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 think 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 limitations 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 Businesses Tax Deduction Secrets. This 70pp 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.
Click for more info or to purchase and download
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.
Anna says
As a DOR auditor, I caution against disregarding potential use tax/deferred sales tax liabilities. That is often the largest liability for businesses that have been diligent in other areas of their tax reporting. In addition to internet and catalog purchases, businesses should also be aware of vendors who provide both taxable and non taxable items. Often times after you have given a vendor your reseller permit, they stop charging tax on everything they sell to you, including the items that you do not resell. If the taxes on those items aren’t voluntarily reported, they now carry a 50% penalty for misuse of the reseller permit. That can add up fast!
Steve says
Thanks Anna. And I really didn’t mean to imply that people should disregard use tax. (I just re-read the post and don’t think I say that anyplace… But to be clear: One needs to pay the taxes one owes.)
What I would say, though, is that one should simply make a good effort to comply and then not worry about an audit.
BTW, I don’t think I said this in the post, but I would also say that if you’re a small business, you ought to avoid buying from catalogs and from websites that don’t charge Washington state sales tax. My reasoning here? The small business owner can then skip the headache and hassle of figuring out what their use tax liability is, reporting that on state excise tax returns, etc.
jason says
Does the WA state IRS ever
Forgive or negotiate a settlement if in fact your company is out of state and you have no knowledge that you needed to collect sales tax. IE: online sales etc
Steve says
I don’t know. Sorry. You may want to get more detailed info or help from a Washington state “state” tax expert. BTW, Mark Hugh is someone I know personally and a true expert in this area.
Misty says
NO! WA State Department of Revenue will go after you for every penny and that don’t care whether they shut down small businesses or not. They are absolutely ruthless! My 2nd audit was worse than the first one. Complete nightmare. You are better off to refuse to sell to anyone in WA State just to avoid their Dept of Revenue.
They have a new tax law starting in Jan 2018 by the way, which is similar to Colorado–another state to cross of your customer list. The new law will require businesses to either collect and remit sales taxes to WA or send notices to your customers, every one of them, annually to remind them to pay the sales tax themselves. If you choose the latter, you are also required to send a complete list of all sales to WA State with your customers name, address, what they bought, subtotal, sales tax if charged, and grand total, plus where it was shipped to. No privacy in this state.
Colorado and WA State found loop holes around the Federal law that prohibits states from charging sales tax to customers outside its state. Complete bullshit. I think if enough companies band together and make it a policy to refuse to sell to anyone in states that have laws like WA and Colorado…it might just tick off enough consumers that they will get tired of hearing people complain and have to reverse their laws.
ed zeman says
to avoid the issue with excise tax, I usually prefer to pay the sale tax at source and not worry about filing for it.