If a company inadvertently underpays its sales and use taxes, there’s a good chance the state and/or local Department of Revenue will find the error and collect. Ah, but, when it’s the other way around, and a company has inadvertently paid too much tax, a reverse audit may be the only way to catch the error. And, that nifty reverse audit can mean thousands of dollars in refunds.
Internal audits in the traditional sense might not catch these costly tax mistakes, as that type of audit tends to focus on a company’s policies, procedures, and budgets. A reverse audit, completed by a professional services firm, combs through thousands and sometimes millions of transactions with a company’s vendors.
Ten industries frequently overpay sales and use taxes, according to an Accounting Today story citing a study by a Chicago tax and consulting firm. Those are manufacturing, engineering/research, and development, biotechnology, printing/publishing, technology, telecommunications, financial services, insurance, healthcare, and pharmaceuticals.
Some companies don’t have a built-out tax department, which would review transactions. Turnover in accounts payable departments or a change of vendor can also create the problem. Truly, most companies don’t have the personnel needed to complete the labor-intensive work.
A manufacturing client was under a state audit and the auditor had attempted to assess taxes of over $400,000. With LBMC's help, the auditor reduced the assessment then conducted a reverse audit and found the company had overpaid almost $900,000 extra in taxes. That company ultimately received a net refund of over $500,000.
A company that paid taxes on computers, office supplies, software, building maintenance and more each month to its vendors but also paid the Department of Revenue on the same transactions. In essence, the company inadvertently paid taxes twice on some things — once to the vendor and once to the state. A reverse audit on four years of transactions resulted in nearly a $1 million tax refund to the company.
According to a recent article in the Journal of Accountancy, a policy and procedures review is one tool to address the sales and use tax risk.
“The risk posed by state and local sales and use taxes should be viewed in the same manner as other business risks, e.g., product liability, theft and casualty,” the article notes.
The reverse audit process may start with a meeting with a company’s tax professionals, accounts-payable manager, capital asset coordinator and other employees familiar with tax reports and accounts payable files.
Once an overpayment is found, the next step should be to educate the company so it won’t happen again.
LBMC tries to educate our clients about when they should pay tax and when they should not. We work with the client to stop the bleeding.
Another type of reverse audit can help companies find Work Opportunity Tax Credits they may have missed. A company hiring from certain groups — including food stamp recipients, qualified disabled or unemployed veterans, qualified ex-felons, the long-term unemployed, Empowerment Zone residents and more — may be eligible for the credit. These are federal tax credits distributed at the state level and ranging from $2,400 to $9,600 depending on the group.
Discovering and claiming these credits takes time and requires digging into an employee’s history for addresses, ethnicity and unemployment records.
Documentation of credits is very tedious and labor intensive. Most companies do not have the staff to perform a WOTC review.
A tax expert can provide more information or answer questions specific to your company. If you’re interested in learning whether your company can save money with a reverse audit, LBMC will, in many cases, conduct a reverse audit at no additional cost to the company. A fee is collected only after an overpayment has been identified and realized.