by Diane Yetter, president of Yetter Consulting Services, Inc. and founder of The Sales Tax Institute

Most companies are carefully monitoring all cash outflows as a direct result of the uncertain economy. At the same time, however, many states are increasing their audit resources and conducting more sales tax audits in an effort to combat revenue shortfalls.

As an account payable professional, your role will likely become increasingly more important as your company prepares for upcoming audits and looks to reduce its potential audit exposure. There are many things to keep in mind as you prepare for an audit.

General A/P Considerations

Regardless of when your company is contacted for an audit, there are several ways to reduce potential audit exposure.

First, determine if there is a recordkeeping policy established by your company and ensure that it meets sales and use tax audit requirements. Each state has a statute of limitations, typically three to five years, which represents the number of years that the state can go back and review a taxpayer's records. For that reason, your books and records should be retained for any periods still open for audit. We would suggest an additional one to two years beyond the statute of limitations to ensure that adequate records are maintained in the event the statute of limitations is extended as part of an audit. Invoices must be retained, but purchase orders typically provide better support in an audit because they typically provide a more complete description and the intended use of the item purchased. Additionally, shipping/receiving reports often identify where the item is to be used.

Another area that should be reviewed prior to the auditor's arrival is your company's use tax accrual process. Companies can face many challenges with this process, including:

• ensuring an appropriately trained person has responsibility for making taxability decisions,
• knowledge loss as a result of employee turnover,
• limited training resources,
• consistency amongst multiple systems managing operational data,
• procurement card transactions, and
• the tracking and documentation of when and to whom the taxes are paid (vendor or state).

If you are using a less sophisticated process for making tax decisions, there are some things you can do to improve its effectiveness:

• Enter sales tax listed on vendor invoices as a separate line item in your accounts payable voucher distribution, enabling:
• Reports to be provided to auditors reflecting tax paid to vendors
• Reports to be provided to your Tax Department reflecting invoices without sales tax to assist in use tax accruals and taxability reviews
• Use a separate use tax accrual general ledger account number to segregate use tax accrued from sales tax collected
• If possible, set up accounts or sub-accounts for each state, this will make the reconciliation and audit processes less difficult.
• Use an "Use Tax Accrued" stamp to improve documentation
• Accounts Payables clerks stamp each invoice on which use tax was accrued to reflect accruals and reduce audit review time.
• Once the auditor validates this process by reconciling a stamped invoice to the use tax accrued report, they can reduce audit time by relying on the invoice stamp.
• Verify that the appropriate sales tax was charged
• As part of the accounts payable use tax process, a tax verification process should be established.
• This process should include verification of taxability, rates, and jurisdiction.
• Error-handling procedures should be established incorporating tolerances to manage differences between vendor-charged tax and your determination of the correct tax related to local tax differences.

In order to reduce some of the use tax determination issues, you may want to consider an automated system for handling your use tax obligations. When choosing to implement an automated tax system, things to consider include:

• Changes in use that may affect the taxability of the purchase
• Vendor exceptions
• Commodity/product code exceptions
• Special rates or jurisdictional issues

You should evaluate the tax software functionality and find out if the application requires any process enhancements or has a standard interface that will meet your needs.

Audit Planning and Strategies

Once contacted by a state for an audit, one way to potentially minimize your liability is to request a state-approved managed audit program. Under these programs, the state sets up specific guidelines for performing the audit and then the company performs the audit fieldwork. Once complete, the state reviews the company's work by spot checking certain transactions and performing short tests on the company's findings. These types of audits are generally offered to smaller companies or ones in business (or in the state) for a relatively short period of time.

There are many benefits to doing a managed audit, including fewer auditor distractions, a limited focus on "grey" issues, and a reduced interest liability if the audit can be performed in less time than a standard audit. As managed audits may be performed internally or by third-party consultants, utilizing a third party may increase credibility with the state. Companies should ensure they have the resources available to pull the records and complete the fieldwork if they choose this option, if offered by the state.

If, however, your company has received notification and is faced with a standard audit, you should begin preparing by first making sure all the requested records as well as other anticipated records are available. Typical records requested include:

• detailed general ledgers,
• journal entries,
• purchase journals,
• purchase invoices,
• depreciation schedules,
• sales/use tax returns and workpapers, and
• shipping documentation.

After gathering and reviewing the records, certain record issues may be uncovered that should be addressed prior to the auditor's arrival and, in fact, may need to be discussed with the auditor during the audit procedure determination phase. Some of these issues could be a direct result of a change in accounting systems, a change in tax maintenance (improved or worsening tax controls), missing records, or electronic records (EDI, ERS, Purchasing cards). You may also want to consult outside assistance to discuss recent developments in the tax laws or to perform a review of significant exposure areas or potential overpayments or credits.

Prior to the initial auditor meeting, an auditor coordinator should be assigned to handle all questions posed by the auditor. This is generally a sales and use tax specialist. In addition, a work area should be established away from areas where the auditor may be able to hear casual conversations that may include information relevant to the audit. Employees located near the auditor should be made aware of the auditor's presence and advised to restrict their comments.

During the audit, request regular audit status reports as well as periodic lists of proposed adjustments so that taxability problems and questions can be addressed at the auditor level. Keep in mind that disputed items are usually easier to negotiate at the auditor level.

After the audit, you may be issued a tax assessment or even a no-change audit statement. It is important to evaluate the appropriateness of the audit report and evaluate your options. All states differ in their rules regarding audit procedures. If a protest is warranted, make sure you understand the protest process and applicable deadlines.

When you're handling purchases, consider the use tax implications. Ask yourself what is being purchased, who requested the purchase, how will it be used, and where will it be used. Making good tax decisions and ensuring that appropriate documentation is maintained can provide many audit benefits, including reduced audit time, reduced resource impact and a reduced audit liability.