Why Was My Business Selected for a NYS Sales & Use Tax Audit?

The New York State Department of Taxation and Finance (DTF) is charged with the administration and enforcement of twenty two different types of taxes. As part of its enforcement efforts, DTF conducts well over 500,000 tax audits per year. Many of the audits are sales and use tax audits. In fiscal year 2007, DTF collected more than 3 billion dollars as the result of audits and denial of refund claims. This was an increase of 1 billion dollars compared to 2006. The increase was primarily due to the use of business intelligence tools, improvements in technology enhancing the audit selection process, a better trained audit staff and successful litigation. If your business has ever been selected for a sales and use tax audit you may think it was due to luck of the draw – it was not.

While private enterprise and most NYS governmental agencies have severely curtailed hiring during these difficult economic times, DTF has increased its audit staff by over fifteen percent. DTF now has over 1,700 auditors, 189 hired just this past year. Many of these new auditors are assigned to “desk audits”, which are limited-scope audits of tax returns, with the balance assigned to “field audits,” the more inclusive three-year reviews of taxpayer records. While desk audit selections are generated mostly from differences found between what businesses report to the federal government vs. DTF, the field audit selection is much more feared, and may be the result of any number of factors.
The increase in audit staff is no doubt helping DTF increase audit collections. But the key to DTF’s current success is its ability to identify the most productive audits to conduct. By being able to identify more productive audits DTF has created a more efficient audit, often supported by statistical documentation, which is hard to dispute. By being more selective in audit targets DTF is often able to secure a quick agreement and payment by those targeted. Following are some of the ways DTF uses both external and internal resources to select its most productive targets:

• Complaints received from customers or disgruntled employees, – these types of referrals are taken very seriously by DTF because not only is it often firsthand information, but often hardcopy documentation is available. The documentation may take the form of a sales receipt, copies of books and records, photographs, video tapes, etc. These types of audit referrals often result in criminal tax cases.
  
  
• Auditor field experience – auditors are trained to identify productive audit candidates. At the conclusion of an audit, auditors are required to submit audit referrals generated as a result of the current case under audit. An example of a productive audit referral is when the auditor reviews a resale certificate issued by someone who is not registered for sales tax. An audit inquiry is then issued.
  
  
• Investigator referrals – DTF uses investigative aids as their eyes and ears on the street. These staff is assigned to investigate a complaint or situation before a formal audit is initiated. An investigator may be used to observe customer activity at a given location which is later used to estimate sales data which is then compared to sales information reported by that vendor. Vendors with large discrepancies become audit targets. An often used technique is to visit an office building for the purpose of gathering names listed on the lobby directory. The names are crossed checked with sales tax registration to identify unregistered vendors who may be productive audit targets. In addition, investigators and tax auditors use the Internet as an effective audit selection tool.
  
  
• Change in tax laws – DTF has changed is laws and regulations over the past year to allow gathering of information from third parties. Recently enacted provisions requires beer, wine and liquor wholesalers to file information returns that report sales to their retail customers, franchisors to report sales information of their franchisees and insurance companies to report payments made to repair shops. DTF uses certain computer analysis to identify information that is not in agreement. These targets are often assigned to the desk audit unit.
  
  
• “Economic nexus” laws – this applies to companies that operate in multiple states. Nexus with no registration is non-compliance with sales tax and possible income/corporation tax as well. DTF has increased its use of third-party data to identify companies that are good sales tax and corporation tax audit targets.
• Industry initiative – based upon audit experiences DTF knows which industries are most productive to audit. As DTF becomes aware of tax issues in an industry or that laws are being ignored by most taxpayers in that industry DTF, will initiate a “special audit project” to audit nearly every taxpayer in that industry if they fail to fall within certain guidelines.
  
  
• Frequent late filings and payments or no filings and payments – these red flags indicate noncompliance.
  
  
• Recurring taxpayer audits – some taxpayers are targeted simply because of their size. Businesses that have major operations in a state can expect to be audited every audit cycle (generally every three years).
  
  
• Follow-up audits – policy mandates that auditors include in their audit report at the conclusion of an audit a re-audit date for all productive audits. Generally, an audit is productive if it produces between $3,000 and $5,000 of sales or use tax for each day expended on the audit.
  
  
• You return doesn’t look as expected – based upon analyzing returns filed in a particular industry, DTF computes certain statistics such as taxable ratios (a percentage of gross sales reported as taxable sales). If your return doesn’t fall within the expected ratio your return(s) will be selected for audit. Not reporting use tax when DTF expects that you should will put you on DTF’s radar screen.
  
  
• Exchange of audit information – third-party information obtained from cigarette agents, fuel wholesalers, other taxing and government entities, including the IRS, is compared with data reported on returns. The more egregious differences are selected for desk audit.
  
  
• Response to amended returns or refund claims – taxpayers should expect some level of review in response to the filing of an amended return or refund claim. Generally, the review will be assigned to desk audit unless books and records required for review are too voluminous. In addition, DTF has employed a new system called Case Identification and Selection System (CISS) which is a risk-based predictive modeling tool for identifying potentially questionable refund claims. The denial of a refund claim is as productive as collecting dollars on audit. In its first year of use, fiscal year 2005-2006, CISS increased DTF’s annual denials of refunds from $40 to $98 million which is a substantial return on the investment made.
  
  
• Mandate to form Special Investigation Units (SIU) in each district office – in 2007 DTF began redeploying staff from regular audit units to create new fraud teams to focus aggressively on taxpayer fraud. SIU staff includes specially trained forensic auditors, investigators and attorneys, charged with conducting proactive tax fraud investigations. They use all of the investigative and enforcement tools available and employ new techniques to identify patterns of fraudulent behavior including data mining by the Data Resources Unit (DRU). The DRU supports field audit projects and is used to identify projects which should be continued, abandoned or expanded.

Even if your business is not among being those being audited in DTF’s current audit cycle, it doesn’t mean you won’t be targeted in the future. Now is the time to be proactive. Review your level of compliance and implement plans to increase compliance, before you are identified as an audit target. Compliant taxpayers have nothing to fear. Identify your weakness, know your potential exposure, and evaluate your options. The choice is yours; if DTF targets your business, being prepared is your best defense.