Navigating a Pennsylvania Sales Tax Audit
Last Updated on September 20, 2022
Now more than ever, states are stepping up efforts to fill their coffers by auditing companies for sales and use tax. With the Wayfair decision affecting remote sellers and the proverbial pause in audits in 2020 due to COVID, sales tax audits are becoming more prevalent in every applicable state. In fact, state sales tax revenue grew by 40% year over year from 2020 to 2021 alone. While part of that is obviously due to companies normalizing their business activities, it’s also been a collective effort by states to make up for lost time and substantial dollars. Like most states, Pennsylvania has its share of intricacies when it comes to sales tax, so let’s examine ways for the taxpayer to safely navigate a PA sales tax audit.
AUDIT PREPAREDNESS
The key to surviving an audit in any state is to be proactive and anticipate areas where the auditor might be paying close attention. Ensure you keep up-to-date records on both sales and purchases. If your sales are retail-centric – involving food especially – there are particular product groups where the auditor may focus on due to certain ingredients being taxable or where the food is being consumed. On both the sales and purchase side, multi-item invoices are also a prime target where the sales tax is not explicitly broken out, i.e. some items are tax exempt, others are not and sales tax is unspecified. In many of these instances, the auditor may flag all of that as being taxable since it is not spelled out.
If sales are relatively cut and dry, the focus may be on purchases. Typically, the auditor reviews the fixed asset portion (big dollars) in full and samples the expenses. The latter part can be tricky, depending on what methodology the auditor employs, as the sampling may be skewed unfairly in the state’s favor. Of course, the idea of a sales tax audit is for the state to end up “winning” and collecting tax, so the auditor is rarely going to do the taxpayer any favors.
The taxpayer should only be responsible for the tax they rightly owe – nothing more, nothing less – so scrutinizing the sampling methodology, sample size and projections might make all the difference in the world. Also, ensure you stay on top of exemption certificates on both the customers who shouldn’t be charged sales tax as well as the vendors who shouldn’t be charging you sales tax.
UNDER AUDIT
The Pennsylvania Department of Revenue will initiate the sales tax audit by sending a notice to the taxpayer. The audit period is 3 years in Pennsylvania, but the taxpayer may have signed waivers extending the period. It is never advisable for the taxpayer to sign a waiver as it carries additional penalties and interest which can be very costly. It is imperative that you review past records from the prior audit for low-hanging fruit.
The taxpayer should reply in a timely manner to set up an initial meeting to begin the field audit. There are many seasoned state auditors, but do your research on your state contact. States have had a difficult time juggling so many audits, so they frequently hire people from diverse backgrounds, show them the ropes and send them out into the field. This practice becomes problematic for the taxpayer as the field auditor may have tunnel vision in broadly assessing tax, forcing the taxpayer to go on the defensive to ensure they are only paying their fair share. Knowing your auditor beforehand may give you an upper hand.
While some data is exchanged online, most field audits are performed onsite at the taxpayer’s place of business. To keep the audit limited to only the information requested, it is important to safeguard the area as much as possible, so do not keep or show any records that are not on the list. Also, ensure the auditor has an adequate but non-descript workspace and accommodate accordingly, but not too much. The auditor will then start comparing the taxpayer’s records with what the state shows on the returns.
Do you know when or if your business was affected by COVID? Did you increase or decrease lines of production? Did you add additional square footage or add new equipment? For any change in your business, it is important to document the dates to show any material discrepancies as to why sales or purchase figures changed. By being proactive and helping to shape the narrative, it will help address issues where the auditor may have no choice but to assess tax.
For use tax, the auditor may scrutinize paid items used or consumed by the business, so keep track of your use tax accruals and be ready to address any questions. In many cases, the taxpayer should conduct a “limited” plant or production tour to illustrate to the field auditor how certain items are used as an invoice, exemption cert or file can only tell you so much.
A good defense is a good offense in terms of offsetting any possible exposures via credits or overpayments of tax. With sales tax exemptions changing constantly, vendors charging sales tax in lieu of exemption certificates, and a when-in-doubt methodology of paying invoices unchecked, there could be material dollars left on the table. Pennsylvania accepts credits during and post-audit, but submitting credits while the audit is in motion is advisable and could put a huge dent into the assessment.
A sales and use tax refund review using the same methodology employed by the auditor on fixed assets and expenses should be an absolute must. The review would be limited to the audit period. It’s a safe exercise as it is commonplace for taxpayers to submit credits during an audit as opposed to filing outside that could trigger an audit. In Pennsylvania, refunds/credits in the audit period can be filed within six months of the date of the notice of assessment.
When the audit is complete, the field auditor will summarize the findings and submit a report to the taxpayer outlining the assessment.
POST-AUDIT
The real battle begins once the taxpayer receives the final assessment. At that point, the taxpayer should review the findings and vet out what they believe to be an error as well as what credits were denied. If the taxpayer plans on fighting the audit, they should go ahead and pay the amount due immediately. Why? Because the process to reduce that assessment could take months or years where penalties and interest will accrue. It’s highly advisable to pay the audit, and if you choose to contest it, the only amount in question is what was paid – nothing more.
In Pennsylvania, the taxpayer has 60 days to file for Redetermination on both counts. This process may be spread out over three different levels:
- Board of Appeals (BOA): This is the first stop, but unfortunately very little relief is granted. BOA often “kicks the can” to the next level and denies almost everything, forcing the taxpayer to require deeper expertise in regard to sales tax law and substantiating a position for relief.
- Board of Finance and Revenue (BF&R): The BF&R is a different committee that reviews findings, and here a larger amount of concessions to the assessment or credits can be granted. Due to the backlog especially during COVID, the BF&R may also offer a compromise where the taxpayer receives a fraction of the relief, but is settled almost instantaneously. The taxpayer then has 30 days to file an appeal from the BF&R to the Commonwealth Court.
- Commonwealth Court (CC): The final stop is the CC, which unfortunately can drag on for not months, but years for the taxpayer to argue their position. This will require a skilled sales tax attorney who has a detailed understanding of Pennsylvania case law. Unless the CC chooses a case to go to trial, the process can take several years unless they opt for a compromise at this stage.
Sales tax audits are a necessary part of doing business in any state. The key is to stay proactive, anticipate where the audit may go, keep good records and know your options. If the taxpayer ends up owing substantial dollars, they will always be on the 3-year cycle for the next one. If the taxpayer ends up with a net refund or zero exposure, the state may not come back. A sales tax audit can be a long, tedious battle, but it doesn’t mean the taxpayer won’t win in the end.
Need Support for Your PA Sales Tax Audit?
TaxMatrix is the largest Pennsylvania sales and use tax refund filer (according to BF&R Records) where the company has serviced taxpayers across many industries since 1999. The sales & use tax consultancy firm works with some of the most notable taxpayers in the Commonwealth, managing and defending audits, and performing sales & use tax recoveries/refund reviews. If you are under audit or interested in a refund review, contact us today for a free consultation at 855-SUT-DESK or send us a message.