Industries most at risk
Bars, Restaurants and Lounges, Liquor Stores, Laundromats, Car Washes, Auto Repair Shops, and retailers and others.
Background
Many of the cash audits performed by the Division of Taxation are imposed on businesses that are known for maintaining poor accounting records. This makes the business susceptible to assessments that may or may not be accurate. The State of New Jersey, has the authority to adjust your business gross receipts, should you fail to provide documentation that adequately supports the returns you have filed. This authority has been granted by N.J.S.A. as well numerous court decisions that have held valid the director's methodology in determining a business gross receipt. The most common method the State of New Jersey uses to make these determinations are known as the "markup method", which can be produce some incredibly tragic results. Taxpayers have argued that this method of selecting a small sample to represent the entire population of transactions can sometimes create false results, that can not be overcome by the taxpayer.
The "Markup Audit" or "Mark on Audit"
In a markup audit, the State (director) through its auditors identify some factors in your business that can "reliably" be used as a base factor to extrapolate your gross receipt. An example of a basic factor may be gallons of water used at a laundry. Let's use that example for this illustration.
Laundromat ABC is selected for audit by the State of New Jersey but did not maintain records of daily receipts from each machine, or did maintained reliable receipts as deemed sufficient by the State (i.e., merely bank deposit slips will not suffice). The State choose to impose the mark up method on the laundromat. First, the auditor selects a test year and within that test year selects a test period, for example 2014 test year the 5 weeks in May as its test period. It makes a request from the local water company and usually receives the amount of water consumed in gallons by the laundromat for that test period. The auditor may then contact the machine manufacturer who provides the average water gallon consumption per wash cycle for each particular machine. A computation is made (factoring out small % for other use and waste) which will estimate how many washes were performed. Additional computations are then prepared to calculate price per wash cycle, wash cycles to dry time and wash and folds loads. The state uses these computations to mark on to the gallon of water consumption the wash price and dryer price. Assuming no other business activity, the State will then pro rate the earnings from the five week period (test period) to the annualized the gross receipts for the test year. The auditor well then apply the error ratio in the test year to all open statutory periods (usually 4 years) to make a final assessment.
This is merely a condensed explanation of the process and varies for audit to audit or business to business, but the methodology is usually the same and can be complicated. We recommend a taxpayer seek representation by a qualified CPA or an attorney who understands how the mark up method is used in an audit.
How to avoid a mark up audit
First, pay your taxes. Sales taxes are collected from clients not paid for by the business. Nothing bothers me more than knowing a business that charged me sales tax did not remit the taxes to the State. Remember when you fail to declare sales taxes you are not stealing from the State, you are stealing from your clients. The same applies to payroll withholding taxes. Truth is always the best defense and makes it more difficult for the State to assert this method. Also, these trust fund taxes can be assessed against the individual owner personally or against the individual responsible for collecting and remitting the taxes, even if he is not the owner or officer.
Second, Keep adequate records and keep them for a period of four years(in most cases). A mark up audit can only hold up if the State can successfully prove that the taxpayer records were insufficient to verify gross receipts. If you have an automated POS system, keep daily receipts and Z totals. Record all cash payouts and make sure your Z totals ties to your deposits less cash payouts. Make sure your ST50 ties to receipts and to your business tax return. These forms are usually prepared by your accountant, by information that you have provided.
Third always file your returns. By not filing your returns timely, you not only pay interest and penalties but you maintain the statute on the returns open until it is filed. The statute of limitation to assess starts when the return is filed not when the return is due. By not filing for three years, you leave seven years open for assessment. In addition the State imposes 100.00 per month as an indefinite penalty until the return is filed. This could add up to serious amounts due to the State .
How We Can Assist You during the Process
This all depends at which point you hire us. If you hire us before you were selected for audit, we can assist in you in adopting a control system that will meet the State record keeping requirements and minimize the risk of having the State use the Mark On method if you are audited. If you hire us after audit selection we can help smooth the process. If you hire us within 90 days of the final determination, we can assist in the appeal.
The audit process can be stressful for clients, especially during the initial period in which the auditor is probing into your business and repeatedly requesting financial documentation, schedules and reports. Most taxpayers who choose to represent themselves take personal offense to how intrusive an audit may be. Most times taxpayers are uncertain as to whether the auditor may have the authorization to do what they are doing, which creates more stress.
When we represent the taxpayer during the audit, we deal directly with the auditor and for most of the audit, the auditor only deals with our office. Usually, the only time the auditor and taxpayer meet is during the initial field work done by the auditor to gather information for the audit or if a special meeting is requested by the client or the auditor. We do not make any assertions that we will reduce the liability, however, we scrutinize the auditors request, review the schedule and provide representation between the auditor and the client, usually helping to present information that may favor the client's position to the auditor.
After the audit is completed and a final determination is made, most taxpayers have 90 days to file for to have an administrative hearing if the feel to protest the findings of the auditor. If the protest is not filed within the 90 days the assessment usually stands as final. We can assist the taxpayer in preparing the appeal and represent the taxpayer at conference. If the case is not resolved at conference the taxpayer may seek legal counsel and file a formal appeal with the NJ Tax Court. We cannot represent the taxpayer in tax court and he will need to hire an attorney.