Chapter TWO

How Far Back Can a State Audit You (or What is the Sales Tax Audit Statute of Limitations)?

How Far Back Can a State Audit You (or What is the Sales Tax Audit Statute of Limitations)? What should your record retention policy be for a sales tax audit? What should you do if the auditor requests a waiver of the statute of limitations?

In this chapter, we will highlight the statute of limitations for various states and a corollary issue of just how long you should retain your sales tax records.

Statute of Limitations

A statute of limitations is a law that sets forth the maximum time after an event that legal proceedings based on that event may be initiated. When applied in a sales and use tax context, there are time limits established by state laws that govern how long a taxpayer has to file a refund claim after paying tax erroneously and how long taxing jurisdictions have to assess you tax.

This will be your first contact with an auditor. The letter says you have been selected for an audit. Accompanying the letter will be a questionnaire requesting information about the company.

This is a standard part of the process. It will not do you any good to delay responding or to be incomplete in your answers.Most states have just adopted the federal statute of limitations meaning that they have a 3 year limitation, except in the case where the tax liability is understated by 25% or more which gives the state 6 years to go back. Other states use something different than 3 years. The most common other time limit is 4 years but some states use a 5 or 6 year statute of limitations. One interesting state is Louisiana. In Louisiana the statute of limitations is 3 years, but 3 years after December 31st. 

Handy Chart on Each State's Statute of Limitations

Click on the image above access a chart from CCH showing every state’s statute of limitations for assessments

Tolling of the Statute of Limitations

Here is a concept that I frequently hear being used incorrectly. Tolling is a legal doctrine that means “paused” or “stopped” while a certain condition exists. For example, if a company does not file sales tax returns when required to do so, the statute of limitations is tolled or paused and does not run out. Frequently, people will say that the statute of limitations is NOT tolled in this scenario but that is incorrect usage that leads to confusion. Suffice it to say that however you use the tolling word, the sobering fact is, under certain conditions, a state can go back much further than the statute of limitations would seem to indicate.

Tolling of the Statute of Limitations
Tolling is a legal doctrine that means “paused” or “stopped” while a certain condition exists. For example, if a company does not file sales tax returns when required to do so, the statute of limitations is tolled or paused and does not run out. Frequently, people will say that the statute of limitations is NOT tolled in this scenario but that is incorrect usage that leads to confusion. Suffice it to say that however you use the tolling word, the sobering fact is, under certain conditions, a state can go back much further than the statute of limitations would seem to indicate.

Waiver of the Statute of Limitations

Invariably the audit fieldwork takes longer than the auditor initially estimated. That may be the auditor’s sole fault or it may be because things got too hectic at your office and you had to ask for some more time to supply the requested records. Usually, it’s the fault of both the taxpayer and the auditor. Who’s at fault is not important though.

In this case, the auditor will request a waiver of the statute of limitations. The statute of limitations in many states is three (3) years and in some it’s four (4) or even five (5) years. In other words, in general, for states with a four (4) year statute of limitations, tax cannot be assessed (or refunded) on items purchased more than 4 years ago. 

If your company files its sales tax returns on a monthly basis, that means every month that passes, another month (48 months ago) is no longer accessible to an auditor. The immediate temptation is to attempt to delay the auditor somehow so that some purchases can fall “out of statute”. However, it is important to remember that the auditor has all the power in this situation. The auditor can ask you to sign a “waiver” of the limitation statute. A statute waiver agreement is just that — you agree to extend the statute of limitations on the earliest months in an audit to allow the auditor to complete the audit. 

TIP ► Clients frequently ask us if they should sign this agreement. Our short answer is generally yes.

If you refuse to sign the agreement, a number of things might happen and most of them are bad. The auditor will just estimate the audit using available records. Most auditors will be conservative (from their viewpoint) and not risk understating the tax liability and will usually overstate it by a significant amount. Refusing to sign a waiver may be seen as unreasonable by an auditor and will cause the auditor to spend many hours in a short time frame getting all the paperwork completed before the statute expires. This is not bad per se, but when it comes time for that auditor to make a reasonable compromise later in the process, you can be sure they will remember this part of the audit.

sales tax audit statute of limitations

On the other hand, we have seen instances where refusing to sign a waiver actually worked in the Taxpayer’s favor. In this case, records were so sparse and the client knew even if they were found it would mean bad news. In this case, the assessment calculated by the auditor was actually less than the amount projected by the client. Finally, in the interim period in which you refuse to sign a waiver extension agreement the auditor may quit or even forget about your audit. We have seen it, but it would be very difficult to predict.

TIP ► We generally recommend that our clients go ahead and sign the agreement to waive the statute of limitations.

The auditor will usually not miss a deadline and you will have succeeded only in alienating the person who has the most leeway in whether to tax certain purchases.

TIP ► Signing the waiver could be beneficial.

Signing the waiver can also delay the audit to a more convenient time and give a taxpayer time to locate requested documentation that was not initially available. It is also beneficial to have the waiver allow for more time to find offsetting refunds or credits to reduce the assessment.

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