New Jersey Manual of Audit Procedures

State of New Jersey Department of the Treasury

Division of Taxation

NJMAP

New Jersey Manual of Audit Procedures

May 2021 i

Disclaimer

The information contained in this manual is intended to provide general guidance for the Division's Audit Branches. However, the Division reserves the right to depart from the procedures outlined herein, if the facts and circumstances of a particular audit warrant such a departure. Such departure will in no way undermine or invalidate any audit assessment where all applicable statutory and regulatory requirements are met. This manual does not reflect changes in laws, regulations, notices, decisions, or administrative procedures that may have been enacted, issued or adopted since the manual was last updated. This manual and the information contained herein may not be cited as authority to support any audit position. Taxpayers and Division auditors are to be guided by the controlling statutes, regulations and case law in presenting their respective positions in the context of an audit or investigation. This manual does not constitute a public policy statement of the Division. Moreover, this manual does not constitute written guidance by the Division to the public at large or to any specific taxpayer. The auditing methods and techniques suggested in this manual are intended primarily as administrative guidance, and may not be appropriate, applicable or necessary for every audit. Auditors should use discretion, in consultation with their supervisors when needed, when deciding which techniques should be used in a particular audit, and should consult with their supervisors whenever atypical factual patterns or legal issues arise.

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Chapter 1 Overview ............................................................................................ 1 1.1 Division of Taxation..............................................................................................................................1 1.2 Mission Statement of the New Jersey Division of Taxation .................................................................1 1.3 Manual of Audit Procedures ................................................................................................................1 1.4 The Tax Audit .......................................................................................................................................2

Chapter 2 Rights and Responsibilities ................................................................. 3 2.1 Taxpayers' Bill of Rights........................................................................................................................3 2.2 Right to Representation .......................................................................................................................3 2.3 Who Can Execute the Appointment of Taxpayer Representative .......................................................4 2.4 Revoking an Appointment of Taxpayer Representative.......................................................................4 2.5 Paid Tax Preparer Requirements and Responsibilities.........................................................................4

Chapter 3 Confidentiality .................................................................................... 5 3.1 Purpose of Confidentiality....................................................................................................................5 3.2 Violating Confidentiality is a Crime ......................................................................................................5 3.3 Rules Regarding Federal Tax Data........................................................................................................5 3.4 Disclosure of Certain Tax Information Permitted ................................................................................5 3.5 Furnishing of Tax Information to Private Debt Collection Service Providers .......................................7 3.6 Communicating with Taxpayer and/or AuthorizedRepresentative.....................................................7

Chapter 4 Ethics .................................................................................................. 8 Chapter 5 Audit Standards .................................................................................. 9

5.1 Personal Standards...............................................................................................................................9 5.2 Responsibilities of the Auditor.............................................................................................................9 5.3 Field Audits in General .........................................................................................................................9 5.4 Relationship of Taxpayer and Auditor................................................................................................10 Chapter 6 Audit Activity .................................................................................... 11 6.1 Division Responsibilities .....................................................................................................................11 6.2 Responsibilities of Audit Activity........................................................................................................11 6.3 Organization of Audit Activity ............................................................................................................11 6.4 In-State Field Audit Branch ................................................................................................................12 6.5 Out-of-State Audit Branch..................................................................................................................12 6.6 Office Audit Branch ............................................................................................................................12 6.7 Sales Tax Refund-Excise Tax Branch...................................................................................................13 6.8 Individual Tax Audit............................................................................................................................13 Chapter 7 General Concepts .............................................................................. 15 7.1 Consent Forms ...................................................................................................................................15 7.2 Extending the Statute of Limitations..................................................................................................15 7.3 Information Document Requests .......................................................................................................16 7.4 Refunds ..............................................................................................................................................16 iii

7.5 Form A-1730 Refund Claims for Paid Audit Assessments ..................................................................16 7.6 Form A-1730 Refund Claim Requirements.........................................................................................17 7.7 Refunds for Other Assessments .........................................................................................................17 7.8 Interest on Refunds............................................................................................................................17 7.9 Postmark Rule ....................................................................................................................................18 7.10 Penalties and Interest ........................................................................................................................18 7.11 Trust Fund Taxes ................................................................................................................................18 7.12 Responsible Persons...........................................................................................................................18 Chapter 8 Field Audit - Pre-Audit Preparation ................................................... 20 8.1 Preliminary Review of Taxpayer's Records and Tax Returns .............................................................20 8.2 Determining the Audit Periods...........................................................................................................20 8.3 Preparing Analysis Schedules .............................................................................................................20 8.4 Initial Contact Letter...........................................................................................................................21 8.5 Pre-Audit Interview and Tour, and Pre-Audit Questionnaire.............................................................21 8.6 Discussing Taxpayer's Records and Recordkeeping Systems.............................................................22 8.7 Discussing Taxpayer's Accounting Practices ......................................................................................22 8.8 Evaluating Taxpayer's Internal Control ..............................................................................................22 8.9 Discussing the Audit ...........................................................................................................................23 8.10 Requesting Taxpayer's Books and Records ........................................................................................23 8.11 Walk-Away Audit................................................................................................................................23 8.12 Sampling Agreement..........................................................................................................................23 8.13 Audit Plan ...........................................................................................................................................23 Chapter 9 Field Audit Procedures ? Employer Withholding Tax ......................... 25 9.1 Reviewing Forms W-2 and W-3..........................................................................................................25 9.2 Reviewing Forms 1099 .......................................................................................................................25 9.3 Employee vs. Independent Contractor ..............................................................................................25 9.4 Reviewing Payments to Construction Contractors ............................................................................25 Chapter 10 Field Audit Procedures - Sales and Use Tax .................................... 26 10.1 Verifying Gross Receipts ....................................................................................................................26 10.1A Examining Sales Invoices ....................................................................................................................26 10.2 Examining General Ledger Accounts..................................................................................................26 10.3 Examining the General Journal ..........................................................................................................27 10.4 Examining the Cash Receipts Journal .................................................................................................27 10.5 Examining the Accounts Receivable Journal ......................................................................................27 10.6 Examining Total Sales .........................................................................................................................27 10.7 Examining Bank Deposits ...................................................................................................................27 10.8 Examining Nontaxed Sales/Deductions .............................................................................................28 10.9 Exemption Certificates .......................................................................................................................28 iv

10.10 Reviewing Exemption Certificates......................................................................................................29 10.10A Sales on and after January 1, 2008 - Completed Certificate on File.................................................29 10.10B Sales from January 1, 2008 to September 30, 2011 - Completed Certificate Not on File ................29 10.10C Sales on and after October 1, 2011 - Fully Completed Certificate Not on File .................................29 10.10D Sales from October 1, 2005 to December 31, 2007 .........................................................................30 10.10E Sales before October 1, 2005............................................................................................................31 10.11 Exception for Fraud ............................................................................................................................31 10.12 Interstate or Foreign Sales (Shipped Out of New Jersey)...................................................................31 10.12A Deductions Allowed..........................................................................................................................31 10.12B Deductions Disallowed......................................................................................................................32 10.13 Purchases Subject to Use Tax.............................................................................................................32 10.14 Purchases Not Subject to Use Tax......................................................................................................33 10.15 Identifying Purchases Subject to Use Tax...........................................................................................33 10.16 Examining Purchase Invoices for Expense Accounts and Fixed Assets ..............................................33 10.17 Use Tax Accrual Account ....................................................................................................................34 10.18 Urban Enterprise Zones (UEZ) and UEZ-Impacted Business Districts ................................................34 10.19 Benefits for Qualified Businesses .......................................................................................................34 10.19A Qualified Businesses inUEZ...............................................................................................................34 10.19B Qualified Businesses in UEZ-Impacted Business Districts.................................................................35 10.19C Partial Sales Tax Exemption - UEZ .....................................................................................................35 10.20 Auditing Reduced Rate Transactions ? UEZ .......................................................................................36 10.21 Sales of Services with Qualified Tangible Personal Property .............................................................36 10.22 Purchases and Use Tax - UEZ .............................................................................................................36 10.23 Salem County .....................................................................................................................................37 10.23A Salem County Reduced Sales TaxRate..............................................................................................37 10.23B Auditing Reduced Rate Transactions ? Salem County ......................................................................37 10.23C Sales of Services with Qualified Tangible Personal Property ? Salem County..................................38 10.23D Purchases and Use Tax ? Salem County ...........................................................................................38 Chapter 11 Sampling......................................................................................... 39 11.1 Overview ............................................................................................................................................39 11.2 Considerations in Selecting Sampling Method...................................................................................39 11.3 Types of Sampling Methods...............................................................................................................39 11.3A Block Sampling ...................................................................................................................................39 11.3B Stratified Sampling .............................................................................................................................40 11.3C Statistical Sampling ............................................................................................................................40 11.4 Sampling Agreement..........................................................................................................................40 11.5 Extraordinary Items............................................................................................................................40 11.6 Missing Documentation for Sample Items .........................................................................................41 v

Chapter 12 Cash Audits ..................................................................................... 42 12.1 Definition............................................................................................................................................42 12.2 Analysis of Books and Records ...........................................................................................................42 12.3 Purchases ...........................................................................................................................................42 12.4 Indirect Method vs. Direct Method....................................................................................................43 12.5 Indirect Audit Methods ......................................................................................................................44 12.6 Mark-On Analysis ...............................................................................................................................44 12.7 Average Weighted Mark-On ..............................................................................................................44 12.8 Mark-On Calculations.........................................................................................................................45 12.9 Calculating Audited Sales and Audited Mark-On for the Sample Period ...........................................45 12.10 Calculating Audited Purchases and Audited Sales for the Audit Period.............................................45 12.11 Constructive Dividends and Pro Rata Share Income ..........................................................................46

Chapter 13 Field Audit Work Papers.................................................................. 47 13.1 Work Paper Standards .......................................................................................................................47 13.2 Indexing..............................................................................................................................................47 13.3 Cross-Referencing ..............................................................................................................................47 13.4 Contents of Work Papers ...................................................................................................................47 13.5 Data Furnished By Taxpayer...............................................................................................................48 13.6 Other Miscellaneous Documents.......................................................................................................48

Chapter 14 Field Audit - Post-Audit Procedures ................................................ 49 14.1 Post-Audit Conference and Report ....................................................................................................49 14.2 Taxpayer Agrees With the Audit Findings ..........................................................................................49 14.3 Taxpayer Disagrees With the Audit Findings......................................................................................49 14.4 Steps Required to Avoid Future Tax Deficiencies...............................................................................50 14.5 Audit Narrative in General .................................................................................................................50 14.6 Content of the Audit Narrative ..........................................................................................................50 14.6A Description of Taxpayer's Business ....................................................................................................51 14.6B Date(s) of Site Visit(s) .........................................................................................................................51 14.6C Unusual Circumstances ......................................................................................................................51 14.6D Description of Taxpayer's Records .....................................................................................................51 14.6E Description of Taxpayer's Accounting Methods ................................................................................51 14.6F Reconciliation of Gross Receipts ........................................................................................................52 14.6G The Sample .........................................................................................................................................52 14.6H Explanation of Audit ProceduresUsed...............................................................................................52 14.6I Conclusion of the Audit......................................................................................................................53 14.7 Report to Assistant Director (AD Report)...........................................................................................53

Chapter 15 Sales and Use Tax Refunds ............................................................. 54 15.1 Determining Whether the Refund Claim is Complete........................................................................54

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15.2 Confirming the Taxpayer's Address ...................................................................................................54 15.3 Reviewing the Taxpayer's Account ....................................................................................................54 15.4 Verifying Timeliness of Claim .............................................................................................................54 15.5 Refund Period Extended By Consent Form ........................................................................................55 15.6 Verifying Validity of Claim ..................................................................................................................55 15.7 Denying the Refund............................................................................................................................55 15.8 Approving the Refund ........................................................................................................................55 15.9 Taxpayer Has No Outstanding Liabilities............................................................................................55 15.10 Taxpayer Has Outstanding Liabilities .................................................................................................56 15.11 Denying in Part/Approving in Part .....................................................................................................56 15.12 Paying Interest on Refunds ................................................................................................................56 15.13 Offsetting an Approved Tax Refund Against a Tax Audit Assessment ...............................................56 15.14 Refund Claim Received Before Field Work Completed......................................................................56 15.15 Taxpayer Signs Offset Agreement ......................................................................................................57 15.16 Taxpayer Objects to Signing the Offset Agreement ...........................................................................57 15.17 Refund Claim Received After Field Work Completed (Or Nearly Completed) ...................................57 15.18 Refund Requests From Other Areas of the Division...........................................................................57 Chapter 16 Office Audit Branch ......................................................................... 58 16.1 Refund and Offset Provisions .............................................................................................................58 16.2 Applications of Overpayments to Prior & Subsequent Years.............................................................58 16.3 Applied Date to Be Used For Overpayment Within the Same Tax.....................................................58 16.4 Applied Date for Overpayment ..........................................................................................................58 16.5 Estimated Tax Assessment .................................................................................................................58 16.6 Corporation Business Tax...................................................................................................................59 16.7 Documentation ..................................................................................................................................59 16.8 Audit Discontinued.............................................................................................................................59 16.9 Corporate Services "A" Group............................................................................................................60 16.10 Tax Clearance Certificates ..................................................................................................................60 16.11 Corporate Services "B" Group............................................................................................................66 16.12 Special Audit Group............................................................................................................................70 16.13 Processing IRS Revenue Agent Reports (RAR) and Related Amended Returns .................................71 16.14 Checking for Open Audits...................................................................................................................71 16.15 Examining Revenue Agent Reports Information/Amended Returns .................................................71 16.16 Amended Return Filed as a Result of Revenue Agent Reports ..........................................................71 16.17 Net Operating Losses .........................................................................................................................72 16.18 Allocation Factor ................................................................................................................................72 16.19 Tax Credits..........................................................................................................................................72 16.20 Worksheets ........................................................................................................................................72 vii

16.21 Assessments .......................................................................................................................................72 16.22 Refunds and Credits ...........................................................................................................................73 16.23 Banking Financial Corporations (BF-CBT) CBT-BK and CBT-FN Eligibility ...........................................73 16.24 Insurance Premiums, Retaliatory, Ocean Marine and Risk Retention Taxes .....................................74 16.25 Auditing Sanitary Landfill Tax Returns ...............................................................................................74 16.26 Reviewing for the Tax Benefit Transfer Program ...............................................................................75 16.27 "Regular Audit" Groups......................................................................................................................75 Chapter 17 "Regular Audit" Procedures ............................................................ 76 17.1 The Selection Process.........................................................................................................................76 17.2 Determining the Audit Period ............................................................................................................76 17.3 Preparing to Audit the Returns ..........................................................................................................76 17.4 Auditing the Returns ..........................................................................................................................76 17.5 Schedule A ? Lines 1 through 28 ........................................................................................................76 17.6 Federal Return Prepared On a Separate-Entity Basis.........................................................................76 17.7 Federal Return Prepared On a Consolidated Basis ............................................................................77 17.8 Line 29 ? Interest on Federal, State, and Municipal Obligations .......................................................77 17.9 Line 30 ? Related Interest Addback....................................................................................................77 17.10 Line 31 ? New Jersey State and Other States' Taxes Deducted Above ..............................................77 17.11 Line 32 ? Depreciation and Other Adjustments from Schedule S ......................................................77 17.12 Line 33(a) - Deduction for IRS Sec 78 Gross-up not Deducted at Line 37 ..........................................77 17.13 Line 33(b) - Other Deductions and Additions.....................................................................................77 17.14 Line 33(c) - Elimination of Nonoperational Activity ...........................................................................78 17.15 Line 33(d) - Interest and Intangible Expenses and CostsAddback.....................................................78 17.16 Line 35 ? Net Operating Loss Deduction ............................................................................................78 17.17 Line 37 ? Dividend Exclusion ..............................................................................................................78 17.18 Line 3, Schedule B ? Loans to Stockholders/Affiliates........................................................................79 17.19 Line 24, Schedule B ? Loans from Stockholders/Affiliates .................................................................79 17.20 Schedule J ? Allocation Schedule .......................................................................................................79 17.21 Property Fraction ...............................................................................................................................80 17.21A Verifying the Denominator................................................................................................................80 17.21B Verifying the Numerator ...................................................................................................................80 17.22 Receipts Fraction................................................................................................................................80 17.22A Verifying the Denominator................................................................................................................81 17.22B Verifying the Numerator ...................................................................................................................81 17.23 Throwout............................................................................................................................................81 17.24 Payroll Fraction ..................................................................................................................................82 17.24A Verifying the Denominator................................................................................................................82 17.24B Verifying the Numerator ...................................................................................................................82 viii

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