A sales tax audit has key differences from a regular audit. First, the scope of the audit looks at a business’s gross receipts and various ways of measuring gross receipts. The businesses that are most frequently subject to sales tax audit include bars, restaurants, retail stores, manufacturers, wholesalers, services businesses that sell goods, and a variety of others.
Throughout their years of practice, sales tax auditors have developed ways of determining gross receipts that are innovative and industry specific. For example, if the business audited were a coin-operated laundromat, the Board of Equalization may measure water consumption levels for the business against the number of washing machines it has. Pour tests are common for restaurant and bars (the amount of alcohol used to make each drink) and inventory audits are common for other types of businesses.
The Board of Equalization sometimes feels that these methods are more telling than a standard gross receipts test. In addition, the Board of Equalization will normally ask for a substantial amount of documents in testing and verifying gross receipts during a sales tax audit.
These include bank statements, balance sheets, inventory purchase orders, utility bills, and cash register tapes (among other items). In addition, the Board of Equalization auditor may come out to the target business in order to do a sample test. A sample test is where the auditor measures gross receipts for a specified period (they will be at your business all day). This sample can later be applied to an entire period in order to properly calculate gross receipts.
The inherent problem with this method is that your sample period may not be representative of a business’s yearly sales. Good examples of this are businesses that have seasonal sales or those being audited for a particular item that had abnormal sales within the sample period. Obviously, a two-week sample measure might substantially increase or decrease a taxpayer’s sales tax audit liability depending on when that sample was taken.
The Difficulty with Sales Tax Audits
From a practical standpoint, gross receipts are a difficult to get a precise measurement on and there is no industry standard method for performing a test for gross receipts. As such, the various methods that the Board of Equalization uses to measure gross receipts vary in the level of effectiveness in a sales tax audit. Some are quite reliable and others are no more than educated guess work.
In addition, if you have any familiarity with statistics, you know that there is a lot of “wiggle room” associated with how you collect data for a sample and how that data is measured. This leaves a lot of power in the hands of your Board of Equalization auditor and leads to extraordinary swings in measurements of taxable measure (gross receipts). As a result, those under audit are often presented with staggering bills after a sales tax audit. Some of these bills, after attorney review, are found to have no basis in realty.
In conclusion, as you can see, sales tax audits have a lot of built in complexities that many people fail to consider. Because of the latitude involved in a sales tax audit and the various methods of calculating sales tax liability, I generally recommend that taxpayers engage with a sales tax audit attorney as soon as possible in the process in order to mitigate the damage involved.
Qualified tax counsel can go a long way toward getting the audit under control and mitigating the amount of liability involved.