PA Department of Revenue
Audits versus Desk Reviews
Arbitrary & Capricious? Business Owners Be Aware!
Is “tomato” pronounced “tomahto” (the British pronunciation) or “tomayto” (the American pronunciation)? Does anybody care? According to the DailyWritingTips.com, because of the song, tomayto, tomahto, the expression is often used to express an “unimportant difference.”
However, when it comes to the PA Department of Revenue (DOR), there’s a MAJOR difference between it conducting an audit and a desk review. The PA DOR alternatively refers to its underreporting program as a “review”, “desk review”, and “desk audit review”. On June 5, the Allentown Morning Call published an article about Business Tax Cheats Zapped for $6 Million of PA Revenue Investigators. The PA DOR is currently focusing its audit examinations on taxpayers who underpay their sales tax and income tax by using zappers. Zappers are software programs that delete selected sales from the business’s point of sales (POS) operating system. Some of the sophisticated zappers tell the business owner how many dollars in sales were zapped so the owner can pocket those sales, and some zappers adjust inventory numbers to support the under-reported sales. The use of zappers is FRAUD and the PA DOR is justified assessing and prosecuting tax cheats. Taxpayers who are audited by the PA DOR are subject to normal examination procedures and appeal rights.
The issue is whether assessments stemming from reviews are fair. The current reviews being conducted are of a Schedule C business’s gross receipts (to determine if the proper amount of income tax is being paid) and total sales reported per the business’s sales tax filings (to determine if the proper amount of sales tax is being remitted). The DOR has stated that it uses analytics to justify its findings of underreported sales. Due to the reporting of credit card sales by banks (IRS Form 1099-K), the DOR may extrapolate what the total sales are based on the credit card sales, the difference being unreported cash sales. The DOR also uses sales information gleamed from other taxpayers. So if you have a business in Western PA that experiences 10% cash sales, the DOR conceivably may find that your cash sales are really 40% of total sales based on (1) a similar business in the Philadelphia area (whose demographics are entirely different than yours) or (2) using analytics based on an unrealistic or flawed statistics. That’s comparing apples to oranges and not comparing tomaytos to tomahtos.
During these reviews, the DOR is requesting that the taxpayer prove that the underreported sales do not exist. This is logically fallacious! The DOR is asking the taxpayer to prove the non-existence of sales in place of providing adequate evidence for the existence of those unreported sales. The burden of proof should be on the DOR, the party making the assertion. Shifting the burden of proof is the fallacy of putting the burden of proof on the person who denies the assertion being made. The source of the fallacy is the assumption that something is true unless proven otherwise. So if the taxpayer is unable to convince the DOR (or another PA agency) that there were no unreported sales, PA assesses the taxpayer.
How does a taxpayer appeal the findings of a desk review? According to the DOR, when a review is performed, the taxpayer does not have the same examination procedure rights that are provided to a taxpayer who is audited. Defending against the review findings is difficult since the DOR has refused to release a coherent legal explanation of how the Schedule C review works. It is thus inherently difficult to argue that the PA assessment is erroneous and without merit without fully understanding how PA arrived at its findings.
Regardless of the “review” nomenclature, the DOR has no right to simply assess additional taxes against any filed return without conducting an examination. We believe this is an abuse of the DOR’s powers and is arbitrary and capricious and is a violation of the taxpayer’s rights.
The frustration of dealing with the DOR and the cost of doing so are exasperated by the fact that the taxpayer has 60 days to appeal the assessment to the PA Board of Appeals (BOA). The problem with that right to appeal is that the BOA is a unit within the DOR. Talk about house odds with a stacked deck.
The BOA decision can be appealed to the Board of Finance and Revenue which is comprised of three members. Two members are appointed by the governor and the third member is the State Treasurer (or appointee). The next appeal needs to be made to the Commonwealth Court.
When taxpayers consider the time and cost associated with appeals, especially when the burden of proof is on them and not the DOR, it is an uphill battle.
Let’s look at some planning tips to better position you against an unfair assessment from PA.
If you receive an inquiry from PA regarding you reported sales for Schedule C or your PA sales tax filing, immediately contact your tax professional and send him/her a copy of the notice. You don’t want to learn that PA has closed its inquiry and assessed a tax because you failed to timely response.
If a representative from a taxing jurisdiction visits your business, it is best not to speak with him/her. Be polite, courteous and respectful when you tell the agent to contact your tax professional.
Each month, maintain electronic (or paper) copies of all bank statements used in your business. The DOR will ask for these. Save time by having these in your files so that valuable response time is not lost waiting for your bank to send these to you.
Maintain daily point of sales/POS (cash register) printouts showing all sales. A PA desk review will very likely ask for these reports. If the POS system has the capability of showing cash, check, credit card, etc. types of receipts, be sure to maintain this documentation.
All cash sales should be deposited in your business checking account. Do not make use cash sales to pay for COD payments or to pay yourself for business expenses. This practice will allow your business to better reconcile gross sales per the POS to your bank deposits. If you need cash in your business, maintain a petty cash fund and use withdrawals from the business checking account to fund the petty cash fund.
If your sales tax filings show non-taxable sales, be sure that your files contain a current and properly executed sales tax exemption certificate for those non-taxable sales. We recommend that these exemption files be updated at least once every three years and that the “old” exemption certificates are maintained along with the new ones.
Make sure your gross revenues agree (or reconcile) on all tax filings. Your total sales reported for sales tax purposes should agree with your total sales reported on your federal and PA Schedule C (as well as your POS system and your bank deposits). If you are a cash basis taxpayer, you will need to reconcile your sales reported on your sales tax returns to your income tax filings. This is necessary since your sales tax is reported on the accrual basis whereas your sales for income tax reporting are on the cash basis.
Your total POS revenues and bank deposits will in many cases be greater than your reported sales for income and sales tax reporting purposes which is why a monthly reconciliation is recommended to our clients. Don’t forget that those bank deposits and POS receipts include tips and sales tax collected. You need to break these out on a reconciliation worksheet to compute your business revenues.
Maintain your monthly gross receipts/sales files for at least 5 years along with your reconciliation worksheets.
If you would like to discuss your business or personal tax planning, tax preparation and other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.