Audit Process

A Maryland sales and use tax audit typically begins when a business receives an audit notification letter and a request for records. The process may include an initial meeting with the auditor or a phone conversation discussing the audit process and records needed, a review of accounting records and chart of accounts, the selection of expense accounts that are being reviewed, the selection of sample invoices needed in the test period for the sales and expense review, documentation forwarded to the auditor, audit workpapers identifying questioned transactions, requests for additional documentation, documentation forwarded to auditor on disputed items, final field workpapers and a formal assessment notice showing the amount of tax, interest and penalty owed. If disagreements still remain, the business may request an informal hearing within thirty days of the date on the formal assessment notice and, when necessary, file an appeal with the Maryland Tax Court.

Included with the audit notification letter, the auditor will include a record request form which will usually request general ledgers, depreciation schedules, purchase and sales journals, asset invoices for audit period, expense invoices for test period, sales invoices for test period, chart of accounts, resale and exemption certificates for test period, sales and use tax returns for audit period, federal and state income tax returns, bank statements for audit period and other records deemed necessary. If any invoices are not provided, then they will most likely remain on the audit workpapers. Most likely, the current federal tax return will not be filed so an estimated amount will be entered into the sales tax deficiency schedule for sales.

For audits where the auditor is reviewing sales for the proper collection of sales tax, the auditor is reconciling gross sales as reported on the federal tax returns vs sales tax returns vs income deposited into the business bank accounts. According to the type of audit, if the income is higher on the federal tax returns or money deposited into the business bank accounts vs the sales tax returns or POS system, the auditor will use the higher sales amount in projecting the sales tax deficiency on sales. If there are sales or revenue items that are not taxable, then the Taxpayer would have to bring those sales or revenue items to the auditor’s attention. For example, if the business sold lottery tickets and received revenue from the State, then that revenue would not be taxable. The basis in which a Taxpayer files their federal tax return, cash vs accrual, should be the same when pulling reports from the accounting system so the numbers will match up.

The length of a Maryland sales and use tax audit depends on the size of the business, the quality of its records, the number of records requested, the number of disputed transactions and the time the Taxpayer takes in providing these records and the time it takes the auditor to review the records. Preparing records, reviewing workpapers and responding to documentation requests can require many hours. If both parties act timely, then the audit could be finalized within six months. With any delays, then the process can last plus or minus one year. The process may take longer if an informal hearing is requested. One can add an additional six months or less to the process for the informal hearing.

Audit workpapers will have at least three schedules identifying the individual sales, expenses and asset purchases reviewed by the auditor and listed as taxable. Each transaction that has been assessed will have invoice date, invoice number and amount taxable and if the invoice was not provided, the comment column may say missing. The expense and sales schedules will have a corresponding projection schedule where they take the deficiency calculated from the test period and project those numbers over the audit period using numbers from the federal tax returns and/or accounting system. The auditor will also examine the amount of sales tax collected and the use tax remitted to determine that all taxes were properly filed. If there are any discrepancies, then a fourth schedule will be created to list the monthly amounts paid and due to calculate the additional tax due. Once the Taxpayer is provided the final workpapers, the Taxpayer is usually given thirty days or so to review the workpapers and to provide any additional information on any disputed line items before the audit is turned in for the assessment notice to be issued.

The State of Maryland will use a sample period and information from federal income tax returns or accounting system to estimate taxable sales and expenses for the full audit period. Even a small error within the selected sample can produce a much larger projected assessment. The projection methodology and the transactions used in the calculation should be reviewed carefully. The sample period selected for the sales and expenses are usually selected by the auditor in the initial record request. This is just an arbitrary decision, and the Taxpayer can have the test period changed at the beginning of the audit process. If the Taxpayer has changed accounting systems or feels the test period does not represent the business, then the Taxpayer can request a different period or have the test period in a more current year. The taxpayer can also make the test period smaller or larger if they desire. Usually, the auditor will agree to the change.

A sales and use tax assessment can grow significantly when taxable transactions are projected over a four-year audit period. Missing documentation, uncollected sales tax and unpaid use tax can result in an assessment of tens or even hundreds of thousands of dollars. Interest and penalties may further increase the balance by thirty-five to forty-five percent.

Common sales-related mistakes include missing or invalid resale certificates, missing exemption certificates and failing to collect tax on taxable sales or collecting the wrong rate. Businesses may also overlook tax on certain pickup, counter or employee sales. Rentals are generally treated as sales for Maryland sales tax purposes, so the applicable tax may need to be collected.

Yes. If a business cannot provide a valid resale or exemption certificate, the auditor will treat the transaction as taxable. Locating or obtaining valid certificates and presenting them in the required form may help dispute individual sales included in the assessment to be removed.

Maryland use tax applies when a business purchases taxable goods, assets or services without paying Maryland sales tax to the supplier. This commonly occurs when buying from an out-of-state supplier or another vendor that is not licensed to collect Maryland sales tax. Use tax obligations involving business expenses and asset purchases are always examined during an audit.

Some services are taxable in Maryland, while others are not. Confusion about the taxability of a particular service is a common source of audit assessments. Each expense should be evaluated based on the nature of the transaction and Maryland’s applicable sales and use tax rules.

After receiving the final field workpapers, the business will receive an assessment notice that includes the proposed tax, applicable interest and penalties. The business can request an informal hearing, submit additional documentation and challenge disputed items. Maryland may then issue adjusted workpapers and a final determination letter. Further appeals may be filed with the Maryland Tax Court.

An assessment may be reduced when a detailed review identifies incorrect classifications, unsupported projections, valid resale or exemption certificates, tax previously paid, provides missing invoices or other documentation supporting disputed transactions. The outcome depends on the facts, available records and the stage of the audit or appeal.

A business should consider a Maryland sales tax consultant or expert as early as possible after receiving an audit notification letter. Assistance can even be provided after audit workpapers or an assessment notice has been issued, before an informal hearing or before a Maryland Tax Court appeal. The earlier the help is requested, the better. Early review can help identify exposure, organize documentation and prevent avoidable errors. The number one decision to be made is the sample test periods for the audit of the sales and expenses. The Taxpayer wants a period that truly represents the business and that the records are easily available.

Marsu Associates specializes in reviewing Maryland sales and use tax audits. Since 1981, Marsu has helped hundreds of companies work toward reducing assessments to the lowest supportable amount and identifying available refund opportunities. Marsu can assist at any stage of the audit process, from the initial records request through workpaper review, informal hearing and Tax Court preparation.

The purpose of a reverse audit or refund review is to lower the amount of tax due. By law, Maryland must incorporate any refund into the audit workpapers and net the refund against any tax due, before interest and penalty is assessed. Thus, the Taxpayer saved interest and penalty charges on the approved refund amount. If the approved refund amount is larger than the tax assessed, then the Taxpayer will receive a refund check in the amount of the approved refund amount minus the tax assessed in the audit, thus saving all interest and penalty charges.

The refund review is billed on a percentage of savings basis. If no refund is approved, then there is no fee, but the Taxpayer gets the assurance that they are claiming all exemptions and not overpaying on their sales and use taxes. Please review our success stories on our website to see how the refunds approved effected the tax due, if any.

Contact Marsu Associates if your company has received a Maryland sales and use tax audit notification letter, audit workpapers or an assessment notice. Marsu can review the audit findings, identify disputed transactions, help gather supporting documentation and assist your company throughout the audit and appeal process regardless of what audit stage it is in.

For the audit review process, Marsu can bill on an hourly or percentage of savings basis. For the refund review, the client will be billed on a percentage of savings basis. Therefore, if no refund is approved, then the client receives no bill. Win-win. On occasions, Marsu has offered to bill on which method results in the lowest bill, hourly vs. percentage of savings basis. The lower the total assessment amount, the most likely the percentage of savings basis will create the lowest bill for services rendered. I have run into occasions where a Taxpayer hired a lawyer who charges hundreds of dollars an hour have a bill that is more than what the Client saved.