Executive summary:
The Alabama Tax Tribunal recently affirmed the Alabama Department of Revenue’s final tax assessment and imposition of fraud penalties against a liquor store operator who failed to provide complete and accurate reports of taxable sales. The decision echoes dozens of appeal denials each month for the same reason. Failure to maintain appropriate records to support tax returns is the primary reason taxpayers cannot successfully challenge assessments. Good business record keeping must account for tax operations. The tax function is a critically core component, heavily regulated, and often comprehensively enforced. In this article, we discuss the importance of good recordkeeping and why lacking records will lose appeals even before they begin.
Absence of records leaves taxpayers exposed to taxing authority estimation
The factual nature of the decision is hardly consequential to the lesson, i.e., preparation and record keeping is necessary to rebut a taxing authority’s presumption of wrongdoing, but also not irrelevant. The taxpayer, operating a liquor store and adjacent lounge, testified that he maintained records for sales at the store using a register and maintained paper records for the all-cash lounge business. The taxpayer was filing sales tax returns and making payments.
On audit, the taxpayer claimed that most of his business records were destroyed in a fire and could only produce partial records for a month or two. However, and much more problematic, the taxpayer could not produce any records of sales that occurred after the fire. The department relied on records from taxpayer’s vendors to determine that the sales were underreported by 80% and utilized a purchase mark-up of 35% to assess tax, interest and fraud penalties. Before the tribunal, the taxpayer could not provide sufficient evidence to support the returns filed, thus the assessments were upheld.
Takeaways
Under audit, taxpayers have the burden of rebutting an assessment from a taxing authority. The taxing authority does not have to prove beyond a reasonable doubt that the taxpayer under-remitted sales tax. Instead, the taxpayer has to demonstrate that taxes were paid correctly. Taxpayers do not receive the benefit of a grand jury and a high-bar for the taxing authority, much unlike an episode of Law & Order. It is the reality of state and local tax law and a dynamic that all business operators must understand.
Why is record keeping so critical and why are taxpayers unable to rely on short test months to determine tax liabilities? First, most states (and certainly Alabama) have broad discretion to reconstruct sales when records are unavailable. Without evidence to counter the taxing authority, it is virtually impossible to prevail in a challenge to the assessment. Taxing authorities have a cornucopia of methods to estimate tax liabilities, especially sales tax liabilities. Such businesses must maintain a consistent and accurate way to record and preserve sales activity. Second, failure to maintain records often leads to substantial tax and interest assessments – assessments that cannot be reduced or rebutted without evidence, i.e., records. A wide-range of penalties may also be assessed from underpayment to fraud penalties depending on the activity leading to the process failures.
Optimistically, most taxpayers are not willfully skirting the sales tax laws. Indeed, the vast majority of administrative and judicial decisions involve simple negligence with respect to record keeping, thus further emphasizing why preparation is key. There are ways to minimize risks under audit. There are best practices for sales tax record keeping. These practices often vary by product and service sold, by volume, and by type and location of vendors. It is also important to maintain redundancies in record keeping by utilizing cloud storage and similar network safety programs which have exploded in number and convenience in recent years.
Businesses should consider performing a periodic process review of all their record keeping practices, if not also a review of technological and automation solutions which can alleviate the most common errors and negligent practices. Common inefficiencies identified in a process review may include laborious and multi-step tax determinations, outdated software or tax calculation materials, gaps in the exemption certificate process, lack of dedicated processes and routines, and exposure to jurisdictions not currently filing. A comprehensive process review consolidates these findings, identifies and triages problem areas based on risk, and recommends solutions that often leads to better compliance and improved cash flow. Ultimately, an improved sales and use tax compliance process can help mitigate future exposure and provide better handling of state and local tax audits.
Taxpayers with questions about record keeping practices or sales and use tax controls should contact their state and local tax adviser with questions.
