Documentation, Documentation, Documentation
Michael J. Fleming is the founder and president of Sales Tax and More, a full-service consulting and solutions firm with a passion for state tax. He is one of the country's leading authorities on sales tax issues such as consulting and research, registrations, returns, nexus, drop-shipping, eCommerce, and service providers.
Michael is a renowned writer and speaker, and he regularly presents on webinars. He is also the host of the Sales Tax and More Podcast, where he shares his wisdom and learnings with his audience in order to help them navigate the tricky world of taxes.
In this episode…
Mike Fleming will dive into the crucial topic of documentation in sales tax compliance. The discussion highlights documentation's significant impact on audits, exemption certificates, and the overall management of sales tax for businesses. Mike and Ellie elucidate the common pitfalls and best practices in maintaining proper documentation to avoid hefty fines and legal issues with state tax authorities.
Here’s a glimpse of what you’ll learn:
The Importance of Documentation in Audits
Exemption Certificate Management
Impact of Workforce Changes on Documentation Access
Burden of Proof and Taxability
Connect with Michael
Episode Transcript - Audio Version
[00:00] Intro: Welcome to Sales Tax and More. Your go-to resource for all things state-related. Now, here’s your host, Michael Fleming.
[00:19] Mike: Hello everyone. Mike Fleming here, founder of Sales Tax and More and today's co-host of the Sales Tax and More podcast, where we talk about everyone's favorite topic, which is, of course, sales tax. Now, today we're going to talk about documentation and why it's so important, but first, let me introduce you to my co-host Ellie Moffat.
[00:39] Ellie: Hey everyone, really great to be here, and Mike, I'm just over here laughing right now because I wrote out as our title documentation why it's so important, and we didn't get any emphasis, but it is so important. Before we get started, before Mike really gets into that, let's just go, I'll go ahead and tell you about our company, Sales Tax More. So for those who don't know, Sales Tax More is a full-service consulting and solutions firm. We have a really great team here of experienced tax professionals who are very dedicated to fulfilling your state tax-related needs. So we do a lot of sales tax returns, sales tax registrations, consultations, research, and like our name states more. Mike, why don't we just jump right in here, and walk us through what happens when you don't have documentation of your sales, and you are in an audit. So big meat question right off the bat.
[01:35] Mike: All right. And I'm going to make you happy here. What we're going to talk about is why documentation is so important. Did I do better?
[01:45] Ellie: That's much better. Thank you.
[01:47] Mike: All right. So we really have two huge issues when it comes to audits. And sometimes, there is no documentation, and sometimes companies are afraid to give the state the documentation. They really both have the same outcome if the state doesn't have documents that they can review in order to determine whether you owe them money or not.
They're going to make numbers up. They call it estimating, but what it really is they're making the numbers up. And if they're making numbers up, they usually make them up. Fairly high. If you're going to make up a number, why not make it a high number? So that's the first thing.
[02:31] If you don't have the correct documentation or you don't want to provide it, the state's not going away. They're just going to estimate the numbers. So that's the first big problem there. The second issue is when it comes to exemption certificates, and if you don't have the documentation to prove that something was an exempt sale, it then becomes taxable. If you can't properly document an exemption the state's not going to recognize it as an exempt sale.
So a big issue there. And it really has an outsized impact on the audit because most audits are done on a sample basis. So if you're missing the documentation on just one certificate, it's not just the tax that's associated with that certificate. It's what that tax represents as a percentage of the population. So when it's extrapolated out, I can have a huge impact.
[03:33] I always use this example. I was involved in an audit one time. And there was one missing certificate, and sometimes you can get that detailed out, and get it excluded from the audit, but we had not always, but when we had used up all our favors in this audit, and the state wanted to keep it in there. And it was a lot of tax on a single invoices, a piece of heavy earth moving equipment would have been about 8,000 worth of tax and no one wants to pay that. But when they took that error and extrapolated it out over the population, it was over 270,000 error. Now that's a little bit extreme. Most invoices aren't going to have 8,000 worth of tax on them, but. you're usually going to have more than one missing document. You're going to have more than one error when it comes to these exemption certificates.
[04:31] So huge oversized issue in an audit is missing or improper documentation. It's for companies that are required to collect exemption certificates. It is the number one cause for large assessments. So those are the two big issues. Generally, people want to appeal or protest an audit if they feel the state has treated them unfairly. But unfortunately, if you didn't have the documentation during the audit when you appeal or protest this, and I've read these all day long about what the states are doing and why these appeals and protests are being denied and the biggest reason is they don't have the documentation. If you didn't have it up front, now you go in and say, Hey, this was not fair. I want you to redetermine this you don't have any documentation to prove that it wasn't fair. So the state's going to say, hey, this is fair. You can't prove that it's not fair. So those are the big issues when it comes to missing documentation, Ellie.
[05:38] Ellie: Mike I feel that often we are talking about documentation in meetings almost fairly often. We meet weekly to look over what's happening, to try to stay relevant, to try to look up information, and all the time, we see people with documentation issues that bleed into so many other things. Can you touch base on that? What other kinds of issues arise from lack of documentation?
[06:06] Mike: I'm going to switch gears a little bit here and start talking about taxability issues. This is more of an issue when the documentation doesn't match the way that you're taxing or you have conflicting documentation. Your contract says one thing, the invoice says another, and this can create big problems. I'll give you an example. There's this company that came to us, and they were in an audit, and the state was giving them a hard time. They wanted us to check the other states and make sure they weren't going to have a hard time.
So whenever I'm doing research, I ask someone to send me a copy of the of an invoice, a copy of any agreements they have, and then to write out in their own words what exactly they're selling and how they're doing it. Sometimes, I also look at their website because you want to make sure that everything is matching.
[07:05] All the documentation says the same thing, not in the same words, but it has the same impact. It all means the same. And what they told me is they were selling software as a service. But when they describe their product, the first thing they say is the most important thing is you got to download our software and they gave me a sample agreement and the agreement was for downloaded software, and the invoice was for downloaded software.
So when an auditor sees all of that, even if you're remotely accessing something, once you've downloaded. The software allows you to access something else; the auditor is going to see that invoice for downloaded software, and you can start arguing.Oh, no, this is software as a service.
And he'll say, okay, or she'll say, let me see a contract and the contract is for downloaded software. So we want to make sure that what we think we're actually selling is what we're actually portraying, what we're actually going to be showing an auditor, what we're showing our customers or our clients, and they got to all lineup.
[08:23] So it's really, important to do this. And I can give you example after example when someone thought they were selling one thing, but their contracts and their invoices said a whole other story. And it starts with the invoice. That's usually what an auditor is going to look at. So, if you got it wrong on the invoice, It doesn't get much better from that, everything else is, you're fighting an uphill battle. And if it's all wrong, sometimes the contract will supersede the invoice. And if it's right in the contract but wrong on the invoice, then okay, we've got a battle that we can fight there. But if it's wrong all across the board and like that first example I gave, then it can create huge issues.
[09:09] Ellie: Mike, I was talking to Krista in our operations department in general and documentation issues and she mentioned what happens when someone on the team…when someone on a business's team leaves and access becomes a problem. Can you speak on that?
[09:26] Mike: Yeah I call this documentation adjacent, and it's it's really becoming a huge issue. We're seeing more and more of this; we're seeing a lot of turnover out in the workforce, people getting laid off, people leaving, resigning when they have to go back to the office, and a lot of these people—had something to do with the sales tax compliance function. And a lot of these companies, one of the things they do right away is cancel their email accounts.
They may transfer some things over, but they actually shut that email account down, not realizing that in order to get into a lot of these state websites, you have to have access to that email. And sometimes there's two or three people back. And you don't even remember whose email you used or who the original person who set this up was.
[10:24] But now you've got to change an address, or now you've got to, you've got to go into the state and do something, and without having access to that email, then it's almost impossible sometimes. States are very not cooperative in helping you. I shouldn't say that. Some states are, but most states are not. You have to know exactly what's in their system in order for them to allow you to change things. So that's a big issue whenever you want to go back in and update the accounts. Another one is maybe you get an inability to file. Sometimes, if you log into a state site from a new computer, it's going to send you something to verify that you're actually the person who should be doing this.
[11:16] And it's going to an email address that no longer exists. So, the ability to file on time is often disrupted by this. And then there's the issue of missed notices. If the notices are coming to a certain email and that email is turned off, it's not forwarded, then that can become a big issue also. This isn't really missing documentation, but it's missing important information because someone didn't change the way that things get documented. So my suggestion is whenever anyone's going to leave, before you turn off that email, go out and make sure that anything that email was used to sign up for all of these state accounts when it comes to sales tax.
It could have other implications in other areas, but when it comes to state taxes. Make sure that's changed out prior to turning off the email address because they're going to be sending verification emails or even office numbers, same type of thing. If they're going to be calling a certain number, then you want to make sure it's on until you get everything changed out. Just a little bit of advice there, really.
[12:35] Ellie: Yeah. I was going to say, save yourself a headache, take that piece of advice. And don't question it. Okay, Mike, I'm going to just take this moment, maybe you've heard us mention burden of proof on our free webinars, on our podcast that you're listening to right now, on our social media, and some of the free resources that we have, and we have so many, right Mike? We talk about people facing consequences with documentation due to issues with burden of proof. So, could you take a moment and go into that a little bit? And for the listeners, please follow along with all the things I mentioned. And Mike, could you go into that a little?
[13:18] Mike: Yeah, the presumption is, and this is in all states, is that all TPP and enumerated services are taxable unless they're specifically exempt. And the burden of proof to show that something is not taxable is not on the state. They don't have to prove why it is taxable. The assumption is that it's taxable. The burden of proof is generally going to fall on the taxpayer to prove why it’s not taxable. Sometimes that's easy. Sometimes things are plain vanilla, and the state realizes, okay, hey, this is a grocery, and groceries aren't taxable in our state. No big deal, but not everything is always going to be cut and dry. So the burden of proof is going to be on the taxpayer to show why this is not taxable and services, especially. That's a really big issue nowadays. A lot of people still believe that services are not taxable.
[14:20] And I'm going to tell you right now, I don't know of a state out there that has a sales tax that doesn't tax at least some services. Every year, more and more states are taxing more and more services, and services are come into a gray area. Sometimes semantics, how you word something is again; we're going back to that, you're invoicing matching what you're actually doing in the contracts. So the burden of proof is going to be on the taxpayer, and they have to have the documentation and they have to know what they're actually trying to prove. You got to make sure that the documentation you have. Says what you want it to say, and if not, then you got to go back and change the way that you're doing things, but that's what the burden of proof is. The states are going to presume that all TPP and all enumerated services are going to be taxable. And if there's an exemption, you got to prove that you're actually eligible for this exemption from having to either collect or pay the tax.
[15:32] Ellie: All right and Mike, why don't we start to wrap this up here? Do we have any advice for people who are currently knee-deep in documentation issues, experiencing that headache, but do not have a problem with the state yet?
[15:47] Mike: Yeah, that's the important part. No problem with the state yet. You want to address this prior to the state getting involved. From time to time, you should be spot-checking what you're doing, making sure that everything is the way that you think it is, especially when you're adding a new service or adding new states.
And if you find out that you do have documentation issues, the best time it's like planting a tree—the best time to plant the tree 20 years ago. The second best time is today. Same thing with documentation. If you didn't do it right to begin with, start getting it right. If you're missing certificates, go out and start collecting the certificates. If you're not validating the certificates, but sometimes it's not just the fact that you're collecting certificates, you've got to make sure that those certificates would actually survive an audit. What's the sense of having a certificate? Something that gives you a full sense of security if an auditor is just going to kick it.
[16:52] So we call that the validation process. We offer exemption certificate management services. And that validation is something that is real, real important. I think that's what really sets us apart from other companies that are offering this exemption certificate management service. And so you've got to be checking your certificates, make sure they would survive an audit. And if not, going out and getting those certificates updated, making sure that… even some certificates expire. So making sure that the expired certificates are up to date, but even on certificates that don't expire, a lot can change over a three to four-year period.
[17:34] So that certificate may have been valid when you collected it, but maybe they changed entity types. Maybe they changed ownership. Maybe they moved states, and anything that would change a sales tax number is going to invalidate that certificate. So even on certificates that don't expire every three or four years, we think as a best practice, you should be updating your certificates, finding out if there are issues before the state is actually knocking on your door and saying, hey, I want to review your certificates, missing, invoices, reviewing your accounts for where you're not paying use tax.
[18:15] Just because someone sells you something and they don't charge you tax doesn't mean that it's tax-free. It means that if it was something that was taxable, you're supposed to self-assess and remit it to the state as a consumer use tax. And that's the number two reason, or number one in some cases, of large audit assessments.
Someone's got to be periodically checking up to make sure that you're assessing the tax where you need to and you're making sure that it gets to the state. Bottom line, Ellie, don't put it off till tomorrow because you never know when a state's going to knock on your door, send you an email, or let you know that it's time for an audit. If you have documentation issues, try to get it done as soon as possible before the audit starts.
[19:06] Ellie: I think that there are some really good takeaways and this episode. Please let us know if you have them, if you don't have them, if you have questions, and if you have sales tax needs. We do offer many solutions and services.
You can reach out to me directly. emoffat@salestaxandmore.com, or you can visit our website. salestaxandmore.com. In addition to our services, as I plugged before, we have a series of free webinars that provide CPE credit. We have a lot of free resources on our website. We have paid resources as well, and we hope to hear from you. Thank you so much for joining us.
[19:47] Mike: Yes, thank you, everyone, and we hope to see you on the next episode of the Sales Tax and More podcast. Have a great day, everyone.