Preface: Segueing into Segment II…. When sales and use tax compliance issues are located from uncollected or under-accrued tax payments, sometimes with substantial penalties and interest too, it can result in a few businesses even needing to embark on emergency measures……
Appropriate Steps to Avoid the Web of Sales and Use Tax Risks (Segment II)
Credit: Donald J. Sauder, CPA | CVA
Farm Manufacturing, Inc.
Farm Manufacturing, Inc. had been operating for a number of years as a successful metal fabrication company of agricultural equipment. The three-person office staff had rotated in recent years, with better job offers and changes of pace. The experienced office manager was established, and had been there for more than five years, and Ephraim had reason to trust his team and placed confidence in their knowledge of accounting to keep his business running successfully. When he saw an tax audit notice on his desk for sales and use tax from the State Department of Revenue, he never envisioned the sales tax audit problems looming.
After his office manager advised him to contact his accountant with regards to the seeming complexity of the sales tax audit notice, Ephraim mentioned on the phone call to his accountant that he didn’t handle any of those tasks, and was assigning his accountant responsibility to resolve. The accountant responded that he was aware from notes and discussions that Farm Manufacturing, Inc. prepared and filed all sales tax forms in-house, but that he’d be happy to help with tax audit.
After reviewing the information document requests Ephraim forwarded, the accountant contacted the office manager for copies of the prior sales tax filings. The office manager replied, after talking with the accounting department that they were unaware of any necessary filings having ever been prepared for audit period, and more importantly, none had been prepared or filed since they had been at the company to their knowledge. In fact, and furthermore, the registration for sales tax filings, had apparently never been approved at the State Department Revenue.
The accountant began an assessment of the taxable sales from the business with a review of the vendor transactions and revenue type, and calculated the unpaid tax may be around $15,000 to $25,000 per year.
After scheduling the initial audit meeting, that included three days on site filed work, reviewing GL detail, tax filings, customers list’s, invoices, and sale records, it was apparent that the auditor was aware the filings had been both unpaid and unfiled, and that there was substantial tax assessments likely. Since there was no record of what was taxable and what was non-taxable, the auditor prepared their own assessment of $140,000 unpaid sales taxes for the audit period, assuming the tax filings had been appropriately prepared.
The accountant deemed the sales tax to costs or liabilities to be substantially less than the auditor assessment, and requested additional time to work through the details and prepare proper sales tax filings. After a several weeks’ project, the accountant had the revised numbers and prepared sales tax filings, with supporting documents, and scheduled a follow-up with sales tax auditor.
At the meeting, the accountant met with the auditor, to discuss the settlement cost of the Farm Machinery Inc. unpaid audit sales tax liabilities. The sales tax filings indicated the total cost was $92,000 plus accountant fees. The auditor wanted time to review the documents. After, negotiations, they agreed on an $105,000 settlement with an agreement the sales tax compliance would be followed in the future with all tax filings prepared, and taxes submitted to the state, plus penalties and applicable interest.
In this instance, Ephraim assumed his business was running with all tax compliance features in place, and since the accountant was not assigned to file sales tax reports, was unaware of the non-compliance and omission of a standard tax filing feature. More concerning, the accountant made inaccurate assumptions about his clients, given that no sales tax liabilities were ever listed on the balance sheet. The $105,000 settlement reduced working capital to critically low levels. The business survived. Yet, it is not always that way for small business organizations who contact sales tax shoals.
Any business that has experienced a field audit for sales and use tax examinations knows a sales tax and use tax audit can be expensive and create substantial financial problems for a business. When compliance issues are located from uncollected or under-accrued, sales and use tax, sometimes with substantial penalties and interest, can result in a few businesses even needing to embark on emergency measures as outlined in the prior two examples.
Conclusion of Segment II of III