The Anatomy of a New York State Sales Tax Audit

Having been in the financial services business for more than 25 years, I have represented clients in numerous federal and state income-tax audits and state sales-tax audits. With the pressure at the federal and state level to raise revenues, we are finding increased audit activity at both the federal and state level. New York State corporate income-tax audits are the least common as the state benefits from any adjustments made at the federal level. Generally, taxpayers are required to report any federal changes to the state within a 90-day period, beginning with the date of the final federal determination. They merely piggyback off the IRS Audits.

However, New York State has found a goldmine in adding additional revenue to its coffers through sales-tax audits, as many business owners, while attempting to be compliant, do not understand the complex laws and regulations that govern the New York State sales and use tax.

As a transactional tax, every business must have a clear understanding of what it is selling and what it is buying, as the basic premise of the sales-and-use tax law is that every sale is a taxable sale unless it is exempt. Business owners must determine if they are required to collect and remit sales tax on the transactions in which they are the seller and must also determine if they are required to pay sales tax on the transaction in which they are the purchaser. That’s not as easy as it sounds.

 

The New York State sales-tax audit

         What begins with a letter from New York State alerting you to the fact that you have been selected for audit can turn into a long and tedious journey filled with frustration, hard work, additional accounting fees, and interactions with auditors who take the position of “guilty until proven innocent.”

 I have had the opportunity to work with some excellent New York State sales-tax auditors that have been properly trained, understand your industry from a sales-and-use tax perspective, and are willing to educate you in conjunction with their examination of your books and records. As the majority of taxpayers strive to be compliant, they appreciate the guidance and assistance provided when the auditor takes the time to work with them during the examination and provide guidance and training on sales and use taxes within their industry.

However, more often than not, the taxpayer is confronted by an auditor who has little-to-no training or working knowledge about your industry, refuses or is incapable of providing any assistance or education under the sales-and-use tax law, and whose apparent goal is to maximize the assessment against the taxpayer. As a result of this, the sales-tax audit experience develops into an adversarial relationship between the taxpayer and the state — something New York should not be doing, as the state attempts to reinvent and improve the business climate, retain businesses, and attract new businesses to the state.

 

How to prepare for the audit

         There is not much you can do to avoid a sales-tax audit. New York State, on its website, states that some of the reasons a taxpayer can be chosen for audit include:

§ Failure to file a return

§ Failure to report income or sales

§ Excessive credits or exclusions claimed on a return

§ Incorrect or fraudulent refund claims or returns filed

§ Differences found when we compare a return to information we obtain from others such as the IRS, banks, employers, and other businesses

§ Results of prior audits. (However, a prior or a current audit isn’t necessarily cause to be selected for audit again.)

§ Misuse of exemption certificates

Realistically, there is no way to prepare for a sales-tax audit once it is under way. Preparation for a sales-tax audit begins years before you are chosen for the audit. There are so many industry-specific nuances that make it impossible to give you even a brief overview of the sales-and-use tax law as it would pertain to you. Whether you are in construction, manufacturing, retail, or any other business sector, you have to obtain an understanding of how the sales-and-use tax law applies to your industry and also understand the detailed recordkeeping requirements needed to support your payment, collection, and remittance of sales and use taxes.

New York State Tax Bulletin ST-770 (TB-ST-770), which can be found on the New York State Department of Taxation and Finance website (http://www.tax.ny.gov/), provides an overview of the recordkeeping requirements for sales-tax vendors. In the introduction it states:

“If you are registered for purposes of New York State’s sales tax, you are a trustee of New York State and you have a responsibility to collect the proper amount of sales tax from your customers and to remit the tax you have collected with your timely filed sales tax return.

“As a registered sales tax vendor, you are required to keep accurate records of all sales and purchases that you make. Keeping detailed records of your business operation will help you prepare accurate and complete sales tax returns. Detailed records will also serve as documentation of the accuracy of your returns if you are audited.”

Lucky you to have been given such responsibility and then to also have the honor to be scrutinized, chastised, and penalized in an audit where you have tried to do your best in following a set of complex laws and regulations that many of the sales-tax auditors don’t understand.

 

What should you do?

To avoid a most unpleasant experience, you should really do an assessment of how the sales-and-use tax law applies to your business and the potential exposure (time and money) that you may face in a sales-tax audit. If you have not had an audit and are unsure of your obligations and recordkeeping requirements, it may make sense to hire a third party to come in to provide you with a detailed overview of how the sales-and-use tax law applies in your business and assess your exposure. This will provide you with the opportunity to identify and correct, as required, any issues that are discovered. This can be a much more cost-effective method than waiting for the real thing to happen.

Even if you are currently not registered as sales-and-use tax vendor you should look to see if you are required to be. The audit period for a registered sales-tax vendor is generally three years, but the audit period for an unregistered vendor is six years. Those additional three years can amount to a significant amount of tax interest and penalty.

 

Karl Jacob is a tax partner with the accounting firm Dannible & McKee, LLP. Contact him at kjacob@dmcpas.com