Accountants Support Lawmakers’ Move To Limit Auditors

Accountants Support Lawmakers’ Move To Limit Auditors

For the first time in a decade, this year’s Minnesota Legislature did not order the state revenue department to hire more auditors. Accountants say that’s one thing the politicians finally got right.

Call him K. He owns five restaurants in and around the Twin Cities. Six years ago his business was audited by the Minnesota Department of Revenue (DOR). He doesn’t want to be identified with this tale for fear that the DOR will turn “vindictive.”

At the time, K. says, Minnesota was converting to an e-filing system for business taxes. Notifications that reports henceforth must be filed online—the only notices he ever got, K. claims—were printed in a crease of the monthly reporting forms sent to his company by the DOR. “Once I looked, I could see it,” he says, “but our office lady never did.” So for about a year and a half, the office lady continued to send back the paper forms, along with checks to pay the taxes.

Eventually, K. got a notice from the DOR saying that he was delinquent because one month his five restaurants had not filed the required forms. It turned out that the DOR had, in fact, received the checks for that month. “How could you get the checks but not the forms?” K. asked the DOR auditor who arrived to examine his records. He says the auditor speculated that someone back at the office “probably got tired of sending you the notices and threw your [paper] forms in the garbage.”

According to the outraged K., that act of “laziness” is what prompted the audit. Once it began, the audit turned into a nightmare.

As DOR sources readily agree, Minnesota’s sales-and-use tax laws are complex, if not downright byzantine. One of many regulatory quirks declares (more or less) that food consumed on a restaurant’s premises is subject to sales tax but food sold “to go” is exempt. Three of K.’s restaurants have attached bakery outlets, with separate cash registers, that sell coffee and other items to go. But this auditor—this “rogue auditor,” as K. would have it—insisted that the napkins and straws available at the bakery outlets qualified as “condiments,” which meant that the bakeries should be classified as sit-down operations and their sales should be taxed.

Due to that and other problems, the auditor declared that K. owed $1.5 million in back taxes and penalties. That would have meant losing the business and his house, to boot. The auditor was indifferent, K. says.

K. took his case through the DOR’s appeals process and got a greatly improved outcome. He finally settled for paying $60,000 in back taxes; one of the three bakeries did, in fact, sell prepared sandwiches, he concedes. Add to that the $30,000 he paid to his accounting firm by the time the audit and the appeal were done, and his total cost came to about $90,000, not counting staff time.

K. says he will not open another restaurant in Minnesota. He already owns one outlet in Wisconsin, where he is happy to say that the minimum wage for tipped employees is $2.33 an hour, versus $7.25 (the default federal minimum) in Minnesota, where he is not allowed to count tips as wages. If he opens any future restaurants, he says, “I’ll go to Wisconsin or the Dakotas. Anyplace is going to be cheaper than here.”

A Perfect Sound Bite?

K.’s account of his audit is unverified. The DOR obviously cannot dispute the details of an anonymous case. But accurate or not, K.’s story could serve as the template for what some Twin Cities accountants claim is a long-standing state of affairs in which DOR auditors—too often inexperienced, insensitive, belligerent, or all of the above—ride roughshod over corporate taxpayers.

That perception is by no means universal in the accounting community, but it does not appear to be uncommon.

For the most part, the complaining accountants do not blame the DOR for this. Instead they blame the Minnesota Legislature, which for the past decade ordered the DOR to hire additional auditors and collectors in every biennium and then mandated revenue targets for extra “initiative” audits to bring in.

From 2002 until this year, the Legislature set those dollar targets and demanded that the DOR hire more auditors to meet them “even in years when the DOR said it didn’t want them or didn’t have time to train them properly,” says accountant Todd Koch, a partner with John A. Knutson & Company of Falcon Heights.

Accountants agree that these legislative mandates had nothing to do with which political party held sway in any given period. “It’s not about Democrats and Republicans,” Koch insists. “Both parties have seen it as a perfect sound bite for raising more revenue: ‘We want people who aren’t paying their fair share to pay up.’ Who could argue against that?”

The problem, Koch and other accountants maintain, is that the mandates produced not only a lot of inexperienced auditors but a heavy-handed approach to the auditing process. He calls it an issue of philosophy. “For a decade, the Legislature has been telling them, ‘Collect more money!’” he says. That is a departure from what he sees as the correct approach, which should be: “Collect the proper tax, no more, no less.”

It is that perceived philosophy or attitude—grasping and distrustful—that seems to bother accountants more than the inexperience they say they continually run into.

DOR auditors seem especially “punitive” in two areas, says accountant Mark Bakko, a partner with Baker Tilly Virchow Krause in Minneapolis. One is when the issue involves Minnesota’s tax credit for research and development. Even when his clients are in a field such as medical technology, Bakko says, he runs into auditors who have “a predisposition” to find that a company doesn’t qualify for any R&D tax credit at all. “We actually see that,” he says. “It’s not just how much R&D credit [the company] is entitled to but ‘We don’t believe you’re entitled to any at all.’ In a business like medical technology, that’s just nuts.”

Bakko’s second complaint—and the biggest problem area, according to other accountants—is with audits focusing on the state’s complex array of sales and use taxes. When companies fail to collect and pay sales taxes correctly, the cause is far more often an honest mistake than a deliberate attempt to cheat, accountants say. But DOR auditors often appear blind to that. “One thing the DOR could do is help new businesses to understand sales taxes, not come down with a giant hammer to punish people,” Bakko says. “Most people are trying to do the right thing.”

Then Again . . .

This year, for the first time in a decade, the Minnesota Legislature set no targets and ordered no additional hiring of DOR auditors and collectors. That means the DOR went into the biennium of FY 2014–2015, which began July 1, without a mandate to add to staff.

“We requested that,” says Keith Getschel, assistant commissioner for business taxes at the Minnesota Department of Revenue. “The Legislature said OK.” As of July, he said, the business-tax division employed 473 auditors, up from 448 in FY 2012.

Getschel is familiar with complaints about DOR auditors’ training and attitudes. “We have beefed up our training,” he says. But he acknowledges that “whenever you have newer auditors, there is always some training that will take place in the field.” He says that DOR pairs newer auditors with older ones, trying to ensure that “at least two people go out on every audit and that at least one of them is experienced.”

A supervisor’s name and phone number are on every audit letter the DOR sends out, he says. Auditors operate under a code of conduct, and violations can lead to disciplinary actions, including firing. Also, Minnesota taxpayers have a bill of rights “that includes the right to appeal any decision we make,” Getschel says. Disputes can be taken through the DOR’s own appeals process with no charge, or to tax court or district court. “So there are ways to deal with a ‘rogue auditor,’ if there is such a thing,’” he says.

While the DOR does not charge for appeals, however, Bakko and Koch say that the backlog of cases awaiting appeal is somewhere between 18 months and two years. Bakko adds that even a simple audit probably will rack up at least $2,000 in accounting bills for a client business, and an appeal can easily add more than $10,000 to the total.

Issues such as whether a failure to pay required sales taxes is an honest oversight or not will always arise in audits, Getschel says. But as for the charge that the Legislature’s revenue targets have spurred auditors to claw rapaciously for extra dollars, Getschel says that the Taxpayer Bill of Rights prohibits performance evaluations based on the amount of money an auditor collects. “We can’t evaluate an auditor based on dollars,” he says. Evaluation criteria include the number of audits completed and the quality of those audits, Getschel says, with “quality” defined in terms of accuracy and following the law.

The notion that legions of belligerent DOR auditors have been marching forth for years to savage honest businesspeople does not jibe with the perception of all accountants. “I haven’t had these negative experiences,” says accountant Howard Kaminsky, a director with CBIZ MHM of Minneapolis.

Kaminsky says he certainly has noticed, especially over the past five years or so, that Minnesota has stepped up its number of audits. He has seen a “definite uptick” in sales-tax audits and in residency-requirement audits—meaning investigations into whether people claiming residence in other states to avoid paying Minnesota income taxes are really residing for more than half the year in the other state.

The chance that an individual business will be audited in a given year remains less than 5 percent, Kaminsky says, but his firm has thousands of business and individual clients, “so at least a half dozen of our clients are always being audited.” But while he agrees that many state auditors are young and have less than five years of experience, “I just don’t run into a lot of auditors with bad attitudes,” he says.

On occasions when he has objected to a particular auditor, Kaminsky says, he has gone to a DOR supervisor and usually gotten either a different auditor “or a behavior change” from the current one. “In 35 years of practice, I can count on my hands the number of times I have had to go beyond the supervisor,” he says. “A handful of times we’ve had to go to court. But it’s rare that we even appeal [through the DOR’s process] . . . . Ninety percent of the time, our cases are resolved at the agent or supervisor level.”

Kaminsky wonders if some people who find state auditors strikingly churlish or curt might be seeing their own behavior reflected back at them. “Nobody likes to be audited,” he says. “But [auditors] are trying to do their jobs. I wouldn’t like to be treated disrespectfully, like I’m a piranha, and I don’t see why they’d like it, either.”

A Silver Lining?

The fact that this year’s DFL-controlled Legislature refrained from giving the DOR a new hiring mandate and revenue target is one of few good things that can be said about it, as far as an informal consensus of accountants is concerned. The other business-friendly move they mention is a change that turns the state’s sales-tax exemption on capital equipment purchases back into an up-front credit, as originally intended, rather than the refund arrangement it has been for the past several years.

Aside from those two things, accountants mostly agree, the 2013 legislative session produced little but woe for the state’s business climate. Michael Bromelkamp, a principal with the Olsen Thielen accounting firm in Roseville, rattles off the bad news: A new top income tax rate of 9.8 percent on high-income people; a new warehousing tax likely to mean lost business for the state; a lowering of the exemption on Minnesota’s estate tax to $1 million, well below the federal exemption; a new gift tax on amounts of more than $1 million, meaning that Minnesota joins Connecticut as one of only two states that impose their own gift taxes.

Accountants speculate that the combined weight of those taxes might drive a significant number of business owners and other wealthy individuals out of the state. “The high tax on individual earners is probably the most hurtful,” Bromelkamp says. “People aspire to own a business because they can make more money. But if you have to give more than half of it to the feds and the state in income taxes, Medicare, Social Security, and the rest, what incentive is there for an individual to take risks? I’m committed to be a Minnesota resident, but not everyone is.”

Whether and why “job creators” really will flee Minnesota in droves remains to be seen. For now, however, with the DOR getting a respite from hiring mandates, its auditors might take less blame for driving restaurant owners to Wisconsin.

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