The New York Division of Tax Appeals ("Division") in In the Matter of Top Drawer Custom Cabinetry Corp., DTA No. 825588, recently held that a taxpayer who signed a consent to use a test period audit methodology was bound by the consent and waived its right to a detailed audit of the entire period. In November 2010, New York began a sales and use tax audit of Top Drawer Custom Cabinetry Corp. ("Top Drawer"). During the audit, New York determined the sales records provided by Top Drawer were adequate to conduct the audit. In December 2010, Top Drawer's president entered into a test period agreement with New York, which provided in part:
The agreement contained boxes that had been checked to show that
the parties had agreed the test period method could be used for the
audit of sales and recurring expense purchases. The Division used
the test period method to audit the sales and expense purchases for
a three-month test period and asserted $67,447.20 of tax, plus
interest, due for the three-year audit period. Top Drawer appealed
the determination. It argued that despite the signed consent, New
York should have conducted a detailed audit because adequate books
and records were available to the auditors. It believed a detailed
audit would have resulted in decreased tax liability.
The Administrative Law Judge found for New York. He stated that the
use of the test period method was not based on Tax Law
§1138(a)(1), which permits New York under certain
circumstances to estimate a taxpayer's tax liability, but
rather on the written consent of Top Drawer. Top Drawer knowingly
entered into a valid agreement, consenting to a test period audit
in lieu of a detailed audit. Therefore, it could not argue that a
different methodology should have been used after conclusion of the
audit.
The Top Drawer appeal highlights the pitfalls of entering
into an audit methodology agreement in a state tax audit. Before
entering into such an agreement, the taxpayer must assess the test
period methodology being proposed to make sure it will fairly
reflect the tax compliance and exposure for the entire audit
period. This often requires the taxpayer to do some sampling of its
own to determine whether there are any unusual situations that
might skew a test period audit. Although it often is impractical to
insist on a full actual audit, it often is possible to
pre-negotiate how anomalous transactions might be dealt with in a
test period audit.
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