Dealing in goods subject to cigarette and other tobacco products (OTP) taxes presents considerable administrative burdens. The sale of cigarettes and other tobacco products, on which all 50 states impose an excise tax, requires accurate bookkeeping, regular reporting, and tax remittance practices. In addition, manufacturers, distributors, and wholesalers of these highly-regulated products will be the subject of audits by state revenue departments.
In our experience, it is a rare audit that does not result in an alleged deficiency. Some deficiency determinations are minor and easily paid, while others can add up to hundreds of thousands – and even millions – of dollars due, plus interest and penalties. In such cases, it is imperative to engage the assistance of experienced counsel who can assist you in addressing the assessment.
Troutman Pepper’s tobacco team has substantial experience advising clients in cigarette and OTP tax matters and, when necessary, assisting them in disputing assessments. In fact, thus far in 2022, we have assisted clients in successfully disputing more than $45 million in tobacco taxes.
We have drawn on our experience representing clients in such disputes to compile this list of best practices for avoiding, but also contesting, cigarette and OTP tax assessments.
Best Practices for Avoiding a Dispute
- Keep and organize accurate books and records. This tip is important for all business owners, but especially for businesses that deal in excise-taxed products. Being able to produce accurate documentation of your activities can make all the difference in a dispute, as well as prevent disputes. State laws typically establish the minimum recordkeeping requirements. A good recordkeeping system will include
- Copies of invoices and receipts
- Copies of bills of lading and other shipping documentation
- Copies of all communications with state regulators
- Copies of documentation for any tax payments, tax reports, and tax returns
Make your records readily accessible, as you will be asked to produce them during an audit.
- Understand the applicable laws. This one is, again, obvious for all businesses, but crucial for those dealing in highly-regulated products. Keep track of the tax rate applicable to all of your product classes. If there is a question about whether your products qualify as taxable tobacco products, seek clarification. Some laws, for instance tax liquid nicotine, but not certain other forms of nicotine, while other laws tax products, such as vape products, that do not contain nicotine at all.
- File timely returns. Set up a system for making tax reporting easy and automatic. There are third-party providers that can assist, if necessary. Filing thorough, well-prepared returns on time each month generates goodwill and can help prevent audits.
- Periodically audit yourself. Set up periodic self-audits to ensure your reporting is accurate. Self-audits can help businesses mitigate issues that, if not discovered sooner, may result in large assessments. If you discover an issue, many state excise tax laws require that returns be corrected proactively. If you discover a major issue, it may be prudent to have a discussion with relevant taxing authorities.
- If you are audited, make timely and thorough responses. If you are audited, it is critical to be responsive to auditors’ legitimate requests. Initial interactions with auditors can set the tone for the rest of the audit. Review requests for production thoroughly. Auditors appreciate well-organized productions, which are easier to provide if they are already organized.
Best Practices for Dealing with a Dispute
- Engage experienced counsel early. Consider contacting counsel the moment a request for records arrives. Counsel does not always have to respond on your behalf, but they can help you evaluate the legitimacy of requests and help you respond. You should definitely contact counsel immediately upon receipt of a deficiency determination.
- Be aware of deadlines. In tax matters, missing a deadline typically concedes an assessment. Review the assessment carefully and note all deadlines. Review statutes, regulations, and agency guidance to familiarize yourself with the appeal process.
- Provide relevant information to your counsel, as soon as possible and throughout the dispute. Is the disputed issue one that your business has previously discussed with the tax department? Has the tax department’s position changed at any point? Does the disputed issue concern products that had taxes paid on them in another state? Have there been any changes in the manner in which you conduct your business? What individuals or documents can address the facts in issue? These are just some of the questions your counsel may have, and there will be others depending on the nature of your dispute. It is important to make sure that you fully inform counsel of the relevant facts and documents early on in, and throughout, the matter.
- Keep perspective. Running a business is hard work, and a tax dispute will not make it easier. While you will naturally be eager for the dispute’s resolution, it is important to bear in mind that the dispute process can be lengthy – going through the state’s administrative processes with the further possibility of litigation in court. Also bear in mind that most disputes eventually settle.
Proactive measures can help you streamline audits and mitigate the risk of tax assessments. If a dispute arises, early engagement with counsel is critical to developing and executing an effective strategy. Please let us know if we can help.