Among the things we all know to dread is a tax audit. And it isn’t just the IRS that may come asking for documentation of your tax returns. North Carolina’s Department of Revenue also conducts taxpayer audits, and the state’s audit activity is on the rise.

All states are hungry for money and North Carolina is no exception. In an effort to replenish its coffers, North Carolina has stepped up the number of audits it conducts. The focus lately has been on sales tax collections. It is our understanding that North Carolina’s tax department has employees whose sole purpose is to compare amounts reported on sales tax reports to the amounts reported on business income tax returns. If differences are found, the business involved may be selected for an audit.

These discrepancies are usually not due to an incorrect amount of sales tax paid. Instead, the issue is how gross receipts were reported on the required sales tax report. Let’s say you have a business that has sales of inventory subject to sales tax, and provides services that are not subject to sales tax. Many businesses, when completing the sales portion of that report, may only report as gross sales those sales that are subject to sales tax. That’s a mistake, and can get you unwanted attention.

The sales tax form is designed to require that you report all sales. Let me repeat: All sales, whether subject to sales tax or not. This line is called “North Carolina Gross Receipts.” The second line on the form allows for you then to subtract tax-exempt sales. These include wholesale sales or sales to other retailers. This line is called “Sales for Resale.” The third line allows you to subtract sales not subject to sales tax. The most important portion of this category is income from services provided. This line is called “Receipts Exempt From State Tax.” I do need to point out that some services are subject to sales tax. If your business provides services, and you aren’t clear about what’s taxable and what isn’t, you should consult with your accountant or tax professional for more guidance.

After you subtract those two categories, what remains are the sales subject to sales tax.

The point of all this is to try to make the gross sales reported on the sales tax report agree with the gross sales reported on business income tax returns. If they don’t match, it can mean anything from mistakes in bookkeeping to deliberate under-reporting of taxes payable to the state. Either way, the consequences can be inconvenient and costly, including having an auditor come look over your shoulder.

This brings up another subject. Be careful how you report gross sales on your business’s income tax returns. Although income tax returns don’t require or even provide for separating the types of gross revenue – such as breaking down inventory sales versus services provided – it is important that you report gross sales correctly. By that I mean that some businesses may include the collection of the sales tax in the gross receipts shown on their income tax returns, and then separately report the payment of those taxes to the state as an expense. That’s another mistake!

You should not include the sales tax collected in your gross receipts for income tax purposes. That will cause the income tax return to incorrectly show more gross revenues than what you’ve reported on your sales tax reports. And that can catch the Department of Revenue’s attention, and trigger an audit.

By following some of these guidelines, you may be able to prevent a time-consuming audit. As always, consult with your accountant about how this affects you, especially including what is or is not subject to sales tax.

Randy McIntyre is a Certified Public Accountant and a partner in McIntyre, Paradis, Wood & Company, CPAs. He has worked in public accounting since 1977, in Wilmington since 1992. His firm is built on a history of service, technical expertise, and innovative to provide the expertise of larger firms with a personal, one-on-one approach. To learn more about McIntyre, Paradis, Wood & Company, see www.mpwcpas.com. He can be reached at [email protected]  or 910-793-1181.