Watch Out: Sales Tax Audits Are on the Rise

Many states are turning to technology to automate the audit selection process, become more efficient and increase revenue for each audit hour conducted

The current Great Recession has cut deeply into state sales and use tax revenue. Budget shortfalls are in double digits for many states, making it difficult to balance budgets and deliver essential services.

For the first three quarters of 2009, of the 45 states (not including District of Columbia) that collect sales tax, all but a few have suffered declines in revenue in 2009 — with Wisconsin suffering the highest single-quarter decline, 34.4 percent in the second quarter, followed by Arizona with 27.3 percent, also in the second quarter. In the third quarter, there were 16 states that had double-digit hits compared to the same quarter of the prior year.

The drop in revenue is expected to continue. “This is an awful time for states fiscally, but they are even more worried about 2011, 2012, 2013, 2014,” says Scott Pattison, executive director of the National Association of State Budget Officers, in a recent Wall Street Journal article.

To counter revenue shortfalls, a number of states and localities have already done so or plan to:

• Increase their sales and use tax rates. States such as California, Maine and Massachusetts, as well as many others, have done so already or plan to increase their sales and use tax rates. Localities within 15 states have also followed suit. In all, there were more than 1,000 tax rate increases made in 2009.

• Expand their taxable base to include currently nontaxable services or digital products. Five states are moving in this direction, including New York, Washington and Wisconsin.

• Cast a wider net with legislation that expands nexus. A particularly tempting target is revenue generated from e-commerce.

Even though increasing taxes can have negative political consequences, taxing jurisdictions at both the state and local levels will continue to raise tax rates to deal with their shortfalls. Additionally, expect increased audit and collection efforts nationwide.

In the latter part of 2008, Maryland, for example, added 22 auditors to target “scofflaws” and implemented a $90 million collection system to track them down. Similarly, Connecticut has installed a sophisticated audit scoring system to zero in on the highest-potential recoveries.

In January 2010, Washington state replaced the traditional self-issued resale certificate system with state-provided seller permits with one-, two- and four-year expiration periods. The procedure is expected to save the state around $130 million in revenue annually that was previously lost through abuse of the resale certificate privilege.

More efficient and effective enforcement of existing laws is preferable to increasing the tax burden on individuals and businesses but the states and localities will continue to increase tax rates because doing so can generate immediate results, and because they can. But whatever approach states decide to take, sales and use tax will be at the forefront.

This story is from the CCH e-newsletter Figures, written specifically for corporate tax professionals. Figures offers tips, tricks and ideas about how to increase your organization’s productivity and efficiency.  Every issue also features insights with a corporate tax professional

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