Today’s blog is the second in a series of 5 from our “Sales Tax Audit Series – For California and Beyond.” In this blog we discuss the self-audit. In our first blog we called the self-audit a “Mini Sales and Use Tax Audit” or an MSUTA. The purpose of the MSUTA is to be proactive and protect a company from a future bad audit outcome – an unexpected material tax assessment. The MSUTA is very much like your annual medical physical; like an annual health physical, the MSUTA is done to catch problems early and correct them. Like a physical, the MSUTA consists of tests, analysis of the results of the tests, and a prescription for correcting problems.
In keeping with the analogy of a physical, consider a consultant like Miles Consulting Group your physician who can assist in identifying a problem and provide remedies to cure them! The guide below may seem a bit daunting to do yourself. Many of our clients simply don’t have the resources to perform the steps internally. That’s often where we come in. Email us today at info@milesconsultinggroup.com.
When you do an MSUTA you are doing all that you can to ensure that you identify sales and use tax issues before a state auditor finds them. The MSUTA will not only reduce any tax, interest and penalty exposure from a future audit, but it will help you to sleep better. By the way, in California the auditors call an audit that finds no unreported taxes a “no-change audit” – a side benefit to a no-change audit is that your potential for future audits is nearly zero! No state wants to waste valuable audit resources looking into empty wells. So that is our goal – we want your first audit to be a no-change audit.
The Mechanics of a Self-Audit
It’s time to jump into the MSUTA. An MSUTA requires a different mindset than an audit defense. In an audit defense you are attempting to resolve what has already happened – you are trying to un-ring that bell. But, in an MSUTA you are stepping into the auditor’s shoes – you need to act independently and hunt for problem areas: Are there unreported sales and use taxes? Are there unsupported exemptions? Are we making purchases that should have been taxed? Are we paying more tax than we should?
Like an auditor’s sales and use tax audit, your MSUTA will examine two primary areas of your company’s books and records: your gross receipts and your purchases. Every state’s tax laws impose sales and use tax on all gross receipts unless there is documentation to support an exemption, and every state presumes that purchases of tangible personal property (and some services) are taxable with some exceptions that we will discuss in a bit.
Let’s start with our MSUTA of your gross receipts and the questions that you will be asking as you step into the shoes of the state auditor. Remember – when you do the MSUTA you are looking for problems to correct – this is the time to be hyper-critical: “an ounce of prevention is worth a pound of cure.”
The MSUTA for Gross Receipts:
- Do you have any sales on which tax has not been collected? And for those taxes you have collected, have you failed to pay the tax to the state? If the answer is yes to either of these questions then we recommend you perform a number of tests to ensure that exempt sales are properly claimed and are supported by proper documentation and that collected tax has been paid to the state.
- 1st Test – Run a report of all untaxed sales for a period of time: a week, a month, a quarter, a year
- 2nd Test – Identify the most material exempt transactions by dollar amount and determine if you have a valid reason for exempting the sales. The most common support is a valid resale certificate.
3rd Test – Are you confident that the products you are selling are correctly treated as either taxable or exempt in the state? This is the time to ensure that you have research to support the exempt nature of any untaxed products and services.
4th Test – Review your tax accrual account to ensure that collected tax is timely reported to the proper state, in other words, review the credits to your tax accrual account – that’s what auditors do.
Results of Tests 1, 2, 3 and 4 – Now that you have concluded your MSUTA for gross receipts, it’s a best practice to implement written procedures to ensure that you are collecting and reporting tax on the correct products and services and you have procedures to support exempting all untaxed products and services. It’s also important to share these procedures with your sales and accounts receivables personnel.
Performing each of the tests above requires an objective and critical view of a company’s entire sales tax collection process. Our experienced team can assist with any and all of them, including setting up a test of exempt sales, providing guidance about valid resale certificates (and how to collect them retroactively, if needed, and important research on a company’s various revenue streams. Our team also assists with the important documentation and training of the company’s team in these matters. Email us today at info@milesconsultinggroup.com.
The MSUTA for Purchases:
Do you have purchases of fixed assets or expense items upon which you have not paid the tax? In California, unreported purchases subject to use tax is always in the top three for statewide audit recovery, so you must carefully review your purchases of fixed assets and expenses – we know the auditors are looking at them. Are you paying tax on inventory – items that you sell rather than use? The following are tests you should do to ensure that you don’t owe use tax or that you are paying more tax than you should be.
- 1st Test – Run a report of purchases of fixed assets for the last three or four years sorted by your most expensive purchases to the least expensive. (In California you need to look back three years, that’s the statute of limitations, but in some states the statute is four years.)
- 2nd Test – Review your trial balance for purchases into accounts where you make purchases of tangible personal property – these are the accounts that an auditor will review. Expenses are a tricky area in every state – what’s taxable and what is not. Our expertise with every state will ensure that you have a test that will hone in on areas of exposure and opportunities for refunds.
- 3rd Test – Scan your purchases of inventory items to make sure that you aren’t paying tax on items that you resell . Everyone likes to reduce their costs – this is an area that we can help you to get a refund for overpaid sales and use taxes. Call us.
The first MSUTA will take more time and likely require the guidance of an outside consultant, but subsequent MSUTAs should not require that much of your time – you will know where to look for weaknesses and you will know how much you need to test.
Our team of experienced former auditors and sales tax professionals perform these kinds of projects for clients in California and all other states daily. Please contact us at info@mileconsultinggroup.com or 408-266-2259 for a complimentary consultation to discuss your company’s situation.
