During a recent conversation I was reminded of our fabulous “25 Stories About Work” series here on the blog and thought I would share one with you. This post is going to be fairly boring to most, although it will be interesting to those who like to hear about what small business owners go through on the daily, and who may also be interested in what happens if you are presented with a sales and use tax audit. The rest is below the fold.
In the Summer of 2018 I received a letter from a state sales and use tax auditor. This letter said that my business was being audited for sales and use tax for a period of four years. For those who aren’t in the know, sales tax is just that – the money that we collect for sales tax and forward to the state government, who keeps their share, and then parcels out to the counties or whatever other agencies, their shares. Use tax is for things we, well, use on site or hand out – such as printing, safety supplies, etc.
I called the listed agent to verify the letter and indeed, I was going to have to go through this process. And it is a process.
The first thing I did was call my accountant, who gave me an exasperated tone on the phone and said to me “hold on, you are in for an interesting ride”. Fortunately, my accounting firm has an audit division and they assigned me to an extremely intelligent guy, who actually was a state sales and use tax auditor in his past life. More on this later.
To begin, the state demanded the following:
1) Sales invoices for the entire four year period – this wasn’t as easy as you may think, as we had gone through a computer software change in the middle of the audit date and I had to hire an outside company to help extract the older invoices from my previous server. I was able to get them, and I sent all quarter million of them to the auditor.
2) Sales tax exemption certificates – more on this in a bit
3) Purchase invoices for the audit period – after a bit of negotiation, and categorization, we were able to whittle this down to a reasonable amount and format
4) Sales/Use tax returns along with supporting schedules for the audit period – this was the accountants job
5) Depreciation and fixed asset schedules for the audit period – accountant work
6) Credit card statements for the audit period – thank god we went with AMEX – these bills (yes, 48 of them) were available online and I sent them to the auditor
After the auditor got all of this information, the hard work began. My work was divided into three major areas:
1) The auditor chose several hundred random cash invoices that didn’t have sales tax on them and I had to prove why they were sent out as non-taxable.
2) The auditor chose several hundred customers that we didn’t charge sales tax to. We had to provide sales tax exemption certificates for all of these.
3) The auditor made up a gigantic spreadsheet, approximately 500 lines long, that had on it credit card purchases and other purchasing invoices. If the invoice had no sales or use tax paid, I had to prove why we didn’t pay them. If tax was paid on the invoice, I could just provide a copy and cross it off the list.
Part one proved to be very easy, after a bit of back and forth. The vast majority of these invoices were for municipalities, government agencies, and the like or we had tax resale certificates on file for them. We scored a 100% in this category.
Part two was harder. We had tax exemption certificates for the vast majority of these customers, but there were a lot of holes. I started calling places and got almost all of them, but there were a few that I just couldn’t get, as the companies either were out of business, or simply wouldn’t return my calls. I had to try as hard as I could in this category because they took a ratio of the certs you were short and applied this across your enterprise. In other words, if you had 96% of the certificates, they would take the missing 4%, and apply that across all of your sales to come up with the tax you owed. We had to repay the state some sales tax in this category, but it wasn’t much.
Part three was the majority of the work. I had to go back in time and get invoices either to prove that we paid sales tax on the transactions, or come up with a reason why we didn’t (i.e. “postage”). The auditor concentrated a lot of the work on printed material, advertising, and Amazon purchases. This was made more difficult as I wasn’t president of the company during the whole audit period and some of the people who were running the place just weren’t available for comment.
So, on the spreadsheet – it was my job to come up with a copy of the invoice and put a comment in there stating a reason why this shouldn’t be taxable. All of this is guilty until proven innocent, by the way. He was assuming that we didn’t pay the use tax and that he was going to collect it – it was my job to show him that either we paid the tax, or didn’t have to.
Around four or five months later, my aunt died. I was sitting in the airport in Akron, Ohio and will never forget the email I got. It was from the accountant. Before I go to this email, a little about the accountant.
As I mentioned, our accountant has an audit department and I was assigned a person who was a state auditor in his previous life. I never spoke with the auditor after I gave our accountant our power of attorney, and this was an excellent move in hindsight. Basically, the accountant was my go-between to the auditor. There were a few times I was furious about the process and it was extremely beneficial that I had a go-between to lean on in certain situations.
Back to the email I received in the airport. I had spent four or five months painstakingly putting together reams of information from two different computer systems, checking everything, and making copies and had a final product to send to the auditor. When I got the email in the airport, it was immediately evident that the auditor had not read my work- he hadn’t even looked at the spreadsheet and all of my proof that I had supplied. He just came up with a “lower number” and asked if we would pay it. I was livid. The answer to that email was a firm NO.
After some strong words to the accountant, the auditor had to look at my work and finally had to cave. I had to supply hard copies of all of the proof and did so.
In the end, we had to pay about two thousand dollars in back sales and use taxes and penalties, and about six thousand dollars to the accountant (remember, this is for a four year audit period). All of our errors were honest – our biggest one was advertising stuff. We used an out of state printer and an out of state vendor for swag and never paid use tax on those materials. As previously mentioned, we were short some tax resale certificates. For a few invoices on the use side, we just couldn’t find anything and had to give up. A deeper dig could have been done, but at a certain level you reach the point of diminishing returns and frankly, I wanted my life back.
This audit was exhausting and exhaustive. The good news is that my accountant told me that the auditing agency usually scores an audit as to if they will bother you again, and it is highly unlikely as my work was extremely detailed and organized. As Bill Murray said in Caddyshack – “so I got that going for me…which is nice”.