Note: I wrote this post a couple of years ago, but thought I would revive it.
I was watching mixed-martial arts (UFC fighting) and as the announcers were describing the game plan or approach to the fight one of the fighters was taking, the announcer said the fighter was focused on "defining the fight." Meaning, he had developed a strategy and trained accordingly before the fight even started. He had studied his opponent to know his strengths and weaknesses. He had also studied himself and recognized his own strengths and weaknesses.
This is how we should approach multistate tax audits and (in my opinion) life in general. We should develop a strategy and prepare for an audit before it even starts. Preparation helps to eliminate surprises. It also helps you know what to do when things start going wrong. Thus, we must work proactively to 'define the fight.'
In that context, I thought I would provide some general guidelines or ways to 'define the fight' when faced with a multistate income tax or sales and use tax audit:
- Become acquainted with the auditor's supervisor and the manager of the audit office.
- Don't waste time negotiating with the auditor unless you know he has the authority to make a decision. However, don't go over the auditor's head unless absolutely necessary.
- Question why you were selected for audit. Find out how long the audit will take.
- Prepare an audit plan
- Establish ground rules
- Available resources
- Time to prepare documents
- Scheduling of in-office visits
- Procedures for requesting records
- Contact person for auditor (one person)
- Status reports by auditor (don't want surprises)
- Review statute of limitations
- Extending statute of limitations - applies to refunds as well?
- Restricted waivers - statute of limitations open to only particular issues
- Conditional waiver - waive only if assessment prepared by certain date
- Extend statute of limitations only 6 months from date scheduled to come to office
- Negotiate limitation on scope of audit in exchange for signing waiver
- Don't sign if auditor has wasted time (cancelled appointments, etc.)
- Narrow down auditor's request to highest level possible
- Review sampling technique proposed by auditor
- Make sure it is representative
- Statistical sampling?
- Block sampling?
- Ask auditor to include accounts with possible tax overpayments (may lower estimated error rate by increasing the size of the sample)
- Request auditor to submit document requests in writing
- Examine prior audit files
- Examine current tax related files
- Minimize audit adjustments before they happen
- Educate company employees
- Compile basic info
- Perform reverse audit to identify refunds or credits
- Ask auditor to identify overpayments
- Tax paid in error
- Ask for credit within audit or submit refund request
- Vendor / Vendee liability state?
- Review auditor's preliminary work papers
- Exit conference
- Know whether the auditor has the power to negotiate
- Request waiver of penalties and interest
- If we pay today, will interest stop accruing?
- Pay tax on agreed issues to stop interest
- Give auditor a check with as little interest as possible
- Get copy of revised / final work papers
- Re-examine with auditor or supervisor if misunderstandings occur
- request electronic copy of auditor's work papers/assessment so we can reorganize with reason why exempt
- Mark all as "disagree" (until resolution reached)
- Protest (in writing and/or request a hearing)
These are only GENERAL guidelines I have developed throughout my career. They are NOT hard and fast rules. Each case is different and as a result, some guidelines may not make sense. Consequently, please seek the advice of an experienced state tax advisor before implementing any of the ideas provided.
For the most part, I have had great experiences with auditors and built strong working relationships. However, sometimes you are forced to go to appeals to resolve issues and obtain a fair result when the facts or law are being misinterpreted or misapplied.
Hopefully these guidelines will help you when you or your clients receive the dreaded "you've been chosen for audit" letter.