NFIB Tax Advisory Committee Offers Guidelines for Managing a Tax Audit

Date: July 12, 2021

As the owner of a small/independent business, you likely will be selected for an audit at some point either by the IRS, State Revenue Department, city, county or a third-party audit and collection firm under contract with an Alabama city or county.

If you are selected for an audit, it does not suggest that you have done something wrong. Businesses and individuals are selected randomly, across geographic areas and industries. The NFIB Alabama Tax Advisory Committee put together this guide to help you understand how to avoid an audit and what steps to take if your business is audited, but remember. If you do get audited, please seek the help of a tax professional. 

Alabama tax law updates  

Business Delivery License requirement

A business is required to purchase a business delivery license when a business delivers more than $10,000 annually into a taxing jurisdiction and has no other physical presence during the year.  The license is capped at $100 annually with a $10 issuance fee and the penalty is limited to $10 for a violation.  Act No. 2017-415

Business Delivery License

Commercial vehicles traveling through a municipality on business are not required to have a business license or business delivery license if the person is not operating a branch office or doing business in the municipality.  Act No. 2018-411

Business Delivery License per business 

The business delivery license is per business not per vehicle. Act No. 2019-283

Third-Party Audit and Collection Firms

Prohibits a third-party audit and collection firm from charging back the cost of the audit plus travel expenses to the taxpayer.  Act No. 20-31

Sales Tax Exemption

A sales tax exemption for an individual who cultivates and harvests an agricultural product on leased or rented land.  The sales tax exemption specifically exempts the sale of pine straw products by the person who harvested the product.  Act No. 2018-562

Income Tax Credit

$1,000 income tax credit for certain small businesses for hiring an unemployed veteran paying $14.00 per hour.  Act. No. 2018-194

Installment Payment Agreement

Alabama taxpayers are permitted to enter into installment payment agreements for state tax liabilities for longer than 12 months.  Act. 2019-101

Irrigation Tax Credit

Amends the current irrigation tax credit to allow an eligible taxpayer to collect one tax credit during the tax years of 2011-2017 and one tax credit during tax years 2018-2022. Act No. 2018-468

Severance Tax

Amends and simplifies existing language used to calculate and collect forest product severance taxes, forest product manufacturing taxes and to ensure the taxes are paid only once. Act No. 2017-301

Small Business Tax Credit

Allows small businesses to claim a one-time tax credit of $1,500 for hiring a qualified new employee, applicable in the tax year for which the employee completes 12 months of employment. Tax credit is available for small businesses with fewer than 75 employees and requires a $40,000 annual wage for the new hire. Act No. 2016-188

Health Savings Accounts

State income tax deduction for contributions to a Health Savings Account, allows for deductions at the same level as provided on federal tax returns.  Effective for tax years beginning in 2018. Act No. 2016-345

Income Tax Filing Date Conformity

Alabama Income Tax Return due dates will conform to the federal tax return dates. Act No. 2016-412

Local Tax Changes

Requires cities and counties to notify the Dept. of Revenue 90 days in advance of implementing a tax change. If the Dept. of Revenue or the local taxing jurisdiction publishes an incorrect tax rate, the taxpayer will be held hold harmless. Act No. 2018-150

A business could be selected for an audit because of:

  • Random selection
  • Inconsistent tax reporting
  • Improperly using tax exemptions or deductions by individuals or Schedule C taxpayers
  • Revenue discrepancies
  • Mathematical errors
  • A tip received about non-compliance from an employee, former employee, competitor, or a city or county in which you conduct business

“Red flags” that could trigger an audit

  • Rounding to even dollar amounts, such as $100 or $400, rather than rounding to the nearest dollar amount, such as $103 or $412
  • Unreported income
  • Incomplete information
  • Unusually high charitable donations as a percentage of income
  • Income taxed on federal but not on state returns (or vice versa)
  • Home office deductions
  • Filing a Schedule C
  • Consistent Schedule C losses indicating possible hobby
  • Unusually high entertainment deductions as relating to income
  • Low-income with large deductions
  • Fluctuating income or sales

Be sure you keep proper documentation on “red flags”. Proper documentation is needed for ALL items or deductions.

 Upon first contact from the auditor:

  • Call your CPA or tax attorney to notify them you have been selected for an audit.
  • Bring your CPA or tax attorney to any meeting including the initial meeting with the auditor.
  • Ask the auditor to sign a confidentiality agreement prepared by your attorney that addresses confidential and proprietary information, trade secrets and other sensitive issues
  • Ask for a written statement from the auditor regarding the basis for the audit (i.e., who or what drew the attention of the auditor). The auditor is required by law to provide this to you. Insist that the statement be specific. 
  • Request information regarding encryption and security protocols used by the auditor in securing his or her laptop and in storing/sending your sensitive information.
  • Respond quickly to all letters, requests for information and phone calls with advice from your tax professional
  • You have the option of having the audit performed at your business or at the office of the CPA or tax attorney. Generally, it is best NOT to have the audit performed at your place of business
  • If the audit is performed at your business:

        (a) do not leave papers, documents, records in open view

        (b) do not leave your computers “up and running” while unattended

        (c) if possible, do not place the auditor near employees with whom he or she

             can carry on a conversation

        (d) have a designated contact person (you or another designated person)

             for the auditor to contact regarding questions or needs.  The

             last thing you want is the auditor to be engaging in discussions

             with partially informed or non-informed employees

  • If you do not agree with the audit results, ask for an appeal. Generally, you can appeal to the auditor’s supervisor before you go to the formal appeal process
  • Read and understand the Alabama Taxpayer Bill of Rights. Ask your CPA or tax attorney to ensure that your rights are being observed during the audit.
  • Auditors are reviewing confidential information so request that your information remains at your office or with your tax professional
  • Maintain your professionalism, while being polite and friendly
  • When responding to questions, be brief and do not elaborate. If you do not know the answer, then simply reply “I will have to get back with you on this”.  Always be honest.
  • If you need additional time to gather the information the auditor has requested, do not hesitate to reschedule the audit.
  • If the auditor states the audit of your records will be an “indirect” audit method, contact your CPA or tax attorney immediately
  • You can provide auditors electronic copies which should save you money. Never give original documents to an auditor.
  • From the date initially contacted by the auditor until the audit and its results are absolutely completed, keep “running” notes, memorandums in a file, or journal of all contacts, discussions, and/or interactions with the auditor. Examples are: (a) met with auditor on x date and y time include location and who was present, discussion included … (b) keep hard copies of emails and letters with running log of phone calls with date and time and discussion of issues
  • If the auditor asserts that the law requires you to keep certain records, etc., request a copy of the law, regulation or policy statement
  • The auditor may ask you to sign a waiver of the statute of limitations so that older audit periods can remain open during the audit. DO NOT sign the waiver until you consult with your CPA or tax attorney.
  • If the auditor wants to take the records from your office to another acceptable location for audit purposes, request a dated detailed receipt (prepared by the auditor) for the records. Do not accept a “generalized” receipt. Such a receipt only proves you gave the auditor records, not specific records.  In addition, check the receipt against the records before the auditor leaves your office/business with the records.  The receipt should be signed by you and countersigned by the auditor.
  • If the auditor wants to take the records to another location for the audit, ask “where”? Do not assume the records are going to a government office.  Currently, federal, state and local governments are allowing auditors to work out of their homes.  If the auditor announces they are working from his or her home, do not agree for your records to be taken to the auditor’s home. Reason: Irrespective of assurances to the contrary, your business records  contain proprietary information that could be exposed to family and friends including an unsecured email server. 

If you are dealing with an aggressive auditor:

  • you may request a delay in the audit
  • request a new auditor
  • consider recording the audit (requires 10-days written notice that you intend to record)
  • politely ask questions

After the audit, the auditor will

  • Provide preliminary audit results
  • Explain interest and penalties
  • May request additional documents
  • Explain future reporting requirements
  • Make changes to the preliminary audit report based on additional records you provide
  • Review any changes to the audit findings
  • Explain the appeals process and the timely filing requirements for the taxpayer

If you are audited by the State Department of Revenue

  • If you are issued a Final Assessment, you have 30 days to appeal to the Alabama Tax Tribunal
  • You may represent yourself before the Alabama Tax Tribunal and/or your CPA or tax attorney may represent you
  • Review the Alabama Taxpayers Bill of Rights

If you are audited by a private audit and collection firm

  • Alabama is one of the few states that allow private audit and collection firms to collect tax dollars
  • Private auditing and collection firms audit on behalf of ALL their clients simultaneously. If the largest private firm audits you, be aware that it is on behalf of several hundred cities and counties in Alabama.
  • Once you receive the written basis for the audit, ask to deal directly with the city or county that may have caused the audit. Have your CPA or tax attorney reach out to the city or county attorney about resolving the issue directly
  • Private audit and collection firms are for-profit entities and may operate in several states
  • Alabama municipalities and counties sign contracts with private firms to collect a variety of taxes
  • Each contract is negotiated individually with a municipality or county for auditing services or business license discovery/recovery services (i.e., comparing telephone yellow pages to the business license tax rolls)
  • The contracts may allow private firms to keep a significant percentage of the monies collected (i.e. a contingency fee)
  • Because of contingency fee arrangements, private audit, and collection firms are aggressive about taxable nexus (the legal standard for whether a city or county in which you do business but do not reside can tax you.) You and your CPA or tax attorney must be willing to challenge private firms on these issues or risk state-wide exposure for your business license tax liability.
  • If you are issued a Final Assessment, you have 30 days to request an administrative hearing (in front of the auditor’s supervisor) or an administrative appeal (which may be in front of another employee or independent contractor of the private auditing company).

New law for audit and collection firms (effective January 1, 2017)

  • Auditors are required to identify themselves and you may request a number to call to verify the identity of the auditor
  • Taxpayers will be presented a signed and dated written authorization from the municipality or county to the taxpayer upon the initial contact for an audit
  • A copy of the contract between the taxing jurisdiction and the third-party audit and collection firm will be presented upon the first contact with the taxpayer Included in the contract will be a statement of whether the municipality or county has opted into the Alabama Tax Tribunal
  • If a municipality or county has elected out of the Alabama Tax Tribunal, an independent taxpayer advocate will be available to the taxpayer
  • Audits under normal circumstances should only occur every three years
  • A final assessment will be signed by an official of the county or municipality and presented to the taxpayer
  • A private auditing and collection firm is subject to the confidentiality requirements of Code of Alabama Section 40-2A-10.
  • If you are unhappy with the conduct or the results of an audit of a third-party audit and collection firm, contact elected officials from the city, county or your state legislator with your concerns. (When the contract is up for renewal, it would be helpful for the elected official to hear your concerns before renewing the contract)

Remember at all times, the auditor is working for the government, and/or their company, not for you.

 

 

Related Content: Small Business News | Alabama

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