The Washington State Department of Revenue (“DOR”) is the enforcement agency for the state sales, business and occupation (“B&O”), and other excise taxes. The DOR conducts routine excise tax audits through its Audit Division, and it conducts desk audits through its Compliance Division. The nature and scope of a DOR audit depend on whether the audit is a limited scope audit or full audit. As an initial matter, it is important to understand why the taxpayer was selected for audit as this will inform where the DOR will focus their efforts. For example, a taxpayer with an audit assessment history can expect the DOR to revisit many of those same transactions in later periods. Further, changes in reporting, claiming deductions not typical for the taxpayer’s industry, or refund claims will cause the DOR to review those matters. Unregistered taxpayers may be selected for audit through the DOR’s tax discovery efforts. Finally, the DOR may simply choose a taxpayer for audit through random selection.

If Selected for Audit

If a taxpayer is selected for audit, the taxpayer will receive a formal letter, phone call, or both to notify it of the pending DOR review and provide the contact information for the auditor. The letter will provide that the taxpayer has approximately two weeks to contact the auditor to discuss the audit process and to set up a mutually agreed start date for the fieldwork. The taxpayer can request an extension of time if the audit conflicts with other demands on its business. By filling out a confidential tax authorization form and notifying the auditor, the taxpayer can elect to have an outside third party, such as a legal counsel, represent them in the audit.

In the initial DOR letter, the auditor will request the taxpayer provide a general list of financial records. During the first meeting, the auditor will interview the taxpayer about its business activities and financial systems, which allows the auditor to be more specific in his or her next document request. The auditor may also request the taxpayer complete a Washington Business Activities Questionnaire (“WBAQ”) to supplement the interview. Finally, the auditor will confirm which tax periods will be covered by the audit and whether any affiliates will be included.

Notes About Interviews and Document Production

An audit of a taxpayer is an integrated investigation by the DOR’s team of tax lawyers and accountants. As such, the taxpayer must also take an integrated approach to its responses. For example, responses provided at the beginning of the audit on the WBAQ are given great weight by the board of tax appeals (BTA) and superior court judges even though many of the questions are vague, open-ended, and without context. Information obtained during the audit may be shared with other state, city, and federal agencies or the Attorney General’s Office without prior consent of the taxpayer. Therefore, it is important to be accurate in any responses or alternatively, leave it blank if unsure of the correct answer.

The Audit

The audit procedures are designed to test the amounts reported by the taxpayer on its combined excise tax returns. For most businesses, those amounts include the B&O and sales and use tax.

A B&O tax audit will require the auditor to verify receipts reported on the return to the taxpayer’s general ledger. In certain limited cases, the Audit Division may allege that the taxpayer’s general ledger doesn’t capture all of the taxpayer’s receipts, in which case the auditor may choose to verify the amounts reported on the returns to the taxpayer’s bank deposits or federal tax returns. The auditor will look for other taxable transactions, such as reimbursements or pass-through payments, in the general ledger. The taxpayer should have work papers reconciling book income to B&O taxable income in preparation for the audit.

The auditor will also evaluate whether the taxpayer’s receipts are reported under the appropriate B&O tax classification. For example, the auditor may reclassify receipts from the B&O wholesaling tax to the B&O retailing tax if the transaction is not eligible for resale treatment. The auditor will test deductions and exemptions claimed on the return and will deny any deduction with insufficient or incorrect documentation. The Audit Division will pay particular attention to the methods used by the taxpayer to source income under the B&O service and other activities tax.

In a sales and use tax audit, the auditor will test transactions where the taxpayer is required to collect sales tax, as well as any exemption certificate accepted by the taxpayer in lieu of collecting sales tax. In addition, the auditor will review the taxpayer’s purchases for the audit period for any underreported use tax. The Audit Division may examine the capital asset purchases and test the taxpayer’s consumables for use tax. If the seller did not charge tax on the purchase, the Audit Division will test whether the taxpayer’s use of the purchase qualified for an exemption from tax. The auditor may also suggest that sampling may be appropriate for some parts of the audit. After his or her review, the auditor will present the taxpayer with an interim list of transactions that appear to be use tax errors and give the taxpayer an opportunity to support any basis for exemption. The taxpayer should also take this opportunity to identify any sales tax overpayment errors.

Notes on Sampling

Sampling may be appropriate if the audit includes a large number of transactions. The sample size and selection, however, should be designed to produce specific levels of confidence and precision. The sampling methodology should also account for negative transactions, missing documents, and any special data attributes. For example, accounts payable data is typically skewed due to high dollar transactions. As such, the Audit Division generally employs a computer sampling program to stratify the data into three or more strata and tests all the transactions in the high dollar stratum to account for the skewed population. In other audits, the Audit Division will choose a random or block sample. For accounts payable populations, random or block samples should only be used as a last resort due to the inherent sampling error associated with these methods.

Preliminary Assessment

The auditor will provide the taxpayer with the proposed schedules and work papers explaining the audit findings. The taxpayer should use this opportunity to communicate any factual or legal errors in the preliminary assessment to the auditor and support its request for abatement with the appropriate documentation or other relevant evidence. The Audit Division will normally hold the audit open pending the production of such documents. If the documents and other evidence are not produced in a reasonable amount of time, however, under RCW 82.32.050(1), the auditor will finalize the audit and send it to the DOR’s excise tax examiners for a final review before sending the final audit reports and tax bill to the taxpayer. The receipt of the audit reports and tax bill starts a 30-day clock during which the taxpayer must either: (1) pay the tax; (2) obtain an extension; or (3) file an administrative appeal under WAC 458-20-100. A failure by the taxpayer to take one of these actions will result in the taxpayer forfeiting the right to an administrative appeal and incurrence of late payment penalties.

Notes on Identifying Errors in the Audit

Most audits suffer from an information gap between the taxpayer, who is knowledgeable about taxpayer’s activities, and the auditor, who has almost no information about the taxpayer’s activities. Audit standards require auditors to be skeptical and verify corroborating documents rather than rely on representations made by the taxpayer. As a result, factual errors and controversies involving mixed questions of law and fact are best rebutted by gathering the documents and substantiating the taxpayer’s position in much the same way the taxpayer would prepare for a proceeding in superior court or the BTA. An integrated approach avoids duplication of effort, resolves disputes at the earliest level, and indicates to the DOR that the taxpayer is preparing the case for litigation. Moreover, resolving these errors can be very important in situations where the Audit Division uses sampling.

Supervisor’s Conference

The DOR encourages the taxpayers to request a supervisor’s conference if they disagree with the audit at any time during the audit. During the supervisor’s conference, the auditor and his or her manager meet with the taxpayer to resolve any factual or legal disputes. The taxpayer should be prepared to substantiate any request with documentation or other relevant evidence. Even if the taxpayer and Audit Division disagree about the application of the tax law, the taxpayer should use this opportunity to resolve any factual disputes to minimize the time and effort required to resolve factual disputes at the BTA or superior court.

Informal Administrative Review

WAC 458-20-100 provides for an informal administrative review of any assessment by the Appeals Division. The petition for review must be filed within 30 days of the final audit reports and tax bill. The Appeals Division will generally grant a 30-day extension upon request. The Informal administrative review is performed by a tax review officer who is responsible for providing a departmental review but not an independent review. The tax review officer will schedule a hearing to provide the taxpayer with the opportunity to present evidence of a factual or legal error in the assessment. While the Audit Division does not appear at the hearing, the tax review officer will be in frequent contact with the Audit Division regarding the facts surrounding the assessment. After the hearing, the tax review officer may hold the record open for supplemental materials. Once the officer completes its review, a written determination will be prepared listing all of its findings and conclusions. If unsuccessful on appeal, the taxpayer must either: (1) pay the assessment; (2) obtain an extension; or (3) file a petition for reconsideration within 30 days of the determination or face a late payment penalty. The taxpayer may also appeal an unfavorable administrative decision to the BTA or in superior court.

Independent Reviews

The taxpayer may seek an independent review by paying the tax and filing a tax refund case in the superior court in Thurston County or before the BTA.

The BTA consists of three appointed members and is independent from the DOR. The BTA reviews only tax issues, and the vast majority of BTA cases involve property tax appeals. The BTA allows for formal and informal hearings. In order to have the right to appeal a BTA decision to the courts, the BTA hearing must be a formal hearing. The record established in a formal BTA appeal is the record reviewed by the superior court and the court of appeals. Thus, a formal BTA appeal generally requires witnesses, testimony, depositions, etc.

The exclusive superior court remedy is a refund action in Thurston County under RCW 82.32.180. Thurston County is a state trial court of general jurisdiction, but it hears statewide excise tax refund claims. As such, the refund action in Thurston County generally also requires witnesses, testimony, depositions, etc.


The DOR’s team of tax lawyers and accountants take an integrated approach to their audits and so should the taxpayer. At K&L Gates, our team includes former DOR auditors, CPA’s, and experienced tax lawyers that provide integrated support to our clients to efficiently and effectively resolve tax disputes with the DOR.