Handling an Indiana Department of Revenue Audit and Appeal Handling an Indiana Department of Revenue Audit and Appeal

Handling an Indiana Department of Revenue Audit and Appeal

As with any change in gubernatorial administrations, there are often changes in the leadership of state agencies, and the Indiana Department of Revenue (the Department) is no exception. Earlier this year, Governor Holcomb appointed Adam Krupp as the new Commissioner of the Indiana Department of Revenue, and Commissioner Krupp then made several key personnel changes within the Department. Commissioner Krupp and his management team have made several changes in the Department’s operations, including promoting a more “customer friendly” Department of Revenue.  In addition to this new philosophical approach, additional changes are being made to the audit and appeals processes. 
 
Audits by the Indiana Department of Revenue:
 
The basic purpose of an audit has not changed, which is to determine taxpayer compliance with Indiana laws and, when necessary, collect any revenue owed to the State. Yet, as a part of its emphasis on customer service, the Department is making the audit supervisor more accessible to the taxpayer during the course of an audit. In the past, the audit supervisor may have been viewed like the manager of the used car salesman (e.g., "let me take that to my manager and come back to you"). Now, the taxpayer may have the opportunity to talk directly with the manager as issues arise during the audit, and presumably provide an increased opportunity for resolution.  For contractors, the Tax Court's decision in Lowe's Home Centers, LLC v. Indiana Dep't of State Revenue, 23 N.E.3d 52 (Ind. T.C. 2014), review den’d 31 N.E.3d 976 (Ind. 2015), eliminating the sales tax distinction between lump sum contracts and time and materials contracts, followed by the Legislature's retroactive change in the law to reinstate that distinction (Ind. Code §§ 6-2.5-3-2(c), -4-9(b)) is one area where compliance issues may arise, and this ability to elevate the conversation could be helpful.
 
Another point of emphasis in audits by the Department has been documentation. While this is not necessarily new, several recent rulings by the Department, as well as cases decided by the Indiana Tax Court, have revolved around the Department's claim that the taxpayer's documentation was incomplete and/or unreliable. See Von Erdmannsdorff v. Indiana Dep't of State Revenue, 57 N.E.3d 894 (Ind. T.C. 2016); Letter of Findings: 02-20160571; Letter of Findings Number: 01-20150385. A taxpayer is required to keep records and to be able to substantiate its return reporting position. Poor recordkeeping is a recipe for audit problems.
 
One critical area of recordkeeping for contractors is the proper handling of lump sum contracts, compared to time and materials contracts. This involves not only document retention, but care in the preparation of the contracts and the invoices in order to support the intended contractual relationship.
 
Another area of recordkeeping concern for contractors is with the issuance of, and obtaining and retaining, properly and timely issued sales tax exemption certificates. This needs to be handled properly on the front end, with the client and subcontractors alike, so that the client's expectations can be met and audit issues avoided. For example, to the extent that a contractor or builder is undertaking a construction project for an exempt organization, there is the potential for purchases of materials by the general contractor and subcontractors to be exempt from sales and/or use tax since the ultimate recipient of the improvements is an exempt entity.  Ind. Code § 6-2.5-4-9. However, the exempt organization must issue an exemption to the general contractor, who in turn issues an exemption certificate to its subcontractors. 
 
Protests of Proposed Assessments:
 
If there are unresolved issues at the end of the audit, the taxpayer has the ability to formally contest any proposed assessments that have been issued by the Department by filing a protest.  Ind. Code § 6-8.1-5-1. Historically, a taxpayer filed a protest and a hearing was set with a member of the legal division. Following the hearing, the Department issued its decision in the form of a letter of findings. The Department was generally unwilling to engage in settlement discussions until the protest process was completed and the letter of findings issued.
 
In an effort to expedite the review process and to be more customer-oriented, the Department now offers four different protest options to taxpayers: 
 
1.      Final determination with a hearing. This is the traditional process in which there is a hearing, offering the taxpayer an opportunity to explain its position, answer questions, and provide documentation. The Department then issues its written decision after the hearing.
 
2.      Final determination without a hearing. In lieu of attending a protest hearing, the taxpayer has the option to have the Department review the matter and make a determination solely based on the written protest and documentation (if any) the taxpayer presents along with the protest.
 
3.      “Fast track” settlement without a hearing or a final determination. Under this approach, the taxpayer still files its protest in which it details its position and the basis of its disagreement with the Proposed Assessment (or refund denial). However, along with the protest, the taxpayer elects to propose a settlement before any hearing is held and/or final determination is issued. If settlement efforts are not successful, the taxpayer can then pursue one of the other protest options. 
 
4.      Request audit review prior to proceeding with the protest. There are instances in which the taxpayer believes it has documentation, or can provide an explanation, to prove an audit error. The legal division does not want to get into computational issues, but in the past a taxpayer had to first go through the protest process before the file could be returned to audit to address the computational issues. This option allows the audit division to review the new documentation and/or explanation at the outset of the protest process. The review will determine if that new information resolves any part of the protest. The results of the review are then communicated to the taxpayer. At that point the taxpayer can then determine if its protest is resolved or the parties need to move forward with the appeals process.
 
See http://www.in.gov/dor/5691.htm for additional information on this updated appeals process. 
These new options may present an opportunity for a more time and cost efficient resolution of audit disputes. However, the appropriate option for a taxpayer, and the manner in which that option is pursued, will depend upon the specific facts and circumstances of the taxpayer, and the nature of the audit issues. For example, the option of early settlement discussions sounds attractive. However, it will be critically important for the taxpayer's written protest to thoroughly address the facts and the law, illustrating the strength of the taxpayer’s arguments, in order to frame the issues and influence the Department evaluation of the taxpayer’s settlement offer. These options can also present unanticipated traps. A taxpayer has the right, but not the obligation, to request a hearing. However, if the taxpayer asks for a hearing and does not attend the hearing, the Department takes the position that it can treat the protest as if it had never been filed, thereby allowing for collection action (in the case of a Proposed Assessment) and that determination, if valid, could be detrimental for the taxpayer challenging the Department’s actions.  
 
In terms of settlements, the new administration has stated that it wants to take a harder look at resolving issues than was done in the past so as to avoid what it believes to be unnecessary litigation. Whether that is true will undoubtedly be viewed differently among taxpayers.
 
Indiana Tax Court Changes:
 
In the event issues cannot be resolved through the administrative process, the Indiana Tax Court has exclusive jurisdiction to resolve issues with final determinations of the Department.  Ind. Code § 33-26-3-1. There have been claims in recent years that the Tax Court process took too long to resolve cases. In response, the Tax Court Rules have been changed, effective January 1, 2018, to expedite the Tax Court process, and in many cases that should also reduce litigation expenses for taxpayers and the State, alike. While those changes are not technically effective until next year, the Tax Court is already implementing many of those changes.
 
Another recent change at the Tax Court is how the Department is being represented.  Since the outset of the Tax Court in 1986, with extremely few exceptions, the Department has always been represented by the Attorney General's office. Now, the Department has started to hire outside legal counsel in many cases.
 
This calendar year has seen the introduction of many changes to resolving tax disputes with the Department. It is important for taxpayers to be aware of these changes and how they may influence the outcome of a taxpayer's dispute.
 
Mark Richards and Matthew Ehinger are attorneys with Ice Miller LLP. Richards has practiced federal and state tax law for over 30 years, and has experience in resolving tax controversies. Ehinger concentrates his practice on state and local tax planning, compliance and controversy. Richards can be reached at mark.richards@icemiller.com or (317) 236-2471, and Ehinger can be reached at matthew.ehinger@icemiller.com or (317) 236-2183.
 
This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstances.
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