Reverse audit refund opportunities support cash flow and stability

Executive summary:

The economy is in transition. A new administration, certain federal tax reform on the horizon, and a dynamic trade policy, has fueled optimism for a friendlier tax and regulatory environment. However, transition can breed uncertainty and decision paralysis as markets, businesses and consumers look for stability.

Economic upheaval may last months or more before a longer-term and sustainable picture of the economy develops. In the short- and medium-term, businesses looking for liquidity solutions may consider traditional and reliable mechanisms of generating cash-flow and long-term savings through reverse income tax and reverse sales and use tax audits. 

In many cases, reverse state tax audits require minimal or even no onsite review of documentation and employee resource utilization as these reviews can be performed from remote locations and documentation acquired through electronic access. Efficiently 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 term as processes can be improved as a result of the review.

Reverse income tax audits

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) is 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 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.

Takeaways

Regardless of whether economic transition rolls through the summer or next calendar year, reverse audits often lead to longer term tax benefits through optimization of tax processes, improved ongoing compliance and long-term savings. Refund reviews often have the benefit of identifying additional tax and business savings opportunities due to the nature of the review, such as compliance opportunities, credits and incentives, technology implementations, and many more services related to the tax function.