FLORIDA SALES & USE TAX AUDITS:
DUELING PERSPECTIVES
As one of the few Florida licensed attorneys to have ever worked as both a Sales and Use Tax Auditor for the Florida Department of Revenue (FL DOR) AND as a private attorney representing clients against the FL DOR, I have a rather unique perspective on the entire sales and use tax audit perspective. What follows is a peak behind the curtain of a Florida Sales and use tax audit, from both perspectives.
THE INITIAL AUDIT NOTICE
AUDITOR: The process begins with the issuance of the DR-840 (Notice of Intent to Audit Books and Records). In some instances, the taxpayer will know this is coming because some auditors (myself included) will call to get some basic information about the taxpayer and confirm the best location to send the notice and accompanying materials. As "nice" as this is, I believe a good number of auditors don't contact the taxpayer before the Dr-840 is mailed so the taxpayer receives the lovely notice with no warning. The DR-840 should contain a checklist of documents the auditor thinks will be needed to complete the audit. A lot of auditors include items they think they might need. Although this checklist might initially appear daunting, it essentially is informative in nature. The DR-840 should also include a questionnaire that covers basic pre-audit entity questions to get more background on the taxpayer's operations and computer information. The auditor ideally would like the taxpayer's electronic records and the questionnaire identifies the particular service center's computer audit analyst who can provide assistance in getting and/or converting the taxpayer's electronic information into a format the Department, and the assigned auditor, can use. The final parts of the DR-840 packet should be pamphlets relating to the "Taxpayer Bill of Rights" and "What to Expect from an Audit". Though they should be there, I cannot confirm that they are, in fact, always included. They are supposed to be provided.
TAX PROFESSIONAL: From the taxpayer's perspective, though the auditor would like electronic records, there are concerns you should have in providing that. Obviously, if your records are incomplete or otherwise have errors then providing complete records potentially creates big issues. If you don't have the detail for records which had tax included, the auditor will conclude the tax was incorrectly handled in the absence of contradictory information. They say good help is hard to find and an employee who made mistakes can create audit issues (especially if they are no longer employed by that taxpayer). Assuming that doesn't apply and your records are complete and accurate, some auditors will find accounting entries (regular and/or adjusting) and request support or an explanation for them. They could be simple entries to adjust information but an auditor (and his higher ups) may view it as a transaction. I have seen this happen and go to protest since it is hard to explain an entry is just that to someone who refuses to see something in a ledger as anything but a taxable event. Finally, a whole electronic ledger or download provides information to an auditor that they don't need for the audit. Payroll or ownership information is not relevant to the sales and use tax audit and providing it does nothing to add to the audit and simply opens up the opportunity for confusion or accidental disclosure.
INITIAL RECORDS REQUEST
AUDITOR: At this point, the auditor has given the taxpayer a couple weeks to return the questionnaire. Assuming the taxpayer has done this, the auditor will receive the questionnaire and look to call the taxpayer to inquire about electronic records and try to get them. As an auditor, I always wanted to get these answers because I could analyze the entries and check totals versus various control documents. Generally, I could get a fairly good idea at an early stage if there were "issues" in that taxpayer's audit. The auditor, at this time, will also request information be produced with the taxpayer's federal tax returns at the top of that list. Essentially, the first audit step involves comparing federal return gross sales to the taxpayer's DR-15s (monthly sales tax returns). If there is a discrepancy, the auditor will ask the taxpayer to explain it. If it cannot be adequately explained, the auditor will assess tax on that amount (or at least an allocated portion of it). The auditor most likely will also try to coordinate a date to conduct an interview to get further information on the books and records available (and get federal tax returns and other information they can get) and tour the taxpayer's site to see if there is anything that is inconsistent with the auditor's understanding of what the taxpayer does (and reports on its returns). At this point the auditor will probably talk about dates for audit field work.
TAX PROFESSIONAL: From the taxpayer's perspective, the first thing the taxpayer should remember is that the DR-840 indicates the taxpayer can waive the 60 day waiting period. By express provision, the taxpayer has 60 days to prepare for the audit. Does that 60 day period mean not responding to the pre-audit questionnaire and electronic audit survey? What about providing tax returns? I am not aware that this has been litigated to an ultimate decision. Waiting to provide information has the benefit of allowing the taxpayer to be "ready" to address reporting discrepancies rather than having the auditor review information and make conclusions with only partial information. As a side note, early after receiving the notice of audit, the taxpayer should request the report of its monthly sales tax return information for the audit period. The Department runs reports on an audit taxpayer's information that provides return information "as filed" and "as calculated". The "as filed" is a report of what the taxpayer actually filed. The "as computed" is what the Department has determined as what correctly should have been reported. I would recommend each just to compare.
SCHEDULING THE AUDIT FIELD WORK
AUDITOR: This gets us to one of the difficult issues of a sales and use tax audit – scheduling the review of information. I know that some service centers have been instructed to set up audit field work two months out from any given week. This is a general guideline but puts an auditor in a position where they have to set up the taxpayer's audit in a schedule that is trying to be coordinated with a number of other taxpayers – all at the same time. This sets up a rather precarious situation. As the taxpayer's scheduled audit field work date approaches, there is no telling if the auditor's or the taxpayer's schedule have changed due to immovable obligations. Assuming one side can no longer accommodate the schedule, those field work dates have to be adjusted and you are back at the previous precarious two month position. But now time has passed and statute of limitations issues impact the auditor and the performance of the audit. As you might or might not know, once the DR-840 is sent, there is a one year time limit to get the audit conducted and have the Notice of Proposed Assessment become final. Though this sounds like a long time, it passes quickly. With the issuance of the DR-840, the taxpayer is statutorily provided 60 days to prepare for the audit. This means the auditor cannot begin the work before those sixty days pass unless the taxpayer signs a waiver. This one year time frame is also impacted if the particular taxpayer wants his Tax Professional to handle the audit as the primary point of contact. Due to tax season, and the usual post filing date recovery period utilized by most accountants, auditors usually have difficulty getting time to work with a Tax Professional from late January through the end of April. Thus, almost four months are taken out of the year time period if the taxpayer is having their Tax Professional "manage" the audit.
TAX PROFESSIONAL:From the taxpayer's perspective, this may sound like a non-issue for a taxpayer but it is complicated by what you can expect. A taxpayer cannot plan for the unexpected that comes up in its operations. And, it cannot plan for the schedule or practices of the auditor assigned to it. The auditor has complications in other audits which necessarily impact other audits assigned to that auditor potentially including you or your taxpayer. And, if reconciling schedules drags out, the Department may issue the DR-1215 (Notice of Intent to Make Audit Changes) which, in this case, usually means every assumption possible has been made against the taxpayer and they have to refute those assumptions - but in a much shorter time period and regardless of what is going on with the taxpayer's schedule - business or personal.
FIELD WORK BEGINS
AUDITOR: Assuming the stars have aligned with no unexpected delays, which is a big assumption as taxpayers' schedules are unpredictable and the auditor's prior audit obligations cannot cause obstacles, you have now gotten to the field work portion of the audit. Here, the auditor comes to the location where the taxpayer's books and records are located. This means either the auditor is at the taxpayer's place of business (and impacting those day to day operations to some degree) or at the Tax Professional's location. The length of the audit field work will vary depending on the taxpayer's size, nature of operations, "quality of records" and audit methods to be employed. Prior to the field work, the auditor will have discussed the audit with the auditor's supervisor and planned out what records will be reviewed. The auditor can either "sample" some months or perform a "detail" review. With the "sample" method, the auditor will review a portion of the audit period's months. And, to clarify, the audit period is statutorily set at a three year period from the taxpayer's most recent return due at the date of issuing the DR-840. Any transactions "generally" outside this time period are irrelevant for assessment purposes. I say "generally" because there are situations that allow the audit to go back further, but that is another discussion. Another note for the "sample" method is that the auditor can use the auditor's "judgment" and pick months or they can use a program to randomly pick several months which also identifies "spare" months. Or, the auditor can choose a "detail" audit and review every record for a set time period up to the whole audit period. Before you get scared that the auditor will spend weeks on reviewing everything, the auditor has been provided with time expectations within which the auditor is expected to complete the audit. The auditor attempts to meet this target but they can be granted more time or simply exceed the "allotted" time.
TAX PROFESSIONAL: From the taxpayer perspective, with sampling, the auditor sends the sampling plan to the taxpayer. Though already signed by the auditor, the taxpayer does not have to sign it. Using a sampling plan versus a detail review makes the audit process quicker which generally is favored by both sides. And, the sample months selected are supposed to be "random" but the months can be judgmental which means the auditor used his judgment to pick the months. But there is the problem that random doesn't mean it is "typical" for the taxpayer. Maybe a temporary or poor employee impacted the month's reporting. Maybe there were special purchases or events that occurred. With the sampling, each month is treated as representative of the period and then apportioned over the audit period. The taxpayer would like to benefit from an expedited audit and less interference with the operation of its business but risks abound when you limit a sample and then apply it broadly.
AREAS OF FOCUS FOR THE AUDIT – RENT & FIXED ASSETS
AUDITOR: Now, the auditor is reviewing the documents. Generally, the auditor is focused on four areas of the taxpayer's operations: sales, purchases, fixed assets and commercial rental. Commercial rental seems to be a "hot button" for the Department lately and it is one that generally is straight forward for the auditor to handle. The auditor conducts preliminary research using property appraiser websites to identify the owner of record for the taxpayer's location and then looks at the lease for its terms. The auditor will then review payment information to verify tax was charged at the proper rate and actually paid by the taxpayer. This usually is clear cut if the taxpayer has a single location or owns the property. The usual complexity arises when the taxpayer has paid items outside of rent and the respective payments (property taxes or HOA fees for the property) are considered additional rental consideration where tax has not been charged or remitted.
Fixed assets, generally, are another area that isn't too complex. The auditor will look at the taxpayer's federal returns to find depreciation schedule listing fixed assets that were placed in service for the audit period. If those aren't available, the auditor will seek the taxpayer's general ledger. For most taxpayers, this isn't a large area. The biggest concern, as we will discuss shortly with purchases, is if the taxpayer purchased items tax free and did not accrue and remit use tax. This often happens when purchasing items tax free over the internet or improper use of the taxpayer's exemption certificate.
TAX PROFESSIONAL: From the taxpayer's perspective, this relates back to the information issue from above. Tax returns need to reflect information correctly for the audited party. Information reported on the return is treated as correct. In the case of separate but "related" entities, information reported incorrectly can lead to tax consequences. A case I saw, two separate companies with different operations had the same management. One company had better cash flow and purchased an asset for the other company. It was paid for through "management fees" by one company but not taken off the books of the other. That is a fixed asset that isn't used in the business and is not being offered for resale. The Tax Professional had not cleared it off the books and there was use tax due. It went to protest and I am not sure how it turned out. But, at the least, there was a lot of stress and time not spent on either company's operations.
AREAS OF FOCUS FOR THE AUDIT – SALES
AUDITOR: Now, we have the two "big" remaining audit areas – sales and purchases. For a lot of taxpayers, the primary concern is one or the other. But, for some taxpayers, there are concerns with both. As noted above, the auditor has compared the taxpayer's federal return sales to those reported on its monthly sales tax returns. In comparing this, the auditor has also been able to review taxpayer's monthly sales tax returns to look at the tax rate, taxable ratio and amount of exempt sales reported. The auditor has looked at these amounts to see if they vary from "expectations". This is a bit nebulous because the auditor can target some of these areas specifically or can plan to analyze them in light of a review of sales generally. Most auditors will review sales generally and determine from there how the reported numbers compare. The auditor might see the taxpayer's particular monthly tax rates and see that they are a flat tax rate (for example 7.000% for Hillsborough and many Florida counties) and look to verify that the taxpayer took sales for a month and divided by 7% to get taxable sales. Or, possibly the taxpayer took actual sales and multiplied by 7% to get the tax due. Both of these methods provide the chance of error as the amount of tax collected is also an issue. Because, by statute, tax collected is the State's property and must be remitted even if the tax was at the wrong amount or not even due in the first place. Either way, the auditor is looking to verify the taxpayer complied with tax on sales. Furthermore, the auditor will verify exempt sales were properly treated and calculated. Here is where I have seen a divergence on practice. Some auditors strictly adhere to the requirements in Rule 12A-1.039 Florida Administrative Code (F.A.C.) which require copies of resale and exemption certificates be kept on file (or vendor resale authorization number). Yet, I have known other auditors (myself included) who would review purportedly exempt customers in the Department's system to verify their registration without a resale certificate if it was a reasonable situation. Yes, the auditor can check to see if the buyer is registered, but I believe the second situation is the exception and not the rule as I have seen a number of assessments involving disallowed exempt sales. This is a situation good business practices or procedures can avoid.
TAX PROFESSIONAL: From the taxpayer's perspective, a taxpayer (generally most in my opinion) has tried to run his business in compliance with the tax laws and give the State is proper due. But, for any number of reasons such as ignorance or bad advice (even from the DOR) can lead the taxpayer to improperly treat sales. Or, in many other cases, allegedly not treat (or document) exempt sales properly. It would be nice if exempt entities knew what they should do for the vendors they are using. But, most exempt entities don't worry about what they should do for vendors if they get their exempt rate or are under the misconception that possible federal exemption is synonymous with State requirements. This is not the case and the taxpayer suffers if they don't know or get bad advice.
AREAS OF FOCUS FOR THE AUDIT – PURCHASES
AUDITOR: This leaves us with the last remaining audit area – purchases. This is often a major component of the auditor's audit. Depending on the industry, the taxpayer might have to accrue use tax on purchases or the taxpayer purchased the item tax exempt for one reason or another. Generally, use tax on expenses is a common reason an audit is scheduled. The majority of taxpayers do not remit use tax on their returns. The auditor will research the taxpayer's industry to get an idea of how the taxpayer should treat purchases made for its primary operations. This refers back to what I previously mentioned and the auditor will determine if the taxpayer should purchase items exempt. If so, the auditor likely will give a cursory glance to those purchases records because the taxpayer's payment of taxes for items it should have purchased exempt is not a focus point of the audit. If the auditor notices the occurrence, the auditor should alert the taxpayer to the incorrect practice. The auditor may not give a refund on purchases during the audit as the proper procedure is to get the particular vendor to return the incorrectly paid tax and then the vendor can file for a refund after returning the tax to the taxpayer. However, if the taxpayer can get a sworn statement from the selling vendor that tax was paid by the taxpayer and remitted to the State by the vendor, as well as an assignment of rights to the refund, then the taxpayer may be entitled to the refund during the audit. In addition to these purchases, and of more concern to the auditor, the auditor will review "general" purchases to determine what items were purchased tax exempt. For most taxpayers, this comes down to internet purchases. A number of vendors now charge tax on internet purchases because they have realized they have nexus with Florida and could be liable for those taxes. However, most taxpayers still go online for various purchases it is easier or cheaper to do. The auditor generally performs a detail review of specific vendors or expense accounts to find these untaxed transactions and schedule them. It is a bit time consuming for an auditor to detail these expenses for the taxpayer and catalogue the improperly treated transactions.
TAX PROFESSIONAL: From the taxpayer's perspective, use tax is one of, if not the, most common audit assignment reasons. Taxpayers try to run their business the best way they can which is to minimize costs to maximize profit. Where do the best prices usually come from? The internet. So, it takes an educated taxpayer to be compliant. The taxpayer can get the item it needs over the internet but it needs to properly treat the item which oftentimes includes accruing use tax on the item it purchased online and had delivered to it. Even taxpayers with tax departments don't always get this right. What is more common, and can be more detrimental, is where a taxpayer uses a credit card for its purchases. Taxpayers use the card to consolidate purchases but it needs more documentation that just the statement to support proper tax treatment. Credit card statements don't show prices but only totals. That is not enough for most auditors. The credit card statement documents purchases for a Tax Professional to classify the item for federal reporting purposes but typically does not meet an auditor's requirement. Informal or lax accounts payable practices can lead to large tax consequences that go far beyond simply paying tax twice for an item. There is interest and possibly penalties beyond paying tax on tax (if the transaction doesn't show the tax but only the total, then the total with tax is scheduled by the auditor as taxable) and also on other exempt amounts like freight if it is only a lump sum amount that lacks proper documentation. Auditors find these error types in most audits - though sometimes not to a material enough amount.
COMPLETING THE AUDIT
AUDITOR: Now, hopefully the auditor has finished the audit field work and it is time to prepare the auditor's findings. There could have been delays in getting to this point due to conflicts of schedule, incomplete records being provided (or the auditor claiming such) or questions about treatment of various transactions which have required the auditor to get guidance from Department management (either the auditor's supervisor or higher). Assuming we are done with the audit field work, the auditor has to prepare exhibits and write up the standard audit report. Remember, the auditor likely has other audit appointments previously scheduled around the particular taxpayer's audit field work. The creation of the exhibits and standard audit report can take time as the exhibits require citations to proper legal authority either statutory or the F.A.C. After completing the exhibits, the auditor hopefully will send a draft copy to the taxpayer so they can investigate to see if they disagree with some or all of the transactions. Regardless, the exhibits and standard audit report must be provided to the auditor's supervisor for approval. Unfortunately, I have seen that the time involved with this varies greatly. In some cases, the review takes weeks or months. Though, in most cases, this takes only days. But, the point here is that the audit field work is over but any resulting assessment is still not to the taxpayer. If the auditor has not updated the taxpayer on the potential additional liability during audit field work, the Taxpayer can be lulled into a false sense of security and/or forget about the audit altogether due to normal business operations. But, all the time, interest is accruing during this process. Understandably, the Department wants to "get it right the first time" so there is an inherent delay. But, taxpayers need to be aware that they should monitor the audit progress to minimize interest accumulation as much as possible.
Once the auditor's findings are approved, the Department issues a DR-1215 (Notice of Intent to Make Audit Changes). At this point, the taxpayer is granted 30 days in which it can schedule a conference with the auditor and/or the auditor's supervisor to contest the audit findings or provide additional documentation to remove items from the proposed assessment. If the taxpayer and Department disagree on the tax treatment of certain transactions, the parties can prepare a RTA (Request for Technical Assistance) from TADR (Technical Assistance and Dispute Resolution) on how the transaction(s) should be treated. More on this situation/procedure can be its own topic. The Department has taken the position that additional documentation should be provided all at one time so that there is only one revision of the DR-1215. If the DR-1215 is adjusted and reissued, the 30 day period begins anew. Once that passes, the audit is sent to Tallahassee where a NOPA (Notice of Proposed Assessment) is issued. As titled, it is only a proposed assessment as there is a 60 day period before it becomes final. The NOPA includes an explanation of various options to contest the assessment. But, that also, is another subject for another time.
TAX PROFESSIONAL: From the taxpayer's perspective, Department personnel will tell you what they have been told/taught which may not be all of the story. I don't say that to imply they are trying to mislead a taxpayer. In most cases, Department training of employees isn't homogenous (which can be good or bad) meaning some people are told one thing and others another. They might not be correct. Most Department employees try to give the best and right information (at least as far as they know). So, taxpayers would benefit from good record keeping when seeking advice. But, taxpayers should realize Department personnel are not the Pope and not infallible. Incorrect information from Department personnel that are undocumented don't get much sympathy from an auditor and the taxpayer is on the hook for the incorrect treatment repercussions. Along with realizing the importance of correct information, taxpayers need to be aware of abating the two components in addition to tax liability from an audit - penalties and interest. With or without the assistance of a Tax Professional, taxpayers need to know they can argue for reduction in penalties and/or interest. Interest is generally harder to get abated. But, think back to when trying to schedule the audit. Any actions taken by the taxpayer to get the audit performed and actions taken by the auditor and/or Department which extend the audit can be argued as a basis to reduce the components of the assessment.
SUMMARY
I hope this has proven helpful and at least a little educational. The explanation above is a generality and any particular audit can vary based on the factors I listed above with respect to the time it takes to conduct an audit or schedule related (or, as is very common these days, the assigned auditor's departure from the Department). I feel this is representative of what a taxpayer can expect from a "standard" audit. If you disagree, I would gladly discuss it with you further.
ABOUT THE AUTHOR: Mr. Parker is a sales and use tax attorney and an associate in the law firm the Law Offices of Moffa, Sutton, & Donnini, P.A., based in the firm's Tampa office. Mr. Parker's practice includes state tax audits and controversies involving sales and use tax and all other state taxes including communication service tax, cigarette & tobacco tax, motor fuel tax, and Native American taxation. Mr. Parker received his law degree and L.L.M. in Taxation from the University of Florida. If you have any questions please do not hesitate to contact him via phone as listed on his bio on the firm's website or via email at MatthewParker@FloridaSalesTax.com.
ADDITIONAL RESOURCES
FLORIDA SALES AND USE TAX – AUDIT TIMELINE FROM THE DOR'S PERSPECTIVE, dated April 6, 2014, by James Sutton, CPA, Esq.
FLORIDA SALES TAX AUDIT HELP, dated July 14, 2013, by James Sutton, CPA, Esq.