Businesses may find themselves with outstanding tax liabilities as a result of:
- frequent changes in legislation and tax rates
- market and production expansion
- insufficient processes for identifying new registration requirements
- self-accruing use taxes.
In the US, each state conducts its own indirect tax audits for each legal entity and tax type. To make matters more complicated, some local governments (e.g. localities in Alabama, Colorado, and Louisiana) administer indirect tax audits at the local level.
By their nature, indirect tax audits can be meticulous and time consuming and create a number of challenges for taxpayers. Indirect tax audits require additional resources to work with the tax authorities and to reconcile transactional data for the periods under audit. Audits also underscore the challenges of communicating across multiple business units and locations, to gather and substantiate supporting information and documentation.
Taxpayers have a few tools to approach what may be a rapidly-growing open audit listing and to reduce their overall indirect tax exposure: audit defense, managed audits, reverse audits, voluntary disclosure agreements, and amnesties.
Large taxpayers generally have experienced indirect tax audit departments with audit-focused professionals – and so can be successful in remediating indirect tax audits. Other taxpayers, however, may not have the capacity to handle multiple indirect tax audits and typically rely on practitioners to resolve audits as needed.
Regardless of taxpayer size, audit defense requires working one-on-one with auditors to gather the necessary data and documentation for review. An important first step is to reach an understanding in writing with the auditor regarding the audit timeline and any sampling procedures that may be used. Taxpayers might consider performing a self-review of tax paid on purchases to identify potential overpayments that may offset any potential liabilities arising during the audit. The statute of limitations will generally expire shortly after the state-administered audit is closed.
Twenty states offer a managed audit program which allows a taxpayer, or qualified practitioner, to perform an audit under certain guidelines set by the state. Taxpayers generally must request participation within 30 to 60 days of receiving an audit notice. Managed audit programs offer several benefits including potential waiver of penalties and interest for underpayments, more control over audit design and review, and quicker resolution. However, managed audit timelines are monitored closely by the state and interest waivers may be revoked by the state for audits exceeding deadlines without good reason. Upon successful completion of a managed audit, the period under review is closed.
Reverse audits, typically performed by practitioners simultaneously with state-administered audits, seek to identify overpayments of taxes on a business’ purchases. Reverse audits may be conducted outside of a state-administered audit:
- for taxpayers operating in industries with broad exemptions
- if there are potential deficiencies in use tax accrual processes
- when tax authorities issue rulings that retroactively change the taxability treatment of certain items.
However, reverse audits performed outside of a state-administered audit do not officially close-out periods, and may trigger audit notices.
Voluntary disclosure and amnesty programs
Voluntary disclosure and amnesty programs are very similar in that they offer non-compliant taxpayers an opportunity to ‘come clean’ with the state. In some cases, penalties and interest may be waived.
Voluntary disclosure programs are usually ongoing programs for registered taxpayers with known underpayments and participation can usually be initiated anonymously. They are typically limited to one submission per year per taxpayer.
Amnesties, on the other hand, are generally established by legislation and are only available for a limited period of time. Amnesties are geared towards unregistered taxpayers that did not collect or remit tax on sales in the jurisdiction. Amnesties and voluntary disclosure submissions typically do not close-out periods and may result in taxpayers receiving notification of audits.