EXTAX^®
Controlling and Recapturing Sales and Use Tax Overpayments

EXTAX® Special Topics:

SALES AND USE TAXES A KEY ISSUE FOR CLIENTS
By Dan Davis, CPA, CFE

Special to Monthly Statement

Sales and use taxes have become a major piece of the California tax pie. Some businesses face greater exposure from such taxes than from federal and state income taxes combined. For such firms, a sales tax audit can mean the difference between surviving and going under.

Until recently, few accountants paid much attention to sales and use tax. It seemed easy enough: sellers simply added a percentage to each sale and gave it to the state. In the past, rates were lower, enforcement was not as aggressive and income and other taxes made up a relatively larger segment of the overall tax burden. Accountants weren’t trained in this area, and considered it unimportant.

In recent years, however, the state of California appears to be more aggressively pursuing income from sales and use tax audit and enforcement programs. The state’s audit program has become more openly focused on raising money. Thus, the necessity for a deeper knowledge of the subject has become increasingly important.

Who’s Audit-Vulnerable?

Businesses that are particularly vulnerable to sales and use tax audits are: grocery and convenience stores; restaurants; bars; liquor stores; manufacturers; printers; advertising agencies; sellers of vehicles, vessels and aircraft; leasing companies; people in high-tech industries, including sellers of computers, software, cell phones, and so on; and construction contractors. This article reviews some of the issues CPAs will encounter in helping their client report sales and use tax.

When the Sales Tax Auditor Calls

Every auditor looks for both sales and use tax, although the emphasis varies with the type of business. The sales tax side is governed by a simple equation: total sales less deductions equals taxable sales.

In California, the revenue reached by the law is gross receipts from sales of tangible personal property. Within the covered revenue, the law exempts specific types of transactions, including sales for resale, sales to the U.S. government, repair and installation labor and sales in interstate commerce. Once exempt revenue is subtracted from total sales of tangible personal property, all that can remain is sales subject to the tax.
Auditors often emphasize only one or two of the three factors in the sales tax equation. In a business where virtually all transactions are taxable, the auditor usually reconciles recorded figures to those reported, traces to original documents for a test period and makes an indirect cross check such as a markup test or a bank deposits analysis. If no discrepancy is found, the sales tax leg of the audit is concluded. If differences arise, they are presumed taxable unless evidence to the contrary is presented.
In businesses where most receipts are exempt, the auditor first makes sure all recorded taxable sales were reported. Then nontaxable sales are sampled and traced to supporting documents. Unsupported deductions are projected throughout the audit period and developed into an assessment for additional taxable sales.
For most types of businesses, the search for additional use tax is more direct. Using asset registers, depreciation schedules or similar records, the auditor traces large additions of furniture, machinery and equipment to contracts, invoices and related documents. Any untaxed purchases of these items (usually from unregistered out-of-state vendors) are set up for assessment.
Taxable purchases other than fixed assets are examined on a test basis. Paid bills may be examined for a block of time or sampled throughout the audit period, which usually covers three years. Unreported purchases from out-of-state vendors are projected from the sample base to the audit population, unless the items were resold or are being held for sale.

Indirect Audit Tests

When examining smaller California businesses, most auditors apply at least one indirect audit test—tests that go “behind” the records—in addition to their standard review of the books and records. Indirect methods include markup tests, bank-deposit reconciliations and various specialized techniques used for particular industry groups.

Markup tests. Markup tests are commonly used in audits of retail firms. Auditors compute composite markup factors by extending samples of invoiced purchases to selling prices. They then verify recorded costs of sales, adjust them as needed and multiply the costs by the composite markup factors to arrive at “audited” sales. Any significant differences between recorded sales and “audited” sales are attributed to unrecorded taxable sales and assessed and penalized accordingly.

Bank-deposit reconciliations. Bank-deposit reconciliations may be used either to support markup audits or to check for additional taxable sales where a markup test would not be feasible. The auditor gathers bank statements, adds up the deposits and compares them to reported sales. Nontaxable deposits, such as loan proceeds or stock sales proceeds, are adjusted out. Remaining differences are taxed as additional sales.

Dan Davis is a senior sales and use tax consultant with Arthur Consulting Group, Inc. Contact him at (916) 686-4154.

California Society, Certified Public Accountants Monthly Statement, Oct.1999



EXTAX^® Controlling and Recapturing Sales and Use Tax Overpayments
	EXTAX® Special Topics: Projection of Credits Increases Texas Audit Recoveries Sales and Use Taxes a Key Issue for Clients Protesting a California Sales & Tax Audit Texas Sales & Use Tax Labor Partially Exempt During Phase-in Period SALES AND USE TAXES A KEY ISSUE FOR CLIENTS By Dan Davis, CPA, CFE Special to Monthly Statement Sales and use taxes have become a major piece of the California tax pie. Some businesses face greater exposure from such taxes than from federal and state income taxes combined. For such firms, a sales tax audit can mean the difference between surviving and going under. Until recently, few accountants paid much attention to sales and use tax. It seemed easy enough: sellers simply added a percentage to each sale and gave it to the state. In the past, rates were lower, enforcement was not as aggressive and income and other taxes made up a relatively larger segment of the overall tax burden. Accountants weren’t trained in this area, and considered it unimportant. In recent years, however, the state of California appears to be more aggressively pursuing income from sales and use tax audit and enforcement programs. The state’s audit program has become more openly focused on raising money. Thus, the necessity for a deeper knowledge of the subject has become increasingly important. Who’s Audit-Vulnerable? Businesses that are particularly vulnerable to sales and use tax audits are: grocery and convenience stores; restaurants; bars; liquor stores; manufacturers; printers; advertising agencies; sellers of vehicles, vessels and aircraft; leasing companies; people in high-tech industries, including sellers of computers, software, cell phones, and so on; and construction contractors. This article reviews some of the issues CPAs will encounter in helping their client report sales and use tax. When the Sales Tax Auditor Calls Every auditor looks for both sales and use tax, although the emphasis varies with the type of business. The sales tax side is governed by a simple equation: total sales less deductions equals taxable sales. In California, the revenue reached by the law is gross receipts from sales of tangible personal property. Within the covered revenue, the law exempts specific types of transactions, including sales for resale, sales to the U.S. government, repair and installation labor and sales in interstate commerce. Once exempt revenue is subtracted from total sales of tangible personal property, all that can remain is sales subject to the tax. Auditors often emphasize only one or two of the three factors in the sales tax equation. In a business where virtually all transactions are taxable, the auditor usually reconciles recorded figures to those reported, traces to original documents for a test period and makes an indirect cross check such as a markup test or a bank deposits analysis. If no discrepancy is found, the sales tax leg of the audit is concluded. If differences arise, they are presumed taxable unless evidence to the contrary is presented. In businesses where most receipts are exempt, the auditor first makes sure all recorded taxable sales were reported. Then nontaxable sales are sampled and traced to supporting documents. Unsupported deductions are projected throughout the audit period and developed into an assessment for additional taxable sales. For most types of businesses, the search for additional use tax is more direct. Using asset registers, depreciation schedules or similar records, the auditor traces large additions of furniture, machinery and equipment to contracts, invoices and related documents. Any untaxed purchases of these items (usually from unregistered out-of-state vendors) are set up for assessment. Taxable purchases other than fixed assets are examined on a test basis. Paid bills may be examined for a block of time or sampled throughout the audit period, which usually covers three years. Unreported purchases from out-of-state vendors are projected from the sample base to the audit population, unless the items were resold or are being held for sale. Indirect Audit Tests When examining smaller California businesses, most auditors apply at least one indirect audit test—tests that go “behind” the records—in addition to their standard review of the books and records. Indirect methods include markup tests, bank-deposit reconciliations and various specialized techniques used for particular industry groups. Markup tests. Markup tests are commonly used in audits of retail firms. Auditors compute composite markup factors by extending samples of invoiced purchases to selling prices. They then verify recorded costs of sales, adjust them as needed and multiply the costs by the composite markup factors to arrive at “audited” sales. Any significant differences between recorded sales and “audited” sales are attributed to unrecorded taxable sales and assessed and penalized accordingly. Bank-deposit reconciliations. Bank-deposit reconciliations may be used either to support markup audits or to check for additional taxable sales where a markup test would not be feasible. The auditor gathers bank statements, adds up the deposits and compares them to reported sales. Nontaxable deposits, such as loan proceeds or stock sales proceeds, are adjusted out. Remaining differences are taxed as additional sales. Dan Davis is a senior sales and use tax consultant with Arthur Consulting Group, Inc. Contact him at (916) 686-4154. California Society, Certified Public Accountants Monthly Statement, Oct.1999
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EXTAX® Controlling and Recapturing Sales and Use Tax Overpayments

EXTAX^®
Controlling and Recapturing Sales and Use Tax Overpayments