Organizations are overpaying sales and use tax

Many tax professionals joke that they’d rather have a root canal than endure a sales and use tax audit, and this sentiment has only grown as state taxing authorities have gotten more aggressive.

It can be arduous indeed to collect everything an auditor wants, which generally includes:
  • A chart of accounts, preferably with account descriptions
  • Access to purchase and sales data, including general ledger, accounts payable, use tax accrual files, sales tax payable details, purchase order details, miscellaneous income details and more
  • Cost center and/or location listings with physical addresses and open/close dates
  • Construction, leasehold improvement and maintenance contracts
  • Vendor master files
  • Product or item master files (if available)
  • Access to invoice copies
  • Access to exemption and resale certificates

Complying with audit requirements conjures an image of a lone tax professional (the tax function of most organizations is notoriously understaffed and overworked) with a stack of boxes, a long list of invoices, a vast spreadsheet and a view of the moon outside the window.

Why an increase?

The reason for the uptick in audits is simple: States are looking for money. As the federal government has pushed more funding responsibility to states, states have gone looking for revenue, and they have found a good source in sales and use tax. In Texas alone, for example, sales tax collection accounts for about 55% of total state tax revenue and more than a quarter of the state’s budget.

Expansion of audits has led retailers and suppliers to be more aggressive in charging sales tax to avoid a tax deficiency. Sales tax might be charged without regard to whether it is appropriate or the transaction is an exempt sale. Regardless, a purchaser may be paying sales tax that is not legally due. That’s where reverse audits come in.

What a reverse audit does

A reverse audit allows an outside professional to put on an auditor’s hat and review transactions much the way a state auditor would, except the main goal is to find overpayments and exemptions and, when possible, to correct the processes that led to them. Like an audit, a reverse audit requires a lot of research, from studying the business to understand the basics ― product descriptions; where items are created, housed and sold; how the organization pays sales and use tax ― to discovering what exemptions may apply. A reverse audit peruses detailed, in-depth data to identify specific transactions where tax may have been overpaid.

In the majority of cases, organizations know they have overpaid because they know they have gaps in their accounting systems: Primarily they lack the personnel to properly assess sales and use tax.  

The recent Grant Thornton LLP webcast “Reverse sales tax audits/audit defense ― Leveraging technology to improve results” asked participants to describe their policies for ensuring sales and use tax compliance. The most common response was that an organization reviews everything and accrues use tax if necessary. Yet this practice rarely happens correctly. Because of the sheer volume of transactions, many companies may simply glance at the invoice to ensure tax was charged without investigating whether the tax is correct. Unless an organization has an enterprise resource planning system so robust that it collects, stores, manages, interprets and integrates the necessary deluge of data, it is virtually impossible to manually review every transaction for sales and use tax compliance in today’s complex, fast-paced world.

Other times, an organization might have its eye on anything that is going to be capitalized. Fixed assets are reviewed at 100%, while expenses with a certain dollar-value threshold ― say, anything over $1,000 ― are manually reviewed. Sometimes, a company doesn’t review anything and assumes the vendor got it right.

What is often true is that transactions are paid without a review of sales tax accuracy. Is the rate correct? Is the item taxable? The tax analyzer may not know how items will be used, and hence the appropriate tax. And the vendor may have charged the wrong tax rate.

Reverse audit professionals look where others have not to find money. They also account for underpayments and do a net-benefit analysis to be sure the client will get enough money back to make pursuit worthwhile.

The need goes on

The need for reverse audits ― to recover money that legally belongs to an organization ― will continue, just as overpayment of sales and use tax will continue.  

One reason for the need is, it’s almost impossible to keep up with changes in sales and use tax regulations. Even if an organization does a comprehensive study of sales and use tax, and gets it right, it’s only “right” for a short time, as state and local authorities may change the laws as frequently as every two years. That makes it difficult even for people who passionately want to stay compliant with the regulations to remain compliant. Luckily, there are technology tools that can help.

Leveraging technology

One of the most frustrating and time-consuming parts of completing a sales and use tax audit or a reverse audit is physically pulling the requested invoices and certificates. Even an audit that utilizes statistical sampling methods may still require thousands of records to be pulled for examination. This task, although necessary, is often labor intensive and lengthy. It can be a drain on an organization’s tax department, which is often already overextended. Using automated tools to ease manual gathering (several methods were highlighted in the Grant Thornton webcast mentioned earlier) can be a life preserver.

Automation options to streamline the document retrieval process are available through a variety of accounting, consulting and technology firms, yet the best place to start might be your own records-management service provider. When thinking about implementation of an automated data-extraction process:

  • Weigh the options and the costs your existing service provider offers
  • Consider that many service provider’s software systems are designed for handling customer service issues ― a payment dispute or some such ― not large-scale audits
  • Consider that a software vendor may have the capability to automate document retrieval and pull data, but it might be unaware of the need for audit purposes

There has been a huge transformation in tools available to help perform audit requests and reverse audits, and leveraging them can save your organization time, money and aggravation.

Brandon Hayes
Senior Manager, State and Local Tax
T +1 214 561 2565

Rob Clarke
Principal, State and Local Tax
T +1 813 204 5153

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