How CPAs can Assist with Common Errors Discovered in Oklahoma Sales Tax Audits

I have also noticed a lot of misconception from taxpayers regarding their CPA’s role in sales tax.  A taxpayer may think that their CPA knows all about their sales tax activities even though sales tax is explicitly excluded in the engagement letter for the annual tax return.  Even if a CPA does not prepare sales tax returns for clients, there are several areas where the CPA can check-in on an annual basis to identify potential risks with the client’s sales tax reporting system. When errors are found early, corrections can be made to the sales tax system to minimize any potential sales tax audit in the future. Sales tax assessments can be generated from a OTC Field Audit, OTC Desk/Discovery Audit, or contract auditors hired by a municipality.

This article will review some common errors found in sales tax audits.  Let’s look at a few of these areas in more detail.

Underreporting of Sales:  All sales are subject to sales tax until they are shown to be exempt (Okla. Admin. Code Sec. 710:65-1-4 (a)).  Sales tax auditors review the federal income tax returns, third party credit card reporting found on the 1099K Federal Form, and other financial records and make comparisons between sales and sales reported to the OTC through the sales tax reports.  Differences are investigated, and any underreporting will be reviewed for potential assessment.

Generally, sales tax reports are based off a point-of-sale system report.  Ideally, these point-of-sale reports will reconcile to the financial records. Often the sales tax reports reconcile when the system is initially set up; however, as time goes by, reconciliations between the sales tax reports and the financial records get off track.  This could be due to changes in circumstances or any number of other errors.  Whatever the case, by making this comparison on an annual basis, differences can be researched and corrected so future years are not impacted.

Exemption Documentation:  The burden of proving that a sale is an exempt sale is upon the vendor (Okla. Admin. Code Sec. 710:65-1-4 (a)). Vendors are held liable for the collection of sales tax unless the purchaser timely provides the vendor with documentation proving the purchaser is exempt from the payment of sales taxes. During a sales tax audit, the auditor will review exempt sales to determine validity of the exemptions claimed.  Missing exemption documents discovered during an audit will be flagged for assessment.  Depending on the population, audit sampling methods may be used for this testing. If audit sampling is used, exceptions will be projected to the entire audit period.

Contractors are consumers/users and must pay sales tax on all purchases of tangible personal property (Okla. Admin. Code Sec. 710:65-7-13) with limited exceptions.  If a business is selling to contractors exempt of sales tax, documentation needs to be maintained for each contract.  Taxpayers selling to contractors should be familiar with the documentation requirements for each exempt contract.  It is common in a sales tax audit to find improper documentation for exempt sales to contractors.

Exemption management systems should be kept up-to-date. Chasing down a missing exemption document during a sales tax audit can prove problematic as there may no longer be a working relationship with the customer, or the customer may no longer be in business.

Reviewing exempt sales documentation to determine if exemptions are current and valid on at least an annual basis will identify any deficiencies.  Taxpayers can make any necessary corrections to the sales tax procedures to ensure that exemptions are properly documented going forward.

Use Tax:  Purchases of tangible personal property from outside of the State are subject to use tax if used or consumed in Oklahoma (Okla. Admin. Code Sec. 710:65-21-3). Auditors will review purchases of both fixed assets and expense purchases and identify any invoices that are taxable for use tax.  Fixed asset purchases are the most common purchase exceptions.  

Oklahoma use tax can come as a surprise for entities based out of State with operations in Oklahoma.  If a centralized purchasing function is located outside of the State of Oklahoma and use tax is not considered at the time of purchase, these transactions can be assessed in a sales tax audit.

Many companies have never reported Oklahoma use tax.  Companies that have not reported Oklahoma use tax are not subject to the usual three-year statute of limitations; therefore, during an audit, the auditor will go back further than three years to assess for these out-of-state purchases.  Due to this expanded look-back window, if use tax appears to be an issue, the taxpayer should consider filing Oklahoma Use Tax returns.  A casual Oklahoma Use Tax account can be easily opened through the taxpayer’s OKTap account. The CPA can identify and quantify these transactions by reviewing any out-of-State purchases for potential Oklahoma Use tax issues on an annual basis.   

Not Charging Sales Tax:  For entities not charging sales tax to customers, annual review of these practices should be made.  Auditors will look at all sales in detail to determine if there is tangible personal property being sold in which sales tax should be charged.  Perhaps the business has expanded from its origins without considering the sales tax consequences or misinterpreted the tax code.

Businesses who incorrectly think they are exempt from collecting sales tax will often get a rude awakening when a sales tax audit is initiated.  If the business has not filed sales tax returns, the usual three-year statute of limitations does not apply and the auditor can look back further than three years to assess for these sales.  Considering sales tax on an annual basis will help identify any misconceptions in interpretation of the sales tax code or changes in the taxability of business transactions.

Sale of Business Assets:  Business owners may not realize that when they sell tangible personal property, a taxable transaction occurs.  They usually consider that sales tax was paid when the asset is first purchased but not realize that sales tax is a transactional tax.  That means both the purchase and the sale of a fixed asset are taxable.  Sales tax auditors review the Federal Income Tax Return Form 4797 filings and determine if sales tax was accounted for on all transactions listed.

The sale of business assets when a business is closing is also reported on Form 4797.  Common wording in purchase and sale agreements (PSA) is to require the buyer to be responsible for the sales tax related to the purchase of the assets.  While the PSA agreement has the buyer responsible for paying the sales tax, the State of Oklahoma places the primary burden of collecting the sales tax on the vendor or seller (Okla. Admin. Code Sec. 710:65-7-2).  Sales tax auditors will review the PSA agreements to determine the amount of tangible personal property sold and make assessments accordingly.  Detailed allocations of tangible personal property, real property and intangibles are necessary to properly account for these bulk asset sales. If any of the items purchased would be considered exempt such as inventory or for use in manufacturing, any such permits need to be obtained prior to the contract sales date. Otherwise, the transaction is taxable for sales tax. CPAs can prepare clients for this by discussing this issue on an annual basis.

Resources Available to Taxpayers:

The OTC website (www.ok.gov/tax/)  provides many resources to assist with complying with Oklahoma sales tax law.  The following resources and links relate specifically to sales tax.

1. Chapter 65 of The Oklahoma Tax Administrative Code is a helpful resource with the administrative rules covering Sales and Use Tax.
   https://oklahoma.gov/content/dam/ok/en/tax/documents/resources/rules-and-policies/agency-rules/Chapter65-2022.pdf

2. Publication D-Oklahoma Sales Tax Vendor Responsibilities for Exempt Sales details vendor responsibilities for exempt sales documentation with helpful examples.
   https://oklahoma.gov/content/dam/ok/en/tax/documents/forms/businesses/general/Publication-D.pdf

1. Guides to Assist with Audits: The OTC has prepared a Field Audit Guide and a Desk Audit Guide for Taxpayers to assist in answering common questions surrounding a sales tax audit.  Sales tax audits are performed not only by the OTC Audit Services Division but also by contract auditors that have been hired by municipalities to perform sales tax audits.   These guides describe the procedures used by the auditor when reviewing records. The guides explain the forms used during an audit, as well as provide resources after an assessment it made.
   
   The Field Audit Guide can be found on the OTC Website or through the following link.
   https://oklahoma.gov/content/dam/ok/en/tax/documents/resources/publications/infographics/TaxpayerFieldAuditGuide.pdf
   
   The Desk Audit Guide can be found on the OTC Website or through the following link.
   https://oklahoma.gov/content/dam/ok/en/tax/documents/resources/publications/infographics/TaxpayerDeskAuditGuide.pdf

4. For specific questions: For specific sales or use tax questions, reach out to the Tax Professionals hotline at 405-521-6827 or email TaxProfessionalQuestion@tax.ok.gov.

The Mission of the OTC is to promote tax compliance through serving taxpayers with transparency and fairness in administration of the tax code and unparalleled customer service. Sales tax audits help ensure one business does not have an unfair advantage over another business by not charging sales tax. The goal of every OTC tax audit is to ensure compliance with Oklahoma sales and use tax statutes. Usually, these audits result in assessments. The OTC is interested in collecting all taxes due by a business and not a penny more.  By identifying common areas where sales tax assessments occur and reviewing these on an annual basis, taxpayers can make corrections before the errors become onerous.

In summary, most sales tax audits have more than one issue identified for assessment.  By discussing these five areas with your clients on an annual basis, CPAs can help reduce some of the risks associated with a sales tax audit. Errors found in each of the above areas can be quantified and reported to the client. CPAs providing these value-added services will not only assist their clients with sales tax reporting accuracy, but likely be mitigating their client’s risk for a potential sales tax assessment.  

Special thanks to Lisa McFadden-Johnson, Oklahoma Tax Commission Audit Services-Business Tax Desk Audit Administrator for assistance with the Discovery audit information contained in this article.

Deanne Nunn, CPA, is a sales tax audit supervisor with the Oklahoma Tax Commission in Oklahoma City. She has been an OSCPA member for 37 years and currently serves on the Continuing Professional Education and Financial Literacy Committees, and is chair of the Public Relations Committee.