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Slumping Economy Means Increased Audit Activity and an Urgency to Prepare

Insights into the audit process with suggested best practices for audit preparation

December 11, 2008
by Don Fuga and Tom Concitis

A perfect storm of macro trends are putting taxpayers, and particularly the corporate tax professional, under intense pressure. The softening economy isleading to such revenue shortfalls that some states are facing record deficits and struggling to fund programs.

In an election year, lawmakers are reluctant to raise taxes to cover these deficits and hesitant to cut funding for popular programs. This predicament is leading many states to increase revenues by rigorously auditing taxpayers.

Since sales-and-use tax laws and regulations are some of the most complex and vary by state, these taxes are constantly targeted for audit by states that impose them. As many businesses are struggling to stay profitable and resources become scarce, many tax professionals find themselves in a bind.

Businesses are pressured to preserve capital in a slumping economy and the tax professional is expected to contribute to this effort. Thus, a real urgency to avoid large audit assessments mandates that the tax professional be prepared to weather the audit storm.

Audit Preparation

Changes in the sales-and-use tax laws generally lead to new compliance needs that taxpayers must learn and adopt. Often the changes can present challenges that can swamp a tax department. For example, states adopting the provisions of the Streamlined Sales Tax Agreement are required to amend their laws to come into compliance with that agreement. The amendments often mean changes in the taxability of goods and services. Aggressive auditing states know this and are taking full advantage of the circumstances by increasing audit activity for large corporate taxpayers, or targeting specific industries like manufacturing or retail.

Taxpayers must prepare for audit activity to continue to rise by staying abreast of sales and use tax law changes, rate changes, and exemption rules on a state-by-state basis down to county, city, and special tax district levels. At the same time, accurate recordkeeping is increasingly paramount.

Changes in corporate structure, product lines, and ownership must be carefully monitored and tracked. While this can be daunting, following certain key practices for audit preparation and management, and using automated tools, will prevent audit snafus and help taxpayers reduce risk.

One important preparation step tax professionals can take is to initiate an open dialogue with other companies in their industry. Perhaps they are also being audited or have been audited and would be willing to share their experiences. By identifying the hot button issues being examined in the industry before his or her own audit begins, a tax professional can take some corrective measures and prepare supporting research for existing processes.

Tax professionals should also be aware that before the audit actually starts, an auditor will review any past audits his or her jurisdiction performed on the company. The auditor will detail areas where it were previously out of compliance and prepare to examine them. The auditor will also review the company’s Web site and look for acquisition information, product information, change in corporate structure or any area which may lend itself to other possible non-compliance issues. The tax professional should think ahead to also examine these same areas so as to avoid any unpleasant surprises.

It is almost certain an auditor will review fixed asset purchases in detail and test sample expense purchases for possible tax omissions, test sample exempt sales transactions for possible non- billing of tax and check to see if the exemption certificates are up-to-date. They will also reconcile the accounting records including the accrued sales tax accounts to ensure that all the tax that was accrued has been remitted.

Internal Complications

There are also several internal factors that can hinder audit preparation and the sales and use tax function as a whole. The tax professional should be prepared to face them and plan to deal effectively with these challenges.

To read on about these internal complications and learn more about how the economy is affecting audit activity, view the full article: Slumping Economy Means Increased Audit Activity and an Urgency to Prepare (PDF).

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* This article was previously published in the November/December edition of the Journal of State Taxation and has been reprinted with permission.

Don Fuga, Principal Research Analyst, and Tom Concitis, Manager Sales Tax Research, combining over 75 years of tax experience, are from Vertex Inc. provider of enterprise corporate tax solutions (www.vertexinc.com).