A notice from the Texas Comptroller’s Office about an upcoming audit or sales tax bill is an unfortunate reality of operating a motor vehicle dealership in the state. Car dealers are a prime target for audits because of the large sales tax revenue they generate and the high risk of underreporting due to confusing sales tax rules. This guide explains the Texas sales audit and appeal process as it applies to motor vehicle dealerships, including a discussion of common areas of risk for underpayment of tax these businesses may have. Know that your motor vehicle dealership has the right to representation when interacting with the Texas Comptroller’s Office. Our Texas sales tax professionals have many years of experience defending clients in audits and pursuing appeals of unfair assessments. If your dealership recently received an audit notice or assessment, we may be able to help.
The Texas Sales Tax Audit Process and 5 Key Issues Affecting Car Dealerships
Notice for a sales tax audit can happen for a variety of reasons, ranging from randomized computer selection to inconsistencies on a prior return or third-party data the Comptroller’s Office receives. For example, the Texas DMV shares vehicle registration information with the Comptroller’s Office to confirm tax was properly paid. The sales tax audit process will begin with a notice that explains the period under audit and requests additional information about the dealership through the completion of an audit questionnaire. Often, the best time to engage a sales tax defense professional is immediately after receiving an audit notice. A professional can identify any procedural issues with the proposed audit that may violate your rights as a taxpayer and can review relevant business documents, including past sales tax returns, to evaluate potential exposure.
The next steps in the audit will include contact from the auditor, usually by phone, to request documents and schedule an entrance conference. The auditor will use the requested documents as controls to reconcile with the reported sales and use tax that the dealership paid over the audited period.
Examples of these requested documents may include:
- Federal income tax returns
- Invoices
- Purchase contracts
- Receipts
- Bank statements
The auditor will examine these records and issue recommendations for any additional sales tax owed during an exit conference. The following issues are some of the most common areas where an auditor may find a motor vehicle dealership has underpaid its sales and use tax in Texas.
1. Misapplying the Texas Sales Tax Rules on Motor Vehicle Trade-Ins
Trade-ins are a valuable tool for dealerships to incentivize the purchase of new motor vehicles. However, collecting the right amount of sales tax due on a trade-in vehicle purchase can be an easy area for auditors to assess. For example, dealerships may improperly reduce the motor vehicle tax on a customer’s purchase of a vehicle that involves the trade-in of an off-highway vehicle, such as an ATV. Further sales tax collection and reporting issues can arise for dealerships on trade-in transactions that involve either split values or that involve multiple transactions through lending relationships. See Publication 96-254 for additional information.
2. Invoicing Practices That Result in an Underreporting of Texas Sales Tax
Another potential problem for motor vehicle dealerships is failing to separate nontaxable charges on invoices for the lease or purchase of motor vehicles. For example, charges for document processing or registration fees are not typically subject to the Texas motor vehicle tax as long as they are separately stated. Dealerships that use lump-sum invoicing or otherwise fail to separate nontaxable charges must collect sales tax on the entire amount. Invoicing practices can also impact the taxability of charges for parts and labor when providing motor vehicle repair or maintenance services.
3. Forgetting to Pay Texas Use Tax on Parts or Supplies Purchased with a Resale Exemption Certificate
Many dealerships wear two hats when purchasing the parts, supplies, equipment, or services necessary to operate the business. For many of these purchases, the dealership is a retailer that intends to resell the parts to customers, either on their own or as part of a motor vehicle maintenance service. Dealerships can generally purchase these items without paying sales tax to suppliers by using a resale exemption certificate. The problem for dealerships arises when they later use these items in their business and do not collect sales tax from the customer or pay the corresponding use tax to the Comptroller’s Office. For example, this issue may be likely for dealerships that purchase supplies tax-free from a supplier but later use them when providing a service covered under a motor vehicle’s extended warranty or optional maintenance agreement.
4. Failing to Distinguish Repair Services from Motor Vehicle Remodeling
Texas distinguishes motor vehicle repair and maintenance services from services to remodel a vehicle for the purpose of sales tax obligations. Some examples of remodeling services may include installing body kits, converting a van into a camper, removing or modifying a trunk to install a sound system, and other work that increases vehicle performance. Dealerships must collect sales tax on all charges for parts and labor when remodeling a vehicle. However, sales tax collection obligations for a repair service will depend on how your dealership invoices the customer.
5. Incomplete Recordkeeping Practices
A final issue that can cause problems for a dealership during an audit is a lack of records to support the remittances reported on its Texas sales and use tax returns. When an auditor does not have the information necessary to confirm a dealership’s taxable sales, they rely on alternative auditing methods to estimate this figure. These auditing methods may include various samplings or projections based on prior returns, the motor vehicle industry, and other data to calculate your sales tax liability. Audit sampling methods are imperfect by nature and can increase your assessment through unfair estimates of taxable sales.
Appealing Your Motor Vehicle Dealership’s Sales Tax Assessment in Texas
Motor vehicle dealers have a couple of options for disputing their assessments after the Texas Comptroller’s Office issues a Notification of Audit Results that states any additional assessment owed. Dealerships can dispute these results to the Texas Comptroller’s Office within 60 days of their issue date. This starts an appeal process that involves a redetermination hearing conducted through the State Office of Administrative Hearings. If you do not appeal within the 60-day period before a notice becomes final, your only recourse for disputing the assessment is to file a lawsuit in district court.
Issues that may warrant an appeal of a motor vehicle dealership’s sales tax assessment could include the following:
- The audit and assessment were made after the statute of limitations had passed.
- The auditor did not accept business records, such as exemption certificates, that support your sales tax position.
- The auditor used prejudicial sampling methods to estimate taxable sales.
- Disputes over a transaction’s taxability (e.g., differentiating a maintenance service from a vehicle remodel).
Despite assurances from the auditor about the legitimacy of their assessment against your dealership, pursuing an appeal can be beneficial based on the unique circumstances of your case. The complexity of the dispute and the potential error by the auditor can create opportunities for a reduction in tax liability, a waiver of penalty, or other settlement of the assessment.