The $100,000 Shakedown
Lisa Hannum of Beehive PR, Inc., describes herself as “one pissed-off small business owner.” And she should be.
Hannum’s rapidly growing St. Paul firm recently emerged from a Minnesota Department of Revenue (DOR) audit. She received a notice from the state in April that she would be audited for compliance with Minnesota’s sales and use tax law. The law requires minute adjustments for goods purchased in one tax district and delivered to a client in another.
Here’s how it’s supposed to work: Say Hannum’s firm buys graphic design services in Minneapolis, where the designer charges 7.275 percent sales tax. The service is for a client in St. Paul, and Hannum bills her client for a “reimbursable expense.” However, the sales tax in St. Paul is 7.625 percent. Under state law, Beehive is required to collect an additional 0.35 percent in sales tax from the St. Paul client. If Hannum doesn’t pass the tax charge onto her client, Beehive is still liable to the state for the difference.
The problem is the complexity of the sales and use tax laws. Even DOR employees don’t always agree on the rules. “Every time we’d call, we’d get a different person and a different answer,” Hannum says. “One person outright admitted, ‘Nobody over here knows what’s going on.’”
In Hannum’s audit notice, the state requested that she prepare a long list of customized reports, covering 2006 through 2009, for review by the state’s auditor. “We keep absolutely meticulous records,” she says. “So we weren’t at all worried about the audit. We spent hours and hours collecting everything on the list.”
On the reports, Hannum’s team noted trade-specific or industry nuances that might affect the audit. For instance, if in the example above the graphic designer delivers the design work on a CD or on paper—anything tangible—then the tax is applicable. But if it’s delivered on line, then it’s not taxable.
On the day of Beehive’s audit, the auditor immediately asked for access to the company accounting software and began entering data from Hannum’s system into her own. “She completely ignored everything we pulled together,” Hannum says.
When the state’s bill arrived a few days later, Beehive owed close to $100,000 in additional sales and use taxes, penalties, and interest. “I about fainted,” Hannum says.
When she recovered from the shock, Hannum called her bookkeeping service (an outside provider), which went through her books line by line to prove to the state that she didn’t owe $100,000 in fraction-of-a-percent sums of sales tax charges for a business that in 2009 generated about $2 million in client billings.
When the bookkeeper completed her job and presented the state auditor with her findings, Hannum owed $5,040. However, the final amount due to her bookkeeper was $7,100.
Hannum’s bookkeeper is seeing an increase in these types of audits. “It used to be one or two of every dozen clients were confronted with an S&U tax audit each year,” says the bookkeeper, who asked that her name be withheld. “Now those who aren’t [audited] are the exception.” Of her 20 small business clients, 18 have been through a sales and use tax audit—four of them have been audited two or more times. One of her clients, an artist who designs furniture and paints murals in homes, was tagged with a $35,000 bill from the state that, upon review, resulted in a refund to the artist because she had overcollected taxes. But she spent several thousand dollars in accounting fees to defend herself.
Lisa Waldrup, a spokesperson for the DOR, says that since the legislature’s program to unearth “non-compliant” taxpayers was instituted in 2002, the state has hired 577 new auditors to enforce it. Waldrup acknowledges that auditors’ lack of experience is “a challenge, and one we’ve taken steps to address. But we have the countervailing pressures of training our people and producing revenue in the short term with the resources we’re given.”
The sales and use tax is a prime target of the auditors. In the 2009 legislative session, the state appropriated roughly $10.4 million with a goal of collecting an additional $41.5 million in unpaid taxes. According to a DOR report last February, with 29 percent of the biennium completed, the state had identified $1.4 million in unpaid sales and use taxes against a goal of just under $5 million.
Just in fiscal 2009, the legislature spent $7 million with a goal of collecting $21 million in additional taxes. DOR auditors collected almost $30 million, including $8.9 million in sales and use taxes from 1,043 non-compliant taxpayers, nearly twice the targeted sum of $4.6 million.
But the state has added insult to the inquiry, doing a slipshod job—taking samples rather than doing thorough audits, coming up with outlandish assessments. How will this promote future compliance from business and, more importantly, the state as a business-friendly place?