What I Learned From Our New York State Sales Tax Audit

A few months ago I overheard a voicemail being left on our office answering machine from The New York State Department of Taxation and Finance. My first thought was “crap, this can’t be good”. They generally don’t call people to say “good job paying your taxes, keep it up!”

I called Mike, who handles our accounting, and he returned the call. Later that day we learned what I had suspected: we were being audited. Supposedly we were “randomly selected”, although I have a hunch that it’s because our second quarter taxes that we had just filed were 1) for the largest amount of income we’ve ever had, and 2) very little of that income was subject to New York sales tax because the majority of our orders are shipped to states other than NY. Of course they’d want to check everything out and make sure they weren’t entitled to a bigger piece of our revenue pie.

They gave us approximately a month to prepare for the audit. It was a lot of work. The auditor needed to see everything. Mike especially had to spend a lot of time reviewing things from years past when he wasn’t managing our accounting.

In the end though, work aside, this actually turned out to be a relatively positive experience for us. We learned quite a bit at a time when we’re still small enough to change things. It also doesn’t hurt that we “won” – New York State ended up owing us a considerable amount of money. No one likes to get audited, but if it has to happen this was kind of the best case scenario.

Anyway, I learned a lot that I think would be helpful to anyone faced with a similar situation.

A Good Accountant is Worth His Weight in Gold

Our first call was to our accountant. We were kind of freaking out. Right away he put us at ease. He told us that a lot of his clients had been audited lately (presumably, NYS, like all other states, is looking for any money they can find, and it’s hard to blame them).

He also advised us that we could give him power of attorney for this audit, moving the location from our warehouse and instead to his office. At no point would we ever have to interact with the auditor. We could just give him everything and he would take care of the rest. We jumped at this opportunity, not only because we knew he’d do a better job communicating with the auditor, but because it wouldn’t disrupt our warehouse operations for a few days.

While he was reviewing everything, he noticed something really big that we had never even considered – we were paying sales tax on our boxes and packing peanuts, but we shouldn’t have been. They are being “resold” to our customers as part of our shipping & handling charges, and are integral to the buying process (the customer can’t get their products without them being packaged). Factor in several years of packing materials, and that’s how NYS ended up owing us money. We’ve since applied for and received a tax exemption from Uline for these materials.

When we first heard that they’d owe us money, we thought it would be in the form of a credit on future taxes. Somehow he negotiated a payment instead of a credit. Again, something we never would have even known about. All in all he was worth every penny and then some! I can’t overstate how important it is to work with a good accountant.

Save Everything

We did get dinged on a few things, although they were more than offset by the credit we received for the packing materials.

The auditor wanted every receipt for every expense to ensure that we had been paying proper sales tax. Despite our best efforts, we weren’t able to dig everything up. I’m as guilty as anyone – there were times when I’d pick up something small like bottled water or paper towels for the warehouse guys, charge it to the company card, and then forget to file the receipt. While it’s still on the books, the auditor has no way of knowing whether I paid the appropriate tax on that sale, and therefore had to assume that we didn’t.

The other example where we owed some money was from online purchases. We made purchases from merchants outside of NY for things like computers where we weren’t charged sales tax. We should have proactively reported those purchases and paid the tax (something everyone should be doing personally as well…although most people don’t).

All in all very minor, but lesson learned going forward.

The Value of This Blog Community

There have been countless times where one of you guys has commented or emailed me in response to one of my posts and either directly or indirectly has helped us fix something we were doing wrong. This audit was probably the biggest example.

Last year on a post about our coupon code and sales strategy, Rob noticed from a screenshot of our checkout page that we weren’t charging sales tax on shipping and the following conversation ensued:

Rob: Is shipping taxable in NY? it is here, so the generally accepted norm is to put the tax after the shipping when presenting the subtotals and totals. If it’s not taxable then the way you’ve got it already makes more sense.

Me: Good question on the shipping. NYS is a small % of our orders…I’ll have to bring it up at our next meeting, probably a question for our accountant given that my googling about it just confused me. George handles paying the NYS sales tax so I’m sure he’ll have some insight too. I’d like to say that we’ve thought it through previously, and we may have, but if we did it was year’s ago and I can’t remember. Update – I decided to look at a few retailers that I purchased from to see how they charged me tax…and it was 50/50. Definitely a question for the accountant.

Me:: A quick update – Rob was correct. We spoke about the tax situation at our meeting. As a group we thought we probably were doing it right by not taxing it, but we asked our accountant and he said that in NYS you do have to charge tax on shipping. We have now changed the site now to reflect that. Thank You Rob!

Rob: Hehe, no worries. Sorry if it’s increased your tax bill!

By proactively fixing that issue we saved ourselves a BIG headache. I’ve never doubted that blogging was worth my time, but if anyone ever did, examples like this really illustrate how it has directly helped our business. Without you guys this site would just be a diary of my ramblings. Big thanks to everyone who takes the time to read, comment, and email.

Posted on August 15th, 2011 in Finance

16 comments on What I Learned From Our New York State Sales Tax Audit

  1. Tim says:

    Great to hear that things went so well tax offices are known to not play fair, despite the hassle and expense of getting ready for this I think it went very well for you guys. I also was really impressed with your accountant being a POA, very smart, you guys may know accounting functions but having the accountant take care of this while you guys focus on what you you do best (run your business) is the wise move. Often business owners struggle to let go of the strangle hold on their business and that prohibits growth. While not the purpose of this post I think that is one of the largest negative actions I see businesses make, thinking they are the master of everything – I know I’m guilty of it!

    • Adam McFarland says:

      Thanks Tim. Yea I’m definitely guilty of that mentality of “I can do everything myself”. When we incorporated back in ’06 we were complex enough, with our client services, e-commerce stores, and other websites like SportsLizard that we needed a good lawyer and accountant. It was clearly beyond anything we could handle, which forced our hand. Then over time we’ve developed good relationships with these professionals and now it seems crazy to operate without their help. All in all I feel like our accountant and lawyer have saved us money – in this case, we would have had the audit on our premises and we definitely would have owed money. And in the cases where they haven’t saved us money, they’ve surely saved a lot of time and headaches!

    • Rob says:

      Tim – minor point but your link doesn’t work. Think you need to 301 the non-www version to the www version (or vice-versa).

  2. Gary says:

    Adam, that’s awesome, glad everything worked out for the best

  3. Dale says:

    Adam, your post will help me out too. As my first year of being “self-employed” I’m trying to figure out how all this works. Like do I need to keep my receipts or are credit card statements enough? But that’s why I have one question for you. Why would you need to prove you paid sales tax on the bottled water and paper towels? Isn’t that Wal-mart or whatever’s job?

    • Adam McFarland says:

      This is a great question Dale. I always assumed the same thing, which was why I was spotty saving my receipts, especially for smaller purchases. The reason they needed the receipts from us was to ensure that we didn’t have a resellers tax exemption with a company when we weren’t actually reselling the products. They were mostly focusing on shelving units and computers, bigger purchases like that. I guess in theory we could have put up a one-page website, got a tax exemption with a computer company, and then bought all of our computers tax-free without ever having intent to sell computers. The way I understand it, in NYS the liability for a tax exemption falls back on the company receiving the goods (i.e. it’s our fault for fraudulently impersonating a retailer and not the computer company where we’re getting the tax-free products). It’s something I never considered, but I guess it does happen. We get a tax exemption on our detailing products of course, and now our boxes and packing materials, but that’s it.

  4. Rob says:

    Yay! I helped with something!

    Congrats on the audit going well – them paying you is a pretty awesome result I’d say. I don’t really understand why you think you would have ended up owing them money if the audit was on your premises though – do they charge you to come out or something?

    • Adam McFarland says:

      Thanks Rob! And thanks again for helping us fix that 🙂

      The main advantage of having it at our accountant’s office instead of the warehouse is that it didn’t disrupt our operations. It also meant that the auditor couldn’t ask us questions – our accountant is much more well versed in what an auditor can and can’t request of us. It likely wouldn’t have had an impact on the outcome, although had we not consulted with our accountant at all we likely would have owed money because we wouldn’t have known about the potential credit for packing materials.

  5. Andrew E. says:

    Not related to the post, but have you looked into an alternative supplier for packing materials? U*** is great for boxes, but in my experience if you use large quantities of other items you can sometimes find them 20%+ lower by doing some digging. For example we use a lot of bubblewrap and styrofoam boxes and we were able to find the companies that produce the actual products.

    Of course though we still use U**** a lot due to speed and availability.


    • Adam McFarland says:

      Andrew –

      We haven’t lately…at least not for our main supplies like boxes and peanuts. If we’re buying something like a cart or chair we do shop around, but many times we end up paying the premium to buy from Uline because they pre-assemble a lot of stuff. They always show up in one day, they never mess up, they always have stuff in stock, and they have a huge selection (we carry 30+ varieties of boxes). There’s also another key reason that I probably shouldn’t post…if you’re curious drop me an email 🙂

      – Adam

  6. Question;

    We are a widget seller in NYS. We have a number of resellers located in other states. When we ship them an order, is ANY part of the order subject to NYS sales tax? I always thought that the shipping cost was taxable, but there seems to be no clear example on the NYS tax website, as all of the examples provided speak to business occurring within NYS. Thanks for any insight you can provide.


    • Adam McFarland says:

      Hi Mike,

      I’m not sure. My guess would be no, but that’s just a guess. That is definitely a question to ask NYS directly or to talk with an accountant about. Sorry I couldn’t be more of a help.

      – Adam

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