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Sales and Use Tax Audits — Be Prepared

Les Rosenbaum 09.08.2014 | Practice Made Perfect

Sales and use tax audits don’t necessarily pop up when you are ready and the best defense is being prepared.  The problem is that the rules are not always clear and so it is difficult to know when your firm is liable.  Case in point: Law firms know that out–of–state vendors are not required to collect New York State and City sales tax and that the firm must pay the tax for office supplies, office furniture, fixtures, and equipment purchased from these vendors.  The wider picture, however, is not so black and white.

To help you be better prepared when the auditor comes around, here is an outline of what you can expect.

Period of the Audit 

Generally, the audit will cover three years from the date the sales tax return was filed.  If no return was filed, there is no statute of limitations and the audit period could be for the entire existence of the firm.  However, New York State, as a matter of policy, limits the audit to six years.

Firm Income

Legal services in New York are not subject to sales or use tax.  Any client disbursements billed that are incidental to the provision of legal services are also not subject to sales or use tax.  However, in Connecticut, lobbying or consulting services for the purpose of influencing any legislative action are taxable.

Fixed Asset Purchases

In most cases, the state will scrutinize all purchases made during the audit period by reviewing invoices, contracts, and leases.  Areas of possible exposure include leasehold improvements and out-of-state purchases of items treated as fixed assets, such as furniture and fixtures and major computer hardware, software and other information technology services that are capitalized.

Recurring Expense Purchases

A review of recurring expense purchases is commonly done on a test basis. The firm has the right to protest audit results done on this basis if the test results are not indicative of the entire audit period.  Areas of potential exposure include purchases of computer hardware and software that are expensed, office supplies, books and periodicals, and taxable information services such as abstracts of title and risk management analysis reports.

Software purchases have their own peculiar rules. Over the counter software purchases are subject to sales and use tax while software that is custom designed specifically for a firm is not. To complicate matters, when you purchase over the counter software (taxable) that is then customized for your firm (not taxable), the vendor must separately state the charges for the custom work or the entire charge will be taxed.

Documentation Required During the Audit

If the firm has made any leasehold improvements, the state will want to see the contract with the contractor, as well as subcontractor invoices and a description of the project.  For periodicals, the state will want to review the invoice with details on the length of the subscription and may also want to see a hard copy of the publication.  Employee purchase reimbursements must be backed up by a copy of the original invoice and not just credit card receipts.

A sales and use tax audit can be a grueling experience and advance preparation can help you start off on firmer footing.  When that time comes, it is best to proceed with the advice of your financial advisor who can guide you through the process with greater confidence.

Questions?  Contact your Berdon advisor or Les Rosenbaum at 212.699.6703 | lrosenbaum@berdonllp.com

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