A Proactive Approach Eases Tax Audit Anxiety

Even in the best of times, state and local governments face revenue constraints and pressures to optimize tax collection efforts.

That is particularly true during periods of economic uncertainty. In response, state and local governments are increasingly auditing manufacturers and other businesses to ensure that tax obligations are being met.

If your company has not faced an audit, assume that it will happen. Here are some recommendations for making that scenario less daunting.

Be prepared for an auditor’s examination. Are proper documents and supporting files up to date and easily accessible? Do your manager and controller have the necessary experience and tax knowledge to handle an audit? By making preparation a continual process, you avoid having to respond in considerable haste when an auditor request arrives.

Be aware of requirements for multiple tax laws and stay compliant. There are thousands of state and local tax jurisdictions in the United States. There are franchise taxes, income taxes, use taxes, sales taxes and other forms of taxation applicable to various manufacturers.

Jurisdictions vary in the nexus, or the basis they use for determining tax obligations. While you cannot be an expert on tax laws throughout the country, you need to be aware of the disparate requirements affecting your business. That is especially relevant if your company’s operations span multiple states. You also need to remain compliant and ensure that filing provisions, payment deadlines and other compliance requirements are continually met.

Look for available exemptions. State and local governments offer tax credits and incentives for job creation, facility expansions, equipment purchases, training and other purposes. As a taxpayer, you must take the initiative in identifying which exemptions are available and desirable for your company.

Be aware of particular auditor concerns. Being aware of the documentation an auditor will want helps make an audit go more smoothly. Critical documentation includes tax records and supporting documentation, and claimed exemption documentation.

Is total income being reported? Have you reported all gross income, taxable income and taxes? Are proper controls in place for meeting financial reporting and tax requirements? In addition to posing those questions, auditors scrutinize situations in which a manufacturer has switched accounting methods, such as moving from a cash-based system to an accrual accounting method. In making such transitions, some reportable income may get overlooked. Auditors will seek verification that all income was recognized and reported.

Taxing knowledge

Are your products taxable, and where do sales occur? Local and state regulations differ in defining what items are subject to sales tax. Also, while your products may be sold to a distributor, wholesaler or some other entity besides the retail customer or end-user, do not assume that sales tax issues are irrelevant. You must maintain documentation that proves your product sales are not taxable or that the proper party is collecting and paying sales taxes on those goods. Jurisdictions vary, too, in how they determine locations of sales or purchases for tax purposes. Auditors will examine whether applicable tax laws are being followed.

Assess your exposure and look for relief when necessary. You need to objectively assess your company’s tax liability exposure. If you uncover known liability, in some tax jurisdictions, voluntary disclosure may be your best option. Such disclosure may save you from having to pay related interest or penalties. In some states, you can request a managed audit—conducted by your company—when you receive an audit notification. That can save interest and penalty costs, too.

No manufacturer wants to face an audit, but preparing for one makes such evaluations less onerous. Such preparation also prompts companies to continually improve reporting processes, and to evaluate tax issues in a strategic manner.

Tony Rocha, CPA, is a Tax Manager for Weaver and Tidwell, L.L.P. He can be reached at alrocha@weaverandtidwell.com
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