Tips for a Painless Sales Tax Audit

I have just been through a Wisconsin Sales & Use Tax Audit with one of my clients and it left me with some tips for all of my small business client.

1. One of the first things you need to do when starting a business is to verify whether your sales are subject to sales tax or not. If none of your sales are subject to sales tax or all of your sales are subject to sales tax, then you do not have anything special to do. If some of your sales are exempt from sales tax, then you need to be sure that you have Exemption Certificates on hand. There is a penalty for claiming the exemption without having the Exemption Certificate from the customer. I recommend filing them alphabetically in a 3-ring binder and if you have the technology, also scanning them and attaching them to your customer record in your Accounting or CRM program.

2. The main area that is being audited lately is the Use Tax as more people are purchasing over the internet. An audit normally consists of an alphabetical sample over the past 4 years. For this reason, I recommend that you file all vendor invoices first by year, and secondly by Vendor in alphabetical order. If you have vendors that you purchase from regularly, they should have their own file. All other vendors can be filed under the first letter of their business name (a generic F file, for example). A normal accounts payable practice is to attach a copy of the check stub to the vendor bill when paid or to write the payment date, amount, and reference number, and account paid out of on the vendor bill if it is scheduled for electronic payment. Be sure that you obtain a vendor bill or receipt for all purchases since it will be assumed that you did not pay sales tax if you cannot produce a receipt. Filing by this method allows you to easily look up any inquiries for internal purposes and also allows you to easily pull the required sample (i.e., 2008 A-F vendors). If you are paperless, this same filing system is appropriate on your computer.

Vendor bills paid with a credit card cause an issue. Some people prefer to attach all invoices to the appropriate credit card when reconciling the credit card and then file the entire bundle under the letter for the credit card company. I prefer to mark on the vendor bills that they were paid by a particular credit card and then file them under the appropriate vendor file. This makes it easier to find a particular invoice as you can look directly in the vendor file and do not have to guess as to what month the purchase happened on the credit card.

3. The purchases that you need to treat with special care are all purchases for which you did not pay sales tax. This means that as each bill is paid, you need to check to see if you paid sales tax or not. If you did not, you need to verify that it falls within the law of items exempt from usage tax. If it does not, then you need to set those bills aside in a "usage tax" file and calculate the usage tax on them when you file your Sales & Use Tax Filing. In particular beware of the following:

• Internet purchases from out of state companies
• Purchases from companies that are normally exempt from tax due to manufacturing or resale but are being used for a purpose different than the reason for the exemption 
• Fixed Asset purchases. Each one of these was looked at separately (no sample was taken).

We have several clients who have so few vendor bills that they file first by the year, and then by a topic (i.e., insurance, purchases, etc), normally in an expandable file folder system. If your vendor bills are small enough to file using this method, that is fine as you will likely have all of your bills looked at instead of a sample anyway.

If a business files timely Wisconsin Sales & Use Tax returns, the records must be retained a minimum of the 4 years open to audit (7-10 is often recommended for income tax purposes anyway). If Sales & Use Tax returns were not filed, then records should be kept for a minimum of 10 years. Exemption certificates marked "Continuous" should never be destroyed.

In Wisconsin there are pen the sample is extrapolated over the 4 years of the audit and interest is calculated at 12% annually on errors. In addition steep penalties can be assessed for failure to produce the documents or failure to use them correctly. If you have any questions related to what is subject to sales or use tax, be sure to ask your accountant  for clarification.

Quarterly reviews

We are in the middle of quarterly projects right now which includes the filing of payroll taxes and the review of financials. 

We prepare actual reports for some of our clients which include analysis and suggestions.  Others need a less formal process, but we like to sit down with all our clients to talk about their financial statements.

If the client has a budget, we compare the actual results with the budget.  We ask questions about any variances in the results. If there isn't a budget, we just compare the current quarter to the previous quarter and the same quarter in the previous year. 

We look at the various ratios on the balance sheet (current, quick, A/R aging, inventory turnover, debt/worth) and the income statement (gross margin, net margin, sales growth).

Looking at the aging of receivables should be done regularly and past due accounts followed up on promptly.  The longer an account is overdue, the less likely the business is to collect.  Inventory should be monitored closely as well, especially if it is perishable.  Even non-perishable goods need to be watched as money is tied up in inventory and therefore can't be used to pay other bills.

Margins need to be looked at for various reasons.  Reduced prices during a sale need to be viewed from an overall standpoint to see if the results were a success.  Increases in the cost of raw materials need to be monitored to see if increases sales prices are warranted.  The same is true for increases in employee expenses-is your staffing level appropriate for your level of sales?

Business owners should be looking at their financial statements on a regular basis and asking these questions themselves, but talking them through quarterly with an accountant or financial advisor is often very helpful.

Does your accountant have a backup plan?

We met with a potential new client recently who had a sad story to tell.  He had an accountant processing his payroll including filing the payroll taxes.  She was a sole proprietor and was the only one who knew all the passwords and logins she used. The woman died unexpectedly and her husband did not know how to access her computer to get the information the client needed to be able to continue processing his payroll and handling the payroll taxes. 
As a result, he ended up missing some filing deadlines and ended up owing the government a large penalty and interest which put his business in a precarious spot.  E&S Entrepreneur Advisors, LLC has the benefit of two owners and we have many redundancies built in so our clients will always be able to get the information they need regardless of what happens to Beth and Susan. 
If you are working with an accounting firm, this shouldn't be an issue but this isn't the first time we have heard about problems with a small accounting business.  A single accountant is great because you are working with the same person every time and she/he really gets to understand your business.  Just make sure when you are creating your own disaster recovery plan, you ask about your accountant's!