A tax expert explains how your company can avoid state audits, and which states are most likely to audit.
As if IRS worries weren't bad enough, many corporations face an increased risk of tax audits from state authorities.
"Not every company faces the same risks," explains Bob Wood, a specialist in state and local taxes at the New York City office of accounting firm Coopers & Lybrand, "but we've detected geographic trends that boost your company's chances in certain locations." (See below.)
Preparing for that risk would be simpler if there were a single set of tax rules and guidelines. "What companies face instead are 50 different sovereignties, all of which have different interpretations of tax laws," notes Wood. So, for example, "a lot of states have a machinery-and-equipment exemption, but a piece of equipment might qualify for it in one state and not in another."
Most states impose a variety of business taxes -- including sales taxes, personal-property taxes, corporate taxes, and franchise taxes -- and they've all got their own audit hot lists. "In New York, for example, one of the most popular audits is of expenses or interest attributable to subsidiary capital," notes Wood. "Once you factor in all these local preferences, the audit risks for most companies can be awesome."
To make matters worse, state and local tax law -- unlike federal law -- is a "kind of seat-of-the-pants matter," says Wood. "There's very little body of case law and no equivalent of the IRS's letter rulings to give businesses guidance about how the courts will handle it if you challenge a tax audit."
The conclusion: there's no way your company can stay on top of all the state and local tax developments that may increase its tax risks. Make certain your accounting firm has a network of regionally based tax experts it can rely on to keep your tax planning up-to-date.
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Which states worry companies the most when it comes to the risk of tax audits? According to Coopers & Lybrand's 1994 survey of state taxes, California topped the list, followed by New York, Texas, Illinois, Ohio, and Pennsylvania. Sales-tax and use-tax audits were those most commonly reported.