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Understanding the tax audit process

|  March 13, 2020
PHOTO: KANGESTUDIO/ISTOCK / GETTY IMAGES PLUS/GETTY IMAGES

PHOTO: KANGESTUDIO/ISTOCK / GETTY IMAGES PLUS/GETTY IMAGES

At some point, your company probably will be selected for a sales and use tax audit — and you’ll need to be prepared. For those pest management professionals (PMPs) who are in states where services are not subject to sales tax, you may think you dodged a bullet. Not true! While the services you sell may not require you to collect and remit sales tax, many of the products you purchase for your office, inventory and operation are subject to use tax. And, use tax falls within the guise of this type of state audit.

WHY WERE YOU CHOSEN?

Your company may have been selected for a sales and use tax audit for a variety of reasons. It could be the state has chosen the pest control industry as high-risk. It could be that your trucks were spotted in a nearby state in which you have not registered for taxes. It could be that one of your suppliers was audited, and your company was red-flagged. Or you could have been chosen at random.

No matter what the reason is, make sure that once you receive the “Request for Audit,” you understand the process, hire a certified public accountant (CPA) with industry experience, and are prepared for a little old-fashioned aggravation.

WHAT INFORMATION WILL THE AUDITOR LOOK FOR?

A sales journal will be required, where the auditor will make his or her selection, looking for sales invoices evidencing what was sold and whether sales tax was charged when required. If there’s no journal, are there resale or tax-exempt certificates on file? If no tax was charged when required, this will add to the error rate discussed below.

Next, a purchase journal will be required that includes all vendor purchases made by your firm. The auditor will select vendor invoices from it to test whether sales tax was properly charged to you, or if you accrued and properly paid use tax on purchases you made during the ordinary course of business. I can tell you from experience, this one becomes difficult, especially for those who make most of their purchases with credit cards. That’s because the original invoices evidencing sales tax paid aren’t usually available, and either need to be secured or added to the error rate — again, discussed below.

Fixed asset purchases during the audit period, along with invoices, will be examined to make sure sales or use tax was remitted. When these items are purchased out of state, that’s where you usually run into trouble. That’s because most sellers doesn’t charge the tax and you, as the buyer, many times don’t accrue and pay the use tax.

Finally, you will be asked for financial statements, bank statements and tax returns, including income and sales and use tax. These items will help confirm that everything is being reported and that all sales and use taxes are accurately remitted.

WHAT HAPPENS IF THE AUDITOR FINDS ISSUES?

As the auditor looks at the material you provide, there probably will be some items that are tax-deficient; he or she will be looking for tax, penalties and interest on those amounts. But that’s not all. Remember the error rate mentioned above (twice)? Well, say the auditor establishes a 5 percent error rate in the sample he or she has taken. This means that 5 percent of the invoices examined should have had sales or use tax accrued and paid. Then, that 5 percent will be applied to the entire period open by statute, usually three years.

This can become extremely costly, and all options — including conducting a full-blown audit for the entire period open under statute — may be wise. You should speak with a qualified CPA or tax attorney to determine the proper course of action.

The above is just the tip of the iceberg on the sales and use tax audit topic. If you get that letter in the mail requesting an audit, call a CPA familiar with the pest control industry to manage the process.


GORDON owns PCO Bookkeepers, an accounting and consulting firm that caters to pest management professionals throughout the United States. He can be reached at dan@pcobookkeepers.com.

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