Expert: Don Sadler - 7/25/2007

Question
QUESTION: We are sorry, but JT Gonzales wasn't able to answer your question:

hi, have a sales tax audit question im in ILLINOIS have a small
business in aprox 2000 I  designed a product and sold it mostly out of
state and on the internet which had no tax due as a result of promoting
that product I did some local business and it grew but was not big. I was
not filing during this time and now someone has turned me in competion
im sure. And the IL dept of rev. has told me they will audit and it is a
investigation also over the time frame I have found a total of up
$7000.00 I may owe for in state sales. I am gathering all my records for the
audit now.Im the worst record keeper on the planet but have been pretty
much a 1 man show and just did not get it done The tax on in state
sales was as low as $30-40 per month or about the most I can find is
$350.00 in a month. My question is do you know what kind of enforcement
posture they may have I have just did a poor job and was by myself and could
not keep up with everything its that simple never ment to cheat and wonder if it is a investigation since someone turned me in. Am just worried as I am a law abiding person and let this get out of control. Please give me some input and thanks a million

ANSWER: Hello Steve,

If  understand correctly, you have been contacted by the Illinois Sales Tax agency (whatever their official name is) and they want to perform a sales tax audit.  Yours is a primarily internet business that does not collect sales tax on items sold outside of Illinois but you do (or should) collect sales tax for sales within Illinois.  Now, you want to know what to expect.

I am not a tax person but I can give you generic advice regarding being audited regardless of the reason or situation.  In your particular case, Sales tax audits are typically designed to determine if you have been appropriate collecting sales tax on your sales and turning that money over to the correct agency.

Auditing is a simple process (in theory) of comparing “what is” to “what should be”.  In your case, "what should be" is the appropriate tax revenue collected by you and submitted to the state according to the law.  "What is" would be the actual tax revenue you did submit.  This implies that the auditors know "What should be" but this is seldom the case and they typically rely on you to tell them.

You can expect the auditors will want to identify “what should be” and "what is". In other words, they will either want to see your sales records that show amount of sales, amount of tax collected, and who they buyer was.  They may already have a list of your sales from some other source though this is unlikely given the nature of the internet and lack of technical sophistication by most government agencies and employees.  They may even have some reason to suspect that most of your sales are really within Illinois and they are not receiving tax revenue like they should (probably the same person that turned you in to begin with).  They know the law and they will expect you to also know it - you should be able to explain why you do not collect sales tax.  

Lack of records can hurt you because the law in your state probably requires that you maintain auditable records - especially for retail operations such as yours.   You mentioned the state is gathering records on you. Don't be intimidated by this - it only means that they are obtaining all sales tax information of what you have turned in and probably a copy of your business license.  What else is there? Not much, I would guess.

You should contact the auditors prior to the audit and ask specifically what documentation you should provide (explain that your records are off-site). This, at least, will give you some insight as to how they intend to determine "what should be".  

Generally speaking, as an “auditee” you have more control of the environment than you might imagine...

You must realize that the person auditing you is doing so for some reason.  Something is suspicious, you were chosen at random, or someone has given them a tip about you (a disgruntled employee, an unhappy customer, a competitor, a jilted lover, whoever).

The state will probably confront you with what they have and say something like "we know you have done much more business inside that sate than these records support; we have reason to believe that you have been hiding in-state sales and keeping sales tax that you have collected (if you even collected it)!"

If you have operated in good faith and made an effort to comply with law, there may not be any problem, they may just want to see some documented proof of your decisions regarding sales tax.  One of the key things auditors look for is “reasonableness”. In other words, even if you lack documented proof (receipts, records, etc), you may still be able to convince them of your legitimate actions provided you are reasonable in your transactions.

However, even if you are a sloppy record keeper, the state will not be able to prove that your sales exceeded what you say they are. The state might be able to compare your business to similar businesses and claim that your sales must be comparable.  This may or may not be true.  In any case, even without actual sales documents.. you might be able to show copies of sales confirmations sent electronically by you or whatever website hosts your products… you might be able to show FedEx of UPS records (they will have the records) showing products shipped (in and out of state), you might be able to show PayPal or credit card records (PayPal and the credit card companies can help you), and finally, you may be ale to show website traffic reports that the majority of your hits are from out of state and how that is consistent with the sales you have reported.

The audit process is generally that they will have an “Entrance conference” with you where they explain the objectives of the audit, the criteria they will use (the “what should be” as mentioned above), the time frame under audit, the expected time they will take conducting your audit, the documents you need to provide, and they should entertain any questions you might have.  You should be prepared to ask specifically why they are auditing you (in particular), what their methodology is, and how will they determine if you are in violation of law, you should insist that they validate their findings with you prior to including them in any report.  You should ask about how you will resolve any disagreements with them, what is the procedure for escalating the issues to their bosses.  You should also obtain the name and telephone of their supervisor.  It would be appropriate to call their supervisor (but not on speaker) while they sit across the desk from you.  You should verify the auditor’s name, the objective of the audit, and ask the supervisor “why me????”

Know this; the person auditing you is typically under VERY GREAT pressure to produce results quickly.  That is the bad thing about being an auditor – the boss is always, ALWAYS, pushing to work faster.  Since you know this, you should use it to your advantage.  It is better for the auditor to write a clean report, let you go, and move on to the next audit than to spend too much time with you with or without getting results; unless, of course, they can recover millions in tax revenue.  Most of the time, going over the budgeted time for an audit has an extreme negative impact on their performance appraisal and they are acutely aware of that fact.  You can manage this by doing the following:

1) NEVER be belligerent or argumentative or uncooperative.

2) Don’t be too smart – be a little dumb so they have to explain everything to you twice.

3) Always be courteous and helpful but very, very slow. Whatever they need – you are very happy to give to them but you don’t have it with you (maybe it is off site and you will have to retrieve it from somewhere else)... make a note of what they need.  Make the note wrong so you will return with the wrong thing.

4) When you return with the wrong thing, make them explain everything all over again as if you don’t understand. Show them the note you wrote down before to prove that you are trying your best to give them what they want but it is all so confusing.

5) Whatever they ask for, always arrange to provide it on a subsequent visit - this stretches out the time.

The point is that they know that the boss will be looking at the number of hours they are spending on your case and they will soon give up – unless your tax situation is really bad or you simply got caught being dishonest and they want to go for big bucks or make an example of you.

Remember; be helpful and friendly but ever so slow, slow, slow.


As a last resort, if it is proven that you owe taxes, you will not likely be prosecuted unless that can show that you deliberately avoided paying the sales tax to them… in other words, if they can show criminal intent.  In my opinion, it is better to be seen as a buffoon of a business person who just didn't know the tax money had to be sent in quarterly and you planned to send it in with your annual tax return, or to claim that you have been holding it as you expected to contacted by the tax department to collect the tax (you didn't know you were supposed to send it in).  Finally, there are a number of businesses that will serve as your advocate in resolving these issues.  Here are some links:

http://www.resourcelinks.net/salestaxil.htm

http://www.bookkeepinghelp.com/IRS/Illinois.asp

You might also be interested in this article that talks about internet sales tax:

http://www.internetretailer.com/internet/marketing-conference/90947-sales-tax-tu


As I said, tax is not my specialty but I hope this helps and would appreciate any feedback.

Don Sadler

---------- FOLLOW-UP ----------

QUESTION: Don what do you think about the potential for them to get after me for not filing as in prosecution im certainly not a crimminal and none was intended just busy and neglect i guess. just looking for a opinion

Answer
Steve, sorry for delayed response... I was not aware of the follow up question.

Who can assess the potential for government to do anything?  First, I don't believe this falls within the criminal code so, at worst, it would be an administrative violation.  Even then, my expereince is that they would prefer to close the case rather than prosecute and spend time testifying, etc.  That said, however, a lot of the consequences depend on your attitude. If you offer a hostile "in your face" aattitude, they may want to do it just for the pleasure of taking you down.  They seldom ever prosecute just because of oversight, negligence, or bad business decisions... provided you were acting in good faith and without the intent to evade taxes or do any financial harm.

I would suggest you might want to be forthright about communication (following previous advice, of course) and show genuine concern about having forgotten to file.