Tobacco Tax Reporting: Audit Triggers and Proven Strategies for Staying Compliant
Tobacco tax reporting can be complex and challenging for many businesses, especially in multiple jurisdictions with different rules and rates. Miscalculating tax liabilities or misreporting product classifications can have harsh consequences, triggering audits that are not only financially taxing but also threaten a company's reputation. We dive into the complexity of excise tax reporting, pinpointing common pitfalls and providing tips to avoid them.
What Triggers Audits in Tobacco Tax Reporting?
States look for a few things when analyzing companies that may qualify for an audit. Of course, these elements may vary depending on the specific state's tax laws and the unique circumstances surrounding each tobacco company. Below is a list of things an auditor may see as a trigger for an audit.
Change in Business Operations
Revenue reporting serves as a significant indicator of a business's health and performance. In the context of tobacco businesses, fluctuations in reported profits can potentially signal issues that might warrant further investigation.
Consider the scenario where a tobacco business consistently reports monthly sales worth $800,000. Should these figures suddenly drop significantly, say to $550,000, it could be a red flag. Such drastic dips in revenue might suggest problems like inventory shrinkage, sales decline, or even potential errors in reporting.
On the other hand, a sudden surge in profits can also raise eyebrows.
For example, if the same business's revenue jumps uncharacteristically from $800,000 to over a million in a short span, it could imply a variety of things. It might be due to a genuine increase in sales, perhaps driven by successful marketing campaigns or new product launches. However, it could also signal issues like overstocking or inaccuracies in revenue reporting.
In both scenarios, these sudden change in business operations can trigger a closer look from regulatory authorities.
Discrepancies in Reports
The jurisdictions get both sides of a story when analyzing reports. They see firsthand what people are selling and receiving. The state will investigate further if there's a mismatch. For instance, if one manufacturer is reporting their sales and the receiver isn’t reporting that sale, there will be further investigations into that inconsistency.
Consistent Noncompliance
Falling into a pattern of noncompliance is risky. When this pattern becomes consistent, it inevitably draws the attention of state authorities. This non-compliance could be due to intentional disregard for regulations, human errors, or repeated omissions that result in non-compliance.
The state's regulatory bodies are ever-watchful for such patterns, especially in industries like tobacco, where accurate reporting is paramount. Once a company falls into this radar, it can become subject to increased scrutiny and potential audits. The consequences of noncompliance can be severe, ranging from fines and penalties to reputational damage and, in extreme cases, jail time.
Randomness
Sometimes being chosen could be the “luck of the draw.” The inevitability of random audits in the tobacco industry is a reality that businesses must acknowledge. Each state jurisdiction carries out its initiatives, each with its unique timeline. Within certain states, the goal might be to audit all tobacco licensees within a single year, while others might spread this process over four years. Regardless of the consistency in accuracy, punctuality, and compliance, the possibility of an audit remains ever-present.
Common errors in tobacco tax reporting That Could Result in Audits
Tobacco tax isn't simply a one-size-fits-all matter. With years of experience in the tobacco compliance industry, these are common errors we see with examples of how they can impact the business.
Product Misclassification
A common filing error is product misclassification. After all, numerous tobacco products enter the market annually.
As of Jan. 20, 2023, the FDA has accepted over
the vast majority being for e-cigarette or e-liquid products.
There are also promotional and seasonal tobacco products that get bought and sold, like summer-flavored blunt wraps. If a tobacco product is classified as nontaxable because the seller didn’t code it correctly, they could be underreporting, leading to the state triggering audits and penalties.
On the other hand, misclassification can lead to overreporting too.
For example, if a business selling lighters and certain accessories to a gas station, coded it as a tobacco product because lighters have smoking associated with them, they would be paying excise tax on something that shouldn’t be taxed. This often isn’t caught until an audit or assessment, which could take months to years to find.
Point of Taxation
Every state has distinct rules regarding the point of taxation and the tax base, which changes based on the tobacco product.
For example, a tobacco company that does business in 10-15 states needs individual points of taxation for each state. The majority of the states they sell use the point of taxation as the purchase price, so the company consistently uses that point of taxation throughout their business and for all states. However, one of the states they do business in, uses selling prices as their taxation point. When the jurisdiction finds this error, the company will have to amend and send an additional payment for all the months or years they were reporting incorrectly.
This could be a severe error if it impacts multiple transactions. It could cause a huge blow to the company’s bottom line, especially if it was left to accrue for a long period of time. Always double-check that you have the correct points of taxation when you enter a new state.
Missing Receipts
Missing receipts are easy triggers for the state to get involved since there is an obvious mismatch of information being reported between two parties.
For example, suppose a manufacturer reported a tobacco sale, but the distributor never reported receiving it. In that case, the state will contact the distributor with an assessment and ask for all invoices received for the month of the report.
This could be a severe error if there are a large number of missing invoices or if a few were high dollar amounts.
Calculation Errors
One common error is calculation inaccuracies. Studies have shown that 88 percent of all spreadsheets have "significant" errors.
Simple miscalculations of figures on returns can skew the reported tax amounts significantly causing overreporting or underreporting. Sometimes, it could come down to “subtract line 2 from line 1,” and the filer may just have an off day and get the number wrong. That will throw the whole report off.
Tax determination automation and e-Filing helps catch human errors like miscalculations before they wreak havoc.
Tips for Avoiding Penalties, Assessments, and Audits
Utilize Electronic Filing when Possible
Electronic filing offers a significant enhancement in the accuracy of tobacco tax reporting. It reduces the likelihood of errors that might lead to penalties or audits.
The convenience provided through e-Filing saves considerable time and simplifies the filing process. Electronic filing offers an immediate confirmation of submission, assuring that the tax filing has been received and processed. Therefore, accuracy, convenience, and direct confirmation make electronic filing increasingly attractive to companies that are still doing pen-to-paper reporting.
Communicate with the Jurisdiction
Navigating the world of excise tax can often feel daunting. It's common to find oneself hesitant to seek clarification or ask questions from state authorities. The fear of 'getting on their radar' can sometimes overshadow the need for understanding and compliance. However, it's important to remember that reaching out for help or asking questions is not a sign of weakness or non-compliance. On the contrary, it displays a commitment to staying compliant and following the rules.
Automate Your Processes
In the world of tobacco filing, automation serves as a vital accelerator for both efficiency and precision.
Imagine this scenario: seasoned tax team experts, who have mastered the ins and outs of their antiquated back office systems, retire. The old systems they leave behind are often challenging to navigate for newcomers. This complexity can lead to miscalculations and, consequently, penalties.
By investing in excise tax automation, financial losses stemming from compliance errors can be avoided. The initial investment in automation is outweighed by the potential savings. It's not just about avoiding monetary penalties, but also about saving time and resources that would otherwise be spent on rectifying these errors.
Ways to include automation in tax:
Automation also ensures continuity and consistency in your operations. With automated systems, the reliance on individual expertise diminishes. Instead, you have a system that is easy to understand and operates for everyone on your team. This reduces the risk of errors when personnel changes occur.
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VP of Revenue