I’m going to do a short post this week—one that covers some information you want to know if the Washington State Department of Revenue decides to audit you.
Understanding the Scope of a Department of Revenue Audit
If the Department of Revenue contacts you about an audit, almost surely they’ll describe the process as an excise tax audit.
We’ve had clients call our offices about this, worried because they don’t have any idea what an excise tax even is. So of course they didn’t know they were supposed to be paying them… but in practice, you do know about excise taxes.
At a state level, in most cases, excise taxes include three common taxes:
1. The gross receipts tax, also known as the business and occupation tax or B & O tax, that businesses pay for the privilege of doing business in the state of Washington.
2. Any sales tax the business collects from customers or clients because what the business sells is subject to sales tax.
3. Any use tax the business needs to pay because some vendor the business purchased stuff from didn’t collect sales tax. The common situation where use tax crops up is when you buy something from a catalog or over the Internet from an out-of-state business that doesn’t collect Washington state sales tax. In this case, you need to pay use tax equal to the sales tax an in-state business would have collected.
During a department of revenue excise audit, predictably, the state looks at all three taxes.
And one final comment about the scope of the audit: Some additional state excise taxes do exist. The state levies excise taxes on tobacco and alcohol, for example. The state also levies excise taxes on gasoline, garbage and real estate sales. But most people only need to worry about the business and occupation tax, the sales tax and the use tax.
Sizing Up Your Audit Risk
Business owners often worry terribly about Department of Revenue audits. But our firm’s experience is that an audit by the state is far less likely to suggest a problem than an audit by the Internal Revenue Service.
In fact, one almost gets the idea that the Department of Revenue auditors roll into town or into your neighborhood and then try to “hit” as many local businesses as possible. Then they seem to disappear for four years… and show up again. It’s sort of like the Olympics.
For this reason, if you’ve been calculating, reporting and remitting business and occupation taxes and sales taxes, you usually have little to worry about.
Oh sure. you may have inadvertently used the wrong tax rate for some stuff. Maybe you missed use tax on some magazine subscription or an Internet purchase. But you should not have too much risk or worry if you’ve been paying your business and occupation tax and you’ve been trying to diligently calculate, collect and remit sales tax.
Where businesses can get into trouble, predictably, is when they haven’t been paying the tax.
Not paying the tax occurs with business and occupation tax when you simply don’t report gross receipts on your monthly, quarterly or annual state excise tax return. But as long as you remember that basically everything you regularly sell or receive money for within the state is subject to business and occupation tax, you should be fine.
But note that the B & O tax hits all sorts of stuff you might not thing of as being a gross receipt. For example, amounts one subsidiary pays to its parent to cover payroll (what’s often called a common paymaster arrangement) are probably subject to business and occupation tax.
And for another example, while profit distributions by a partnership are not taxable to partners, guaranteed payments to partners may be taxable if the partner is an LLC or corporation. (This last application of the business and occupation tax makes no logical sense to me and seems clearly like just another way for the state to penalize small business. But that’s irrelevant…)
Not paying tax occurs with sales tax when you forget to collect and remit tax. Obviously. You know if you’ve done this. Hopefully you haven’t.
The bottom-line, then, with business and occupation tax and with sales tax is that you’ll probably know if you’ve been doing it right. If you have, no problem. If you haven’t, you will end up paying.
The use tax stuff, unfortunately, tends to be a bit more risky and scary. But fortunately, the use tax numbers are usually pretty small.
As noted earlier, if you buy stuff over the Internet or out of a catalogue and the seller doesn’t collect sales tax, you’re supposed to calculate the sales tax you should have paid… and then remit this money as a use tax with your next excise tax return. But that sort of stuff usually isn’t going to add up to all that much money.
Statute of Limitations on Assessments
Finally, a few words about the statute of limitations.
The Department of Revenue can look at the last four years of returns and assess additional excise tax liabilities as per WAC 458-20-230.
Accordingly, if you are audited in, for example, 2014, the auditor may look at 2010, 2011, 2012 and 2013. And if you owe tax from, say, 2010, the state can make you pay those old taxes.
But the state typically can’t go back farther than four years if you’ve been filing your returns diligently. For example, if for some reason the auditor sees you didn’t pay enough tax in 2009 and it’s 2014, you won’t have to pay that tax.
By the way, if the auditor sees or if you see that you overpaid your tax in 2009 and it’s 2014 (so 2009 is outside the statute of limitations) you also won’t be able to get a refund of the past overpayment. The statute of limitationsi works both ways.
One important note: The statute of limitations does not apply to trust funds. For example, if you collect sales tax and then don’t remit that, the statute of limitations doesn’t apply. You owe the money (the funds held in trust) to the state even after four years.
Do You Own a Small Business? Want to Save Taxes?
Here’s something that I’ve noticed again and again about small businesses. They usually don’t do a very good job about maximizing their tax deductions.
More specifically, small business owners usually don’t go to the effort of structuring their business activities to protect legitimate deductions, to create new deductions and to recycle (or double-deduct) the deductions which can be used more than once to save taxes.
Which neatly brings me to my e-book, Small Business Tax Deduction Secrets. This 40pp e-book addresses this information short-fall by talking about how you can annually save thousands or even tens of thousands of dollars in taxes simply by more effectively using legitimate business deductions.
And a quick note: If you’re a client of our CPA firm, you don’t need to purchase this ebook. We will happily provide you with free copies of any of our books, including this one. Just ask for a copy next time you talk to us.