Michigan: Protecting Taxpayers From Unfair Audits
Tax audits have received a lot of press over the past 6 months in the wake of revelations that the IRS had been targeting center-right non-profit organizations for audits. Due to a history of politically motivated abuse in order to intimidate and punish political enemies of those in power, tax audits have a dubious history and maintain a foreboding status in American culture. Setting political intimation aside, the same features that make tax audits such a destructive tool for political bullying—fear, cost, time, effort to comply—also make them a tremendous burden for business and individuals to comply with, even when they are not politically motivated.
While much discussion of sound tax policy focuses on tax form—income or consumption—marginal rates, revenue figures, and tax incentive carve-outs, crafting tax audit policy that is pro-taxpayer is often overlooked—but nonetheless it is extremely important.
Michigan has recently undertaken substantial audit reform that makes the state a shining example and leader in audit policy that protects taxpayers, ensures fairness, and doesn’t push businesses out of the state in the face of overbearing audits. The Mackinac Center chronicled the state of affairs leading up to reform and the details are unpleasant:
“The state’s Department of Treasury has been assessing some back taxes based on only a sampling of records, according to a performance audit. This has taken place even when complete and accurate records exist that could be reviewed.
Those subjected to the tax audits also often are assessed hefty penalties, plus interest.
The performance audit conducted by the Michigan Office of the Auditor General and released in March 2013, criticized the way the Tax Compliance Bureau (TCB) of the Michigan Department of Treasury conducts tax audits.
Under the heading, ‘finding,’ the Auditor General found that:
‘TCB did not review and document all audits in compliance with its audit guidelines. As a result, TCB did not have assurance that audit results were accurate, supported by documentation, and consistent with application of tax laws before the results were provided to the taxpayer.’
Similar findings also were cited in the Auditor General’s 2004 performance audit of the TCB.”
A Crain’s Detroit Business article covered the issue in depth and came to a similar conclusion. In short, the states audit process has at times been opaque, arbitrary, lacked substantive guidance to taxpayers, and frequently ignored the most accurate taxpayer records. This has led to huge headaches for taxpayers, lost productivity due to work hours spent complying with difficult and opaque audits, and expensive litigation to rebut poorly executed and decided audits.
A package of bills is being considered in the state that is designed to address these shortcomings and ensure audits are performed in a fair manner that utilizes the most correct information. Consistency, transparency, and fairness are the guiding principles of these reforms. Michigan HBs 4288-4292 provide formal, statutory guidance to the Department of Treasury on audit procedures; it publishes guidance manuals and documentation of audit processes for taxpayers; give taxpayers the right the right to use their own bookkeeping to rebut auditor findings; and provides taxpayers with more transparent information and up to date documentation from the treasury on their own individual audit as it occurs. The bills essentially serve as a taxpayer “bill of rights” with respect to the state’s audit policy.
Tricia Kinley, the tax policy director for the Michigan Chamber of Commerce, spoke for many Michigan businesses in sharing, “This package is aimed at providing taxpayers with better guidance about what to expect while under audit, improved transparency, and hopefully a ‘roadmap’ for auditors about what is/is not acceptable auditing techniques. Michigan Chamber members have always felt strongly that while it is important to get the type and rate of tax competitive, it is equally important, if not more so – to have the application and execution be done in a way that is fair, consistent, and transparent to taxpayers. This should be a win-win for taxpayers and state government; less litigation costs for all involved.”
Michigan Representative Aric Nesbitt, a key architect and proponent for the package of bills, similarly shared regarding transparency and the Department of Treasury’s guidance, “Nobody likes tax time, which is why we shouldn’t be leaving taxpayers in murky waters when it comes to audit standards and procedures. Allowing the taxpayer to access and understand the ‘hows’ and ‘whys’ of the auditing process is simply good public policy.”
Nesbitt further noted that with regard to the use of sampling and extrapolation methods (as opposed to using a taxpayer’s own books), “We don’t want state auditors to become increasingly reliant on the use of circumstantial evidence during their sampling process when taxpayers have done their part in maintaining adequate records to determine tax liability. Codifying common sense standards for using these sampling processes treats tax payers fairly and prevents unnecessary government action.”
The package is a huge step forward for more fair, balanced, and accountable audits, and an important step for states to take in their effort to protect taxpayers. ALEC model policy outlines the importance of taxpayer transparency, audit simplicity, sound tax tribunals, and reasonable processes for government recovery audits for overpayments of tax dollars. States would be wise to consider these model policies and the example Michigan has set in creating a “bill of rights” for taxpayers facing audits.