Having been in the financial services business for more than 25 years, I have represented clients in numerous federal and state income-tax audits and state sales-tax audits. With the pressure at the federal and state level to raise revenues, we are finding increased audit activity at both the federal and state level. New York State corporate income-tax audits are the least common as the state benefits from any adjustments made at the federal level. Generally, taxpayers are required to report any federal changes to the state within a 90-day period, beginning with the date of the final federal determination. They merely piggyback off the IRS Audits.

However, New York State has found a goldmine in adding additional revenue to its coffers through sales-tax audits, as many business owners, while attempting to be compliant, do not understand the complex laws and regulations that govern the New York State sales and use tax.

As a transactional tax, every business must have a clear understanding of what it is selling and what it is buying, as the basic premise of the sales-and-use tax law is that every sale is a taxable sale unless it is exempt. Business owners must determine if they are required to collect and remit sales tax on the transactions in which they are the seller and must also determine if they are required to pay sales tax on the transaction in which they are the purchaser. That’s not as easy as it sounds.

The New York State sales-tax audit

         What begins with a letter from New York State alerting you to the fact that you have been selected for audit can turn into a long and tedious journey filled with frustration, hard work, additional accounting fees, and interactions with auditors who take the position of “guilty until proven innocent.”

 I have had the opportunity to work with some excellent New York State sales-tax auditors that have been properly trained, understand your industry from a sales-and-use tax perspective, and are willing to educate you in conjunction with their examination of your books and records. As the majority of taxpayers strive to be compliant, they appreciate the guidance and assistance provided when the auditor takes the time to work with them during the examination and provide guidance and training on sales and use taxes within their industry.

However, more often than not, the taxpayer is confronted by an auditor who has little-to-no training or working knowledge about your industry, refuses or is incapable of providing any assistance or education under the sales-and-use tax law, and whose apparent goal is to maximize the assessment against the taxpayer. As a result of this, the sales-tax audit experience develops into an adversarial relationship between the taxpayer and the state — something New York should not be doing, as the state attempts to reinvent and improve the business climate, retain businesses, and attract new businesses to the state.

How to prepare for the audit

         There is not much you can do to avoid a sales-tax audit. New York State, on its website, states that some of the reasons a taxpayer can be chosen for audit include:

§ Failure to file a return

§ Failure to report income or sales

§ Excessive credits or exclusions claimed on a return

§ Incorrect or fraudulent refund claims or returns filed

§ Differences found when we compare a return to information we obtain from others such as the IRS, banks, employers, and other businesses

§ Results of prior audits. (However, a prior or a current audit isn’t necessarily cause to be selected for audit again.)

§ Misuse of exemption certificates

Realistically, there is no way to prepare for a sales-tax audit once it is under way. Preparation for a sales-tax audit begins years before you are chosen for the audit. There are so many industry-specific nuances that make it impossible to give you even a brief overview of the sales-and-use tax law as it would pertain to you. Whether you are in construction, manufacturing, retail, or any other business sector, you have to obtain an understanding of how the sales-and-use tax law applies to your industry and also understand the detailed recordkeeping requirements needed to support your payment, collection, and remittance of sales and use taxes.

New York State Tax Bulletin ST-770 (TB-ST-770), which can be found on the New York State Department of Taxation and Finance website (http://www.tax.ny.gov/), provides an overview of the recordkeeping requirements for sales-tax vendors. In the introduction it states:

“If you are registered for purposes of New York State’s sales tax, you are a trustee of New York State and you have a responsibility to collect the proper amount of sales tax from your customers and to remit the tax you have collected with your timely filed sales tax return.

“As a registered sales tax vendor, you are required to keep accurate records of all sales and purchases that you make. Keeping detailed records of your business operation will help you prepare accurate and complete sales tax returns. Detailed records will also serve as documentation of the accuracy of your returns if you are audited.”

Lucky you to have been given such responsibility and then to also have the honor to be scrutinized, chastised, and penalized in an audit where you have tried to do your best in following a set of complex laws and regulations that many of the sales-tax auditors don’t understand.

What should you do?

To avoid a most unpleasant experience, you should really do an assessment of how the sales-and-use tax law applies to your business and the potential exposure (time and money) that you may face in a sales-tax audit. If you have not had an audit and are unsure of your obligations and recordkeeping requirements, it may make sense to hire a third party to come in to provide you with a detailed overview of how the sales-and-use tax law applies in your business and assess your exposure. This will provide you with the opportunity to identify and correct, as required, any issues that are discovered. This can be a much more cost-effective method than waiting for the real thing to happen.

Even if you are currently not registered as sales-and-use tax vendor you should look to see if you are required to be. The audit period for a registered sales-tax vendor is generally three years, but the audit period for an unregistered vendor is six years. Those additional three years can amount to a significant amount of tax interest and penalty.

Karl Jacob is a tax partner with the accounting firm Dannible & McKee, LLP. Contact him at kjacob@dmcpas.com

Many people believe the rich inherit great fortunes and then sit idly by while their stocks make them more money. When you’re working long hours, this belief can provoke jealousy and inspire questions like, “Do investors even deserve to make money?”

To respond, we must first define ownership, which is best thought of as a set of rights. When I own something, I decide what to do with it. I have dominion and authority.

Your autonomy is only limited by your duty to respect the autonomy of others. Just as you have a right to act however you see fit, so do others. If you infringe on the rights of another without permission, you are acting in the wrong.

In their paper “The Biological Basis of Human Rights,” Hugh Gibbons and Nicholas Skinner argue that the biological basis for legal wrong is “actions that, if undertaken, will diminish the will of another human.”

This self-ownership is then the basis of all our other rights including property rights. Ownership is “self-propagating,” meaning that the rights of ownership transmit from property to its products. Because you own yourself, you also own the fruits of your labor.

For example, when you make a stew, your efforts produced the food and you also own the product. The same goes for my chicken. I own the eggs the chicken produces just like I own the chicken. This is the right to property. With this ownership, I can trade my rights of ownership of goods for the rights to own something else.

Before currency, the product of my labor was the only way I could acquire the product of your labor. In a barter system, I trade my chicken, or the promise of my chicken, for your stew. If I don’t have any goods you want, I can’t acquire the rights to your stew.

However, in today’s monetary system of trade, instead of getting an inherently valuable good as a reward for my labor, I get money. This money is just a placeholder of my labor not yet rewarded.

When I work my 9 a.m. to 5 p.m. job and earn a paycheck, I receive a paper certificate I can trade in for the real reward of my labor. Instead of trying to guess what a farmer really wants for his chicken, I can give him a monetary certificate for him to use as he wishes.

So long as his payment remains in the form of currency, his labor in raising the chicken has still gone unrewarded. But when he uses that money to buy chicken feed or dinner for his family, he is finally reaping the reward of his labor.

Workers can delay the reward of their labor in many ways, sometimes indefinitely. One obvious method is loaning money to someone else who needs it because he either has not labored enough or not saved enough. When you loan someone your money, you are essentially loaning your labor.

Hard work was required to earn that money. Because you let this labor go unrewarded, you are now able to let the money, in some sense, work for you. By making the loan, you allow him to reap your labor’s reward first. In return for this privilege, he pays you back with interest.

Another way to prolong the reward is buying stores of value like real estate, precious metals, collectibles, and stocks. Each of these stores the value of your reward. Unlike an ice-cream cone where the value is either consumed immediately or lost, stores of value safeguard your ability to be rewarded for your labor at a later time.

If the value does more than remain constant but increases regularly, the store of value is an investment. Owning rental property and stocks, as well as owning a private business are all common investments you can make. Each one tends to increase in value over time.

Like loaning money, buying investments defers the reward of your labor while earning you more reward.

If I run my business well, the reward from my business will increase beyond its purchase price. If I run my business poorly, the certificates of labor I spent will forever go unrewarded.

In a business where the only employee is the owner, he obviously deserves all the profits. He is the one who invested money into it and the one laboring for it.

A restaurant is a more interesting example. Often, one owner has hired employees to host people, bus tables, and cook and serve the food. The owner may not work in the restaurant herself, but she will still receive all of the profits.

From those profits, the owner pays her employees, mortgage or rent, bills, and her own salary. She deserves a portion of the profit because she owns the eatery. Her unrewarded labor is at the heart of the value of the business. The present reward for the work done in the past is the restaurant. Just as you own yourself, you own the fruits of your labor. So too when you own a restaurant, you own the fruits of the eatery.

Imagine that this restaurant owner decides to sell her business. A man comes along and buys the place outright. A trade occurs when the previous owner’s unrewarded labor is freed from the restaurant while the new purchaser’s unrewarded labor is sunk into it. The new owner deserves the fruit of his property’s labor just as much as the previous owner did. Even though the previous owner was the one whose sweat equity built the business, she sold her right to ownership. With that right, she transferred the right to the fruits of the property.

Stock ownership works just like this example. Only instead of investors buying companies outright, they are buying the tiniest percentage of a publicly traded company. Their share of the ownership means they are due that share of the profits. Their unrewarded labor, their money, has bought them a store of value.

Investors defer consumption of their reward to get bigger and better compensation in the future. This system of property rights is not only responsible for civilization as we know it but also the most mundane aspects of financial planning.

For example, deferred consumption is the basis for all retirement planning. Taking care of our own retirement requires being able to store the value of our labor in property that not only safely stores the present value but can also beat inflation by continuing to produce more value. Nothing can replace this. To consume your reward later, a financial vehicle is needed to carry that value into the future.

That being said, sinking all of your retirement aspirations into one business might jeopardize those dreams. Small-business owners often make the mistake of pouring all their resources into the business they understand best, where they have the most control. But every business is at the mercy of macroeconomic changes, and small-business owners benefit from diversification.

Property rights give our society the basis for financial security. Some have even argued that property rights are more critical to civilization than democracy. Everyone can benefit from the ability to buy and sell what they own, even minority-business ownership.

David John Marotta is president of Marotta Wealth Management, Inc., which provides fee-only financial planning and wealth management. Contact him at david@emarotta.com. Megan Russell studied cognitive science at the University of Virginia and now specializes in explaining the complexities of economics and finance at www.marottaonmoney.com