As Maine’s former state revenue commissioner, I fought many battles over unreported sales and use tax. States can’t audit every business, every year (nor should they). Like most states, Maine constantly battled to insure its audits were effective. State tax departments don’t want to burden businesses that are properly reporting and paying sales tax, yet they have an obligation to taxpayers to insure that everyone pays their fair share. This post examines how states select businesses for sales and use tax audits.
There is no magic formula and every state is a bit different. As technology changes and different trends appear, the tax audit selection criteria changes as well.
So what are the current criteria?
Certainly, size is a factor. A large retailer has a greater audit risk than a tiny kiosk in a mall. The larger the sales volume, the more likely an audit.
The industry profile of the business is also a criteria. Cash businesses frequently cut corners or keep poor records. State revenue officials know this and find that cash businesses often have more tax problems than businesses that sell products to the government, for example. Larger manufacturing businesses may be more at risk for use tax audits, however.
A sudden change in monthly sales figures can trigger an audit. All states now use automated data systems. These systems can account for seasonal variations (for example, an ice cream stand on the New Jersey shore will sell more ice cream in the summer). Anything that is out of preprogrammed norms may trigger an audit or at least a visit or call from the tax department.
Missing a return or a pattern of late file returns is also a big red flag. Businesses that are constantly late or missing returns are often in trouble.
Once you are audited, the chances of subsequent audits increase dramatically if the audit found significant problems. On the flip side, of course, a “no change” audit often means no new tax audits for years.
A couple more tips to remember. Although only New York State has a tax whistleblower program that pays rewards, often a jilted spouse or disgruntled worker is only too happy to go to the tax authorities. That can mean an audit if the information they provide appears credible.
Also note that sole proprietorships are often audited more than corporations, although this varies greatly by state.
If you are selected for a tax audit, don’t panic. Assuming your affairs are in reasonable order, an accountant should be able to help you if you don’t want to face the audit alone. Sometimes, sales and use tax audits are handled through the mail and a few letters can clarify an issue. Other times you may have to meet with an auditor and provide records.
If you think the risks are higher or you don’t have good records, consider hiring an experienced tax audit attorney. Many states are quite aggressive in their sales tax audits. If there is even a whiff of fraud, it is critical to insure that an audit doesn’t turn into a criminal prosecution.
For more information about tax audit defense, give us a call. From individuals, to small businesses to a major Fortune 500 company, we have handled a wide variety of tax audit cases. We also concentrate in criminal tax defense, IRS collections and Tax Court appeals and offshore reporting. Need more information? Contact attorney Bethany Canfield at or by telephone at (414) 223-0464. All inquiries protected by the attorney-client privilege.
Image courtesy of freedigitalphotos.net