An Open Letter to All Mixed Beverage Permit Holders in the State of Texas

Beginning October 1, 2012, Audit Division of the Comptroller’s Office very quietly and without notice changed their policy related to Mixed Beverage audits. The policy change almost guarantees that if you are selected for audit, you will be assessed a liability.

No matter how good the records, internal controls or adherence to the law, any Mixed Beverage audit is by its very nature an estimation. Since the inception of the tax in the 1970’s, the estimation procedure has employed the depletion methodology. In an effort to be fair and in recognition that any estimation is imperfect, first the TABC and currently the Audit Division of the Comptroller’s Office used to compare what the taxpayer reported to the amount they estimated the taxpayer “should have” reported. If a taxpayer with good records had reported within 7.5% of what the auditor estimated, no liability was assessed. If the taxpayer had bad records, the “close enough” amount was 5%.

Wes Boullioun – Former Texas Comptroller State Tax Auditor, 8 Years

Wes Boullioun – Former Texas Comptroller State Tax Auditor, 8 Years

The new policy does away with looking at error rates. Now, if the calculated tax due is over the auditor’s materiality threshold (most likely, $2,000.00), tax will be assessed. After they calculate your tax due, they will give the taxpayer a 5% allowance off the assessment. That 5% allowance is not new. They already do that.

Why will an assessment most likely be made? There are several important variables which determine the calculation of tax due in the depletion analysis. The pour size of distilled spirits drinks, properly identifying the secondary liquors, properly identifying and proving wine and or beer used in cooking, the quality of record keeping, the glass sizes, wine pour sizes, the range of prices of wine, the calculation of average sales prices of drinks by category (distilled spirits, beer, and wine) all have to be determined with a degree of specificity that is not always exactly accurate. You do not have to be off much in order to get over the $2,000.00 tax due threshold. And remember, the burden of proof is on you. An audit has nothing to do with what actually happened. It has everything to do with what you can prove happened.

Who will be affected the most? It is truly ironic that this new policy will eventually flip who is selected for audit. Under the error rate policy, the largest reporters of tax were the least likely to produce a tax due audit – namely, large hotels and large restaurant chains. This was because those entities were the most likely to have the best internal controls, the most stable employees, the most complete records, and the most oversight in order to quickly identify and resolve problems. Given the leeway that was afforded in the past, it was not as critical to get every variable exactly right in order to get a no tax due audit. But under the new policy, all those variables listed above (and that list is not all inclusive) better be exactly right, or you will be assessed. For perspective, consider the following: If you reported $3,000,000.00 in tax over the four year audit period, a 1% error would produce a $28,500.00 liability (30,000.00 less 5% allowance). A 7.5% error would translate to $213,750.00 in tax due (225,000.00 less 5% allowance). In the past, both these audits would have been no tax due. With numbers like that, it is predictable that smaller but non-compliant taxpayers whom the state used to be concerned with will be less concerning. So the answer to the question posed at the beginning of this paragraph is the good corporate taxpayers will be audited more and the smaller taxpayers will get audited less.

Why did Audit Division change their policy? Money (Your Money). And lots of it.

Is this legal? That is a good question, and I am not sure about the answer. Clearly, the Comptroller has to be able to audit Mixed Beverage taxpayers, and no matter how that is done the audit will be an estimation. However, APA guidelines are supposed to be followed when the agency adopts rules that affect people’s taxes. The depletion methodology has been in use for years and hearings have upheld the agency’s right to use it. However, the depletion spreadsheet was never adopted through the APA procedures. The use of the depletion spreadsheets up until now had the built in error rate benchmarks that required auditors to NTD audits falling into an acceptable range just to keep things fair. Removing the range absolutely changes the dynamics of the equation. The agency is ascribing a level of precision to the depletion methodology now that simply does not exist. One thing that is for sure is that they (Audit Division) did this. And they will continue to do it unless they are challenged. Many things are legal that are not ethical. We have heard for years about transparency in state government. I cannot reconcile how this unannounced policy change that affects all mixed beverage taxpayers in the entire state who get audited squares with transparency.

What should be done about this? Mixed Beverage taxpayers, specifically large taxpayers as a group, need to lobby the legislature to adopt the depletion analysis going through the APA guidelines. Ask for input into its creation and adoption. Lobby the legislature to include the error rate factors. But it will not work unless you approach this as a unified force.