Businesses across the country are reeling financially as a result of the COVID-19 pandemic. The economic crisis is affecting both large and small companies and almost every industry. Some sectors, such as the energy, hotel and restaurant, manufacturing and retail, have been battered. With stay-in-place orders nation-wide, the closure of nonessential businesses and growth of widespread health concerns have grounded much of the economy. In just under a month, the business community has sustained significant losses and laid off or furloughed millions of employees. While government stimulus programs are taking shape, most businesses have critical cash flow problems. Many are challenged to keep even reduced operations in place.
With no end in sight, the economic upheaval may last several months or more. One consideration for businesses looking for cash flow solutions are reverse income tax and reverse sales and use tax audits. In many cases, onsite review of documentation and employee resource utilization is minimal as these reviews can often be performed from remote locations and documentation acquired through electronic access. Expeditiously performed income or sales and use tax reviews may lead to significant refund opportunities and short-term infusions of cash. They may also lead to reduced tax burdens in the long run as processes can be improved as a result of the review.
Reverse Income Tax Audit
A reverse income tax audit (RITA) involves a review of recent state income and franchise tax returns with the objective of identifying potential refunds. The review includes examining available but unclaimed state income tax credits. The RITA review for open years can be accomplished relatively quickly and involves an examination of filed returns, workpapers, and potential interviews with personnel inside the tax function.
There are many substantive income and franchise tax issues that give rise to refunds. These include, but are not limited to tax reform positions, incorrectly apportioned income, net operating losses, mischaracterization of business or nonbusiness income, nexus, Public Law 86-272, incorrectly sourced sales, and failure to claim available credits and incentives. A RITA identifies these and other issue that can result in substantial refunds.
The review may result in income or franchise tax refunds for some or all years open under statutes of limitation. The refunds could result in an infusion of badly needed cash. There are other benefits as well including increased earnings-per-share, longer-term reduced income tax burdens and improved compliance processes.
Reverse Sales and Use Tax Audits
A reverse sales and use tax audit (RSUTA) involves a review of state and local sales and use tax payments with the objective of identifying potential sales and use tax refunds. Like RITAs, an RSUTA review can often be completed relatively quickly. The review generally includes an analysis of filed returns supporting data, and other documentation such as invoices and descriptions of purchases.
Any business with multistate operations or that makes a large quantity of purchases is likely a good candidate for review. Industries that frequently have sales and use tax overpayments include manufacturing, construction, consumer products, health care, public utilities and agriculture. However, opportunity is not limited by industry. Businesses that have never performed a review or that are experiencing any of the following may have sales and use tax overpayments: undergoing or recently subject to a state or local sales and use tax audit, engaging in merger and acquisition activity, planning large capital expenditures, or implementing a new ERP system.
Common issues that give rise to sales and use tax audits include paying tax on products and services that are actually exempt, paying sales and use tax to the wrong jurisdiction, paying tax twice, and failing to tax advantage of state and local credits and incentives that create exemptions in certain circumstances. An RSUTA identifies these and other issues that may lead to refunds.
A reverse sales and use tax audit may lead to short-term cash refunds and long-term tax savings as companies are better positioned to identify sales and use tax exemptions and exclusions after the review. The RSUTA can lead to overall improved compliance processes and more effective audit management.
With virtually every company suffering cash flow problems, examining past returns for income and sales tax refunds may provide some badly needed short-term relief. While the short-term relief is necessary, the reverse audits can lead to longer term tax benefits through optimization of tax processes, improved ongoing compliance and long-term savings. For more information on cash-flow opportunities and considerations due to the COVID-19 pandemic, please visit our resource page, State tax planning in response to economic distress, for new and updated state and local tax thought-leadership and strategies.