In a rare open session, the Multistate Tax Commission’s (MTC) Audit Committee (Committee) met yesterday to discuss changing the way the MTC selects companies to audit on behalf of states. For many taxpayers, the MTC’s process for selecting audit targets is a mystery because it occurs behind closed doors. The current selection process requires states to respond to a series of questionnaires that helps the Committee gather specific information about potential audit targets.  

Potential Two-Step Audit Selection Process

The Committee discussed a proposed two-step process:

  1. The first step is a nomination form where a particular state “nominates” a company for audit. To be nominated for an MTC income tax audit, the potential target must (i) have consolidated federal taxable income of at least $250 million, and (ii) do business in a significant number of states. Optional criteria that support an audit include whether: (i) the taxpayer has large intercompany transactions, (ii) the taxpayer has a captive real estate investment trust (REIT), (iii) the taxpayer’s apportionment factors fluctuate significantly year-to-year, and (iv) several other facts-and-circumstances criteria. Sales tax audit targets are nominated using similar criteria.
  2. The second step entails a vote by 23 participating MTC audit states indicating their interest in auditing a taxpayer. On the ballot, states can vote on whether the taxpayer should be audited and whether a taxpayer should be characterized as a “priority” audit. While targets can be selected at any time during the year, MTC staff indicated that the busiest “inventory filling time” is in July before the MTC’s annual meeting in late July.

“No Change” Audit Policy?

The Committee also discussed implementing a “no change” audit policy. Currently, it is difficult for an MTC auditor to drop a state from a joint audit even if it is apparent early-on that the taxpayer’s potential liability in a given state would be minimal. The Committee discussed establishing a method where an MTC auditor can recommend “no change” (i.e., no audit adjustment) to a particular state prior to the completion of the multistate audit.  

Wanted: Transfer Pricing Audit “Expert”

The final item the Committee discussed before going into closed session was the possibility of developing specialized transfer pricing expertise within the MTC audit staff. MTC Executive Director Joe Huddleston informed the Committee that many states feel they do not have adequate internal staff to audit complicated transfer pricing issues. As a result, several MTC member states have asked the MTC to explore developing transfer pricing expertise among MTC staff that can be used in joint audits. The MTC Executive Committee will formally discuss the possibility of establishing this new expertise when it meets in May.