Sales and use tax reverse audits: what to expect. (State & Local Taxes).

The sales and use tax reverse audit conducted by tax practitioners is similar in many respects to the sales and use tax examinations conducted by state revenue auditors, except the reviewer or tax consultant is seeking the identification and recovery of sales and use tax overpayments remitted

Historically, the reverse audit focused on a manual approach to identify erroneous payments of sales and use tax. This approach has, for the most part, changed in the last several years, with the ability to use electronic data downloads of a company's accounts payable payment files and statistical sampling.

Objective of a Sales and Use Tax Reverse Audit

The objective of recovering erroneously paid sales and use tax can be achieved by reviewing a company's self-assessment of use tax and the analysis of the sales and use tax remitted to the company's suppliers on purchases that qualify for various sales and use tax exemptions.

Several factors are responsible for the overpayment of sales and use tax. In many states, state auditors have become very aggressive in auditing taxpayers and denying various exempt sales. Their aggressiveness results in suppliers denying applicable tax exemptions and charging sales and use tax on purchases normally exempt. An inadequate sales and use tax compliance system may allow tax to be erroneously paid as a use tax on purchases and as a sales tax billed to customers on sale transactions.

Generally, it is the responsibility of the purchaser to make a claim for the exemption. If the exemption is not claimed, the supplier will normally charge sales tax. Many companies have their accounts payable group review purchases to prevent the payment of tax on exempt purchases. If the accounts payable group is not properly directed or advised, sales and use tax may be paid to suppliers in error.

Performing a Sales and Use Tax Reverse Audit

The sales and use tax reverse audit generally starts with meetings at the corporate office and/or possibly at the plant locations or both with the appropriate tax professionals, accounts payable manager, capital asset coordinator and systems personnel familiar with tax reports and accounts payable payment files. During these meetings, it is imperative to gain an understanding of the company's sales and use tax compliance system. Understanding the compliance system will include how taxability decisions are determined at the time purchases are made. Many companies use sales and use tax manuals; others have online systems to communicate the taxability determinations of equipment and supply purchases. It is recommended to review the source of the taxability determinations to identify areas for potential tax recoveries. During the initial meeting, it is important to determine if the taxpayer is a direct-pay holder. The direct-pay permit allows the taxpayer to make purchases without remitting sales tax to a vendor. Instead, the taxpayer is required to self-assess and remit use tax on the taxable purchases directly to the tax authorities.