wrong than the smaller companies because the bigger companies have a heck of a lot more turnover or they don't have any turnover and they're doing something the same way for the last 20 years and things have changed.
They also have a lot more money to fight these audits than you do or I should say in general, rather than singling any of you out there. But so what you wanna do is you wanna
[00:04:00] make sure, not by looking at the competition how they're doing it, but actually take a look at the way the state thinks you should be doing it.
And that's what really matters. You can do that by contacting a company like us and we can do some type of exposure review. You can do that by digging into the statutes, the rules, the regulations on your own. Some states have that all posted out on their website and make it fairly easy.
Other states not so much. It's closely guarded secrets it feels sometimes, but what I would not do is do an AI search on the Internet because a lot of misinformation on the Internet and AI as of today can't tell what's right or wrong. It's really just regurgitating what's out there. And they may be giving you the incorrect information.
That's one area there. Don't go along with the crowd. You don't want to do what someone else is doing because they're the big boy in town and
[00:05:00] you assume that they're getting it correctly. Do the legwork yourself or hire someone like us to do the legwork for you. So that's one thing.
Another thing that causes red flags is paying late when you're doing your returns, constantly amending returns, using the wrong form when you're doing your returns. These are all things that are returns related not balancing correctly. In other words, the state's expecting a certain number and you're not even close to it.
These are all red flags that come to returns. When it comes to returns could cause a red flag. And if you get enough red flags, you get one red flag, it's not like the state's gonna be breathing down your neck and coming looking for you. But if you have enough red flags, now we've got a pattern. And you don't wanna be forming patterns that catches the state's attention.
So that's another area that you need to be paying attention to. Also if you're asking for
[00:06:00] refunds quite often or very large refunds, you gotta be ready for the state to come and take a look at you. Once they have your money, a lot of times they don't wanna let it go. So if you're gonna be asking for a refund, you still gotta ask for it because the refund it can sometimes be a lot of money.
So you gotta ask for it. But be prepared that may trigger an audit. That's a red flag for an audit very often. I could go on and on and talk about different types of red flags, but I think these three are some that you should be paying attention to. And if you have other concerns, send us a question. We'll see what we can do to to get it answered for you.
Ellie Moffat: All right. Thank you Mike. I think that you took it in a good direction here. That being said, let's go to the next question. So how can someone be proactive when it comes to preparing for a sales tax audit? I think we've led in pretty well here.
Michael Fleming: There's two times you want to be preparing for an
[00:07:00] audit. One is pretty much consistently, you gotta have good processes in place that will keep you prepared. So we've got a series of webinars. It's called the Seven Pillars of a Successful Sales Tax Program. You wanna be following those pillars I invite you to go and we've got copies of those webinars out there.
And if you're doing those things. It should keep you prepared for sales tax audit. Now, it doesn't mean that you're never gonna be audited. A lot of audits are done on a lottery basis. But if you have a good plan in place, you shouldn't fear an audit. An auditor's always gonna look to find something, but your assessment should be minimal if you're actually got a process in place, and here's the important part you're following the process because a lot of times you can have a great process. But your people may not be implementing it. So you gotta spot check your own process from time to time internally. So that's number one. You gotta
[00:08:00] have a process in place. Number two you gotta really be concentrating on two areas. The biggest assessments when it comes to sales tax audits are usually related to exemption certificates and resale certificates or a type of exemption certificate and use tax. So since those are the two biggest areas, if you pay attention to those two biggest areas and dedicate people to them and make sure they have the resources to do it correctly. Or you hire someone like us and generally that's gonna be a cheaper solution to keep you compliant when it comes to certificates or use tax than to constantly be training people to handle your certificates in-house and stay on top of the changing rules out there.
But if you're chosen for audit, then what I would do is an internal audit, mock audit, whatever you want to call it. You can have someone like us do it
[00:09:00] or you can do it yourselves. And what you wanna be concentrating on is your certificates. You gotta make sure that they're completely filled out.
You gotta make sure that the reason for why someone is saying they're got a resale certificate makes common sense. For example, if you've got a resale certificate, you're selling desks and you've got a software developer issuing you a resale certificate. Does that make common sense?
Maybe they're gonna start selling desks. But you gotta at least ask the questions. Why is this resale? That's what the auditor's gonna do. And nine times, actually 99 times out of a hundred, they should not have issued that resale certificate. They should have the just paid the tax on it 'cause they're buying it for use in their own business.
So when you're accepting a certificate. You gotta make sure that it's completely filled out that there's an
[00:10:00] actual exemption that could be used. Not that they actually qualify for it, but that there's an exemption that they're saying there is and that it makes common sense. Someone's gotta be checking those certificates for those audits, because just having a certificate on file is not enough. You gotta make sure that it's gonna survive an audit, it's gonna survive an auditor taking a look at it. So that's number one. The second is use tax.
Make sure that if you're not paying tax. Maybe because your vendor didn't charge you tax. But if there wasn't tax charged on your purchase, should there have been tax charged on the purpose? Because just 'cause your vendor doesn't charge it, doesn't mean it's tax free.
Maybe the tax should have been collected or maybe it was a taxable item. And if it wasn't paid to the vendor, then you need to self-assess and remit it to the state as a consumer use tax. So those are the two biggest areas that
[00:11:00] cause the largest assessments out there. So that's where you want to concentrate your time and energy where the biggest problems usually show up.
Now, if you're selling direct to consumers and don't collect a lot of certificates, you don't have a lot of exempt sales, skip that. Concentrate on the use tax. When you're looking at use tax you made any big software purchases. A lot of times they aren't taxed. Software is taxable.
Not only at your main office, but anywhere it's being used. So you may have a use tax responsibility in some of these other states. So any big purchases, any improvements to realty when you're opening a new office, there's a whole lot of purchases going on. These are the things you gotta concentrate on when it comes to use tax in an audit because you know that the auditor is gonna spend their time there because that's where the money generally is.
It's probably too late
[00:12:00] to check taxability once you're getting audited. But it's not a bad job. You wanna make sure that the auditor knows what they're talking about. So you gotta brush yourself up on are there any recent changes on taxability of the items you sell? And even if it's too late for this audit, you can make the changes going forward.
And sometimes it may not be too late. Sometimes, you might be able to get in there and change some of the things in a way that it's going to help you inside of the audit. Maybe you can reissue some of the more recent invoices and a lot of times you can go back to your customers and ask them if you haven't collected tax, " Hey, we're being audited. We should have collected the tax. We didn't. We need you to pay the tax". And a lot of times they will especially if it's medium sized companies. Smaller companies think you're trying to rip 'em off. Bigger companies they don't have the time to get involved a lot of times.
But those medium sized companies have been in
[00:13:00] your position before and a lot of times they're gonna work with you. So those are just a few of the ways. Again, when it comes to sales tax, I can talk and talk and talk. We don't have days to go over this. But again if you have questions, go ahead and send it to us. And we can go into a little bit more detail, but where I would start is the Seven Pillars of a Successful Sales Tax Program. And we have those videos of the past recordings we've done of this audit, and every couple of months we redo it. So we invite you to come to those. They're free. That's where I would start.
Ellie Moffat: All right. Thank you so much, Mike. And you know what? Let's wrap it up with one more question here. Audit defense for us. So this is really a question about us. So our audit defense service, who would that service benefit? Who is not right for it? Who should be looking for this?
Michael Fleming: Anyone with a potential larger liability.
[00:14:00] If you're gonna owe $3,000 of sales tax, it doesn't pay to hire someone like us. Any company, try to do it yourself. And if you have to, then you pay the tax. It's gonna be cheaper than hiring someone like us.
But if you've got a number that's material to you, if it's gonna leave a mark if you have to pay it, then it pays to bring in a professional for a couple of reasons. Number one so many companies out there when they're defending themselves, they let emotion rather than facts take over.
And that is the worst way to interact with an auditor. You gotta take the personalities out. You gotta take your beliefs out. I think it should be this way. The auditor doesn't care how you think it should be done. Here's the way that the state says it should be done.
It's just the facts, Sergeant Joe Friday. Just the facts, ma'am. So that's how auditors think. So that's probably no one out there knows what I'm talking about, but I'm dating myself.
Ellie Moffat: Write in if you do.
[00:15:00] Michael Fleming: Yeah, you write in.
Ellie Moffat: We comment. Yeah.
Michael Fleming: But that's really what it is. It's a benefit. We're a third party. We can address the facts without getting emotional with an auditor. If you can do that, great. If you have a command of your industry and you're sure that you know what's taxable, what's not, maybe you can do it without us. But that's that.
Keeping it to the facts and keeping the emotions out of it. Very important to getting the auditor on your side. And the auditors have a lot of power. They'll work with you if you are working with them and keep it about the facts and treat them with respect. They don't have to be your best buddy.
You don't have to volunteer a whole lot of information out there, but you gotta work with them. You gotta make their job easier. They'll be easier on you. We hear these horror stories all the time. Yeah. The auditor came in and we put 'em out in a trailer in Austin, Texas in the middle of the summer was 115 degrees. They were
[00:16:00] gone in 15 minutes. Yeah. The auditor's gonna get the last laugh there. They're just going to put everything into the audit and make you prove that they're wrong. So you don't want to antagonize the auditor. They have too much power when it comes to making your life a lot tougher. So you make their life tougher.
They're gonna make your life tougher. They're human. The opposite up in Michigan, "Oh, we put 'em in a boiler room, no insulation, no heat minus 15 degrees in there. They were gone in 15 minutes". They're gonna have the last laugh. So that's part of treating the order as a professional, keeping the emotions out.
When we're talking about big money, it's always better, in my opinion, to have another set of eyes in there. We may have had similar experiences or we may have relationships with certain auditors and you know that it's not what you know, but you know how to address an auditor. You know where
[00:17:00] to give in order to get. And the end result can be a lot better for you.
So if you've got large assessments and a large assessment for some people we just had an issue today where the auditor had disallowed an exemption certificate on $40 million worth of sales. And when we got in and we talked about it and we laid everything out. This is something we've gone before.
This is the biggest one. We've had. But we said, "Hey, this was accepted in good faith. We had all of the statutes to back it up. We say, here's the actual fact pattern". Because this auditor wasn't budgeting. And when we were all said and through, we knew how to approach this they waived it.
And instead of it being a $3.3 million assessment, it was a $12,000 assessment. Huge swing there. So the larger the amount of money at stake, the more you want to use a third party. Just to
[00:18:00] have a second set of eyes, just to have someone who's doing this as the regular course of business. Now not everybody has $40 million problems.
Like I said before, if it's material to you, and that may mean $20,000, our fees are gonna be less than $20,000. If we think that we can help you out and save you more than our fees, then we're gonna let you know that. If we think that we're not gonna bring any value to this, then we're gonna let you know that too.
Now, sometimes even when we let someone know, that we don't think that we're gonna be able to save 'em enough for our fees because we're handling the audit and we're gonna do it most times remotely. Because someone's not coming to your place of business where they may hear things and open up another can of worms or whatever else.
Sometimes they want to pay us just to run interference, just to ha handle all of the conversations and get all of
[00:19:00] the information to the auditor, make sure they're be being treated correctly. Get peace of mind and so that the auditor is not intruding on their everyday business. Some people pay for that.
Peace of mind or the potential for what you consider to be a large, potential assessment. Now, something along the lines, if you know that state's gonna have you dead to rights you figured out that there's a problem and it's going to take a miracle for the state not to find it when they're auditing you.
Then maybe you be proactive and you do what's called a managed audit. And it's not available in every state, but a lot of states have it. California has a really good one. And because a lot of people hire third parties like us to do these audits and you can't get away with murder when you're doing a managed audit. And we're doing the audit for you 'cause we're doing it under the supervision of the state.
[00:20:00] So we gotta walk that fine line. However, because the state doesn't have to send someone out and do this audit. They're going to reward you for that and they're going to waive , like California, is generally the penalty and 50% of the interest. Which if you know there's a huge problem and there's no way the state's not gonna find it, be proactive. Ask for a managed audit. And whether you do it yourself or through someone like us, I would do a third party when I'm doing a managed audit. There's just less chance to fudge. We're gonna know where that line needs to be drawn. Then I think that's a way to prepare for sales tax audit too. If it's up in the air, then you don't have to go through a managed audit. But if you just know the state's gonna find you and it's gonna cost you a lot of money there's nothing to argue on the taxability part.
The tax you go owe is the tax you owe.
[00:21:00] But that waiver of penalty and 50% of the interest or in some states a hundred percent of the interest. Some states, none of the interest. But, it can be a huge game changer for you. So that's another way that you can be proactive when it comes to preparing for a sales tax audit.
Ellie Moffat: Okay, fantastic. Thank you, Mike.
Michael Fleming: And I was gonna say I'm referring back to the previous question at this point, but that's another reason why you may wanna hire someone like us or at least talk to someone like us because you may not know when the best time to ask for a managed audit is. When we may be able to say, "Hey, the state's got you dead to rights. Let's go for a managed audit. We're not gonna be able to help this. This is black and white. You just missed it. And the state's not gonna miss it. Let's let's ask for the managed audit so we can get the penalty and interest reduced".
Ellie Moffat: Thank you so much, Mike. Thank you everyone for
[00:22:00] listening. Hopefully there's some really helpful, good information here. If you have sales tax needs, we offer many solutions and services. And we have a lot of online resources for you. We've mentioned some of them today in this podcast. There's a whole series of webinars. We have these podcasts.
There's a lot of free information on our website, as well as paid resources . So you can reach out to me directly. My email is emoffat, E-M-O-F-F-A-T at salestaxandmore.com. You can also go to salestaxandmore.com and thank you so much everyone for joining us today.
Michael Fleming: Take care everyone and hope to see you on the next episode of the Sales Tax and More Podcast. Bye-bye.