Demystifying the MTC Joint Audit Program - Sutherland Asbill

Demystifying the MTC Joint AuditProgram

by Jeffrey A. Friedman, Todd A. Lard, and Charles C. Kearns

Jeffrey A. Friedman Todd A. Lard Charles C. Kearns

Audits of multistate taxpayers typically are factintensive, state law specific, and a draw on taxpayer(and state administrator) resources. It seems intui-tive that a mechanism to allow multiple states tojointly audit a single taxpayer could be beneficial toboth taxpayers and the states. The Multistate TaxCommission for many years has operated its JointAudit Program of large corporations’ income/franchise tax and sales tax returns. However, theJoint Audit Program is viewed negatively by moststate taxpayers. This A Pinch of SALT examines theoperation of the Joint Audit Program and previewswhat a taxpayer might expect if selected for an MTCaudit.

Overview of the Joint Audit Program

The MTC’s Joint Audit Program is authorizedunder Article VIII of the Multistate Tax Compact.1The Joint Audit Program includes compact memberstates that have adopted the compact’s Article VIII,other states that have authorized their participationin the Joint Audit Program by statute, and statesthat have entered into what amounts to a third-party auditor contract (for example, MTC Form

0300-C, Income Tax Audit Authorization) with theMTC.2 States that participate in the Joint AuditProgram are required to pay a fee to the MTC (inaddition to any other MTC membership dues).3Twenty-three states now participate in the Incomeand Franchise Tax Joint Audit Program and 19states participate in the Sales and Use Tax JointAudit Program.4

The Joint Audit Program purports to result in amore efficient audit system for states and taxpayers.The Joint Audit Program relieves states of theburden of conducting audits by delegating theiraudit authority to the MTC staff, while theoreticallyreducing the burden on taxpayers of undergoingmultiple, separate state audits. The MTC’s auditors,however, do not have the authority to assess a tax,but are responsible for making recommendations to

1This A Pinch of SALT reviews the MTC’s Joint AuditProgram but does not explore the MTC’s National NexusProgram, which operates under separate authority and hasdifferent participating states. Information concerning theMTC’s National Nexus Program is available at http://www.mtc.gov/Nexus.aspx?id=526.

2See Multistate Tax Compact Art. VIII, part 1 (‘‘[ArticleVIII] shall be in force only in those party States that specifi-cally provide therefor by statute’’); e.g., Mo. Rev. Stat. section32.057(2)(3) (‘‘the appropriate representative of the multi-state tax commission [may] inspect any return or reportrequired by the respective tax provision of this state, or mayfurnish to such officer an abstract of the return or report orsupply the officer with information contained in the return ordisclosed by the report of any authorized investigation’’);T.C.A. section 67-1-102(b)(10) (‘‘the department has the powerto. . . . Enter into a contract to participate in the MultistateTax Commission Joint Audit Program’’); Wis. Stat. section73.03(28d); (‘‘the department shall have the power and theauthority to: . . . Enter into a contract to participate in theMultistate Tax Commission Joint Audit Program’’); see alsoMultistate Tax Compact Art. VIII, part 2 (‘‘any party State orsubdivision thereof desiring to make or participate in an auditof any accounts, books, papers, records or other documentsmay request the Commission to perform the audit on itsbehalf ’’).

3For a discussion of the effect of recent compact repeallegislation in states such as California and South Dakota onthe MTC’s audit program budget, see Nanette Byrnes, ‘‘StateDefections Impact U.S. Interstate Tax Compact,’’ Reuters(Mar. 7, 2013).

4See the appendix (p. 606) for a list of states participatingin the Joint Audit Program.

State Tax Notes, May 20, 2013 599

the participating states based on their audit find-ings. The MTC summarizes the Income and Fran-chise Tax Joint Audit Program process as follows:

• The MTC’s audit director assigns an audit to anauditor from an audit inventory.

• States decide whether to participate in theaudit; if participating, the state returns asigned audit authorization.

• Auditor contacts the taxpayer and arranges anaudit appointment.

• Auditor conducts field audit work at taxpayer’slocation.

• Auditor completes field work and supplies tax-payer with audit schedules.

• Auditor discusses any proposed audit adjust-ments with taxpayer.

• Taxpayer reviews proposed audit adjustment.• Taxpayer may request meeting with the MTC’s

audit supervisor, audit director, or audit com-mittee at any point during the audit process.

• Audit supervisor reviews audit schedules andreport.

• Individual state audit sent to correspondingstate in the audit as a recommended auditfinding.

• Each state reviews its own completed audits.• Each state determines action to take from audit

(accept or change).• Each state sends out Notice of Assessment

(refund) to taxpayers.• Taxpayers may protest the audit results di-

rectly to states or request Multistate Alterna-tive Dispute Resolution (project developedjointly by states and the Council On StateTaxation).5

The Sales and Use Tax Joint Audit Programinvolves three additional procedures: (1) a computeraudit specialist accompanies the auditor on the firstaudit field trip; (2) the auditor will request electronicrecords of the taxpayer; and (3) the computer auditspecialist will convert the taxpayer’s electronic re-cords to readable files for the auditor.

Validity of the Joint Audit ProgramSome taxpayers have challenged the MTC’s au-

thority to audit on behalf of states. In the seminalcase U.S. Steel Corp. v. Multistate Tax Commission,the taxpayer responded to a joint audit by challeng-ing the constitutionality of the Multistate Tax Com-pact under the U.S. Constitution’s compact clause.6The taxpayer, representing a class of multistatetaxpayers, claimed that the states had exceededtheir constitutional powers by entering into an

agreement without the consent of Congress. TheSupreme Court rejected the taxpayer’s argumentand found that congressional consent is required forthe validity of a compact or agreement betweenstates only if it ‘‘is directed to the formation of anycombination tending to the increase of politicalpower in the States, which may encroach upon orinterfere with the just supremacy of the UnitedStates.’’7 The Court found no such encroachment orinterference is associated with the Multistate TaxCompact.

Shortly after U.S. Steel, in Multistate TaxComm’n v. Merck & Co., Inc., the Oregon SupremeCourt held that a joint audit is an Oregon auditperformed under Oregon law by its agent, the MTC,and its auditors.8 Therefore, the court required thetaxpayer to make available MTC-designated docu-ments and critical personnel so that the MTC couldconduct a joint income tax audit on behalf of the 11states, including Oregon, participating in the Merckaudit.9 In upholding the validity of the MTC jointaudit, the court noted that the MTC auditors do notassess taxpayers but recommend audit results tostates:

The administration of the audit by the Com-mission personnel, as it relates to Oregon, issubject to Oregon legislation and administra-tive rules over the rate of tax, the compositionof the tax base, including components of tax-able income, methods of determining tax liabil-ity and procedures for collecting the tax. It issimultaneously subject to the laws of each ofthe other participating states as it relates tothose states. The Commission auditors aregenerally governed by the varying specific in-structions of the states and by the specificrequirements of the various state tax lawswhich the auditors apply. Thus an audit suchas this is essentially an Oregon audit per-formed under Oregon law by the Oregon De-partment of Revenue acting for conveniencethrough its agent, the Multistate Tax Commis-sion and simultaneously an audit of each of theother participating states in the same manner.Both the decision to audit and the rules gov-erning the audit are those of the individualstates; neither is subject to a vote, howeverweighted, of the Commission.

5The MTC, ‘‘About the MTC Audit Program: Income TaxJoint Audit Process.’’

6U.S. Steel Corp. v. Multistate Tax Commission, 434 U.S.452 (1978).

7Id. at 471.8Multistate Tax Comm’n v. Merck & Co., Inc., 617 P.2d

1371, 1374 (Ore. 1980); see also, Nebraska Revenue Ruling99-08-1, Jan. 23, 2008 (finding the Department of Revenuemay exercise its audit powers through duly appointed agentsunder its general duties to carry out and enforce the tax lawper Neb. Rev. Stat. section 77-369); N.J.S.A. section 54:50-9(a)and -(e), W.Va. Code section 11-10-5d(l).

9Id.

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600 State Tax Notes, May 20, 2013

. . . [The MTC’s uniformity] proposals areadvisory, not directory. They have no force inany state until adopted by that state in accor-dance with its own laws. ORS 305.655, Art. VI,Art. VII. It is for this reason that [the taxpayer]has not cited and we have not found anydecision concerning an audit such as this whichwas necessarily or actually the subject of aCommission vote.10

In Colgate-Palmolive Co. v. Dorgan, the taxpayer(which was a member of the class in the then-pending U.S. Steel case) challenged North Dakota’sauthority to participate in the Joint Audit Program.The North Dakota Supreme Court stated that jointaudits were allowed under North Dakota tax law,separate and apart from North Dakota’s adoption ofthe compact:

A second related question concerns the TaxCommissioner’s authority to appoint em-ployees of the Multistate Tax Commission asauditors for North Dakota tax purposes. Sepa-rate from the authority granted under theMultistate Tax Compact, the Commissionerhas statutory authority to require an audit by‘‘any agent or representative designated by himfor that purpose, * * *’’ [Emphasis supplied.]Section 57-38-56, N.D.C.C.11

Interestingly, the Colgate court suggested that aconcerned taxpayer may seek protection from acourt ‘‘with proper jurisdiction’’: ‘‘if Colgate desiresthat the results of that audit not be made availableto other states it may seek a protective order from acourt with proper jurisdiction.’’12

By the Numbers

A typical audit involves anywhere from 11 to 15states and, thus, taxpayers expend anywhere be-tween 400 to 900 hours over the course of an audit.13

For the fiscal years ended June 1996 through June2012, the MTC’s auditors conducted 309 total (in-come and franchise taxes and sales and use taxes)audits. Those audits during that period averagedabout 18 total audits per year and about 70 hoursper state.14 As of January 31, 2013, 20 income andfranchise tax and 31 sales and use tax audits were inprogress, resulting in proposed income and fran-

chise tax assessments of $35,370,706 and proposedsales and use tax assessments of $479,575.15

Though the MTC reduced the average time perstate audit during the early- to mid-2000s, theaverage time per state audit has increased.16 Unfor-tunately, the audit process is inconsistent.17

The Nomination ProcessThe MTC’s Audit Committee, composed of repre-

sentatives from each state participating in the JointAudit Program, nominates candidates for its ‘‘auditinventory.’’ The Audit Committee rarely meets inpublic, but recently held an open session at theMTC’s winter committee meetings to discuss theway it will select candidates to audit. Namely, theAudit Committee discussed the process of requiringstates to respond to a series of questionnaires thatwill help the committee gather information aboutpotential audit targets. Although the committee’snomination process may be evolving, a review of thenomination criteria reflected in recent draft ques-tionnaires provides insight into the process. Thecriteria used in selecting candidates for each auditvary, although the committee uses the same generalaudit nomination process for both income and fran-chise tax purposes and sales and use tax purposes.

In its most recent discussion draft, the committeerecommends that states consider 11 criteria in nomi-nating candidates for an income and franchise taxaudit.18 Absent an exception, two criteria must bepresent in all cases:

• the taxpayer’s consolidated federal line 28 in-come must be greater than $250 million;19 and

• the taxpayer must have substantial businessactivities in the states in which it files, suchthat its apportionment factors are more than deminimis.20

Furthermore, at least one of the following ninefactors must be present in addition to the mandatorycriteria, when the taxpayer:

• likely has nexus in states in which it is notfiling returns;

• did not properly use combined reporting;• has large intercompany transactions;

10Id. at 1374-1375.11Colgate-Palmolive Co. v. Dorgan, 225 N.W.2d 278, 282

(N.D. 1974).12Id.13Id. (recommending that the MTC auditors limit the

number of includable states to between six and 10, and createa binding audit plan for auditors to follow).

14Multistate Tax Comm’n, ‘‘Audit Director’s Report FiscalYear 6/13’’ (Mar. 2013).

15Id.16See Multistate Tax Comm’n, Audit Director’s Report

Fiscal 6/13 (Mar. 2013).17See Council On State Taxation, ‘‘Recommendations to

Improve Multistate Joint Audit Program,’’ 2007 STT 213-8(Oct. 17, 2007). In 2007 the MTC reported that the averagetime per state audit was 69 hours. Multistate Tax Comm’n,‘‘Report of the Audit Committee and Audit Program’’ (Aug.2007).

18See Multistate Tax Comm’n, ‘‘Income Tax Audit Nomi-nations’’ [Discussion Draft v. 1.5 2-26-13].

19Id.20Id.

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• has apportionment factors in the state thatvary each year;

• has taken a contentious position concerningnonbusiness income;

• has insufficient compliance capabilities relativeto its size and rate of growth;

• has recently undergone a large reorganization,acquisition, or disposition;

• employs real estate investment trusts andother special-purpose entities; or

• is a member of one of certain service industriesthat has yielded significant past audit results.21

Also reflected in a recent discussion draft, theAudit Committee’s nominating criteria for sales anduse tax audits provide lists of criteria to consider, aswell as criteria to avoid. To nominate a taxpayer fora sales tax audit, the taxpayer must have ‘‘substan-tial physical presence in several MTC states, unlessan explanation is provided why an exception shouldbe made.’’22 Similar to the income and franchise taxaudit guidelines, a taxpayer must bear one addi-tional factor before a state can nominate the tax-payer for an audit. Additional sales tax criteriainclude whether the taxpayer:

• has nexus issues;• heavily uses tangible personal property for pro-

motional items to market its products;• sells to end users, ‘‘who would not be expected

to claim a large number of exempt sales, butnonetheless claim large deductions ($250,000or more) for exempt sales on their returns;

• has a history of poor compliance or noncompli-ance issues in previous audits; or

• is involved in the healthcare, retail, or technol-ogy industries, including consumer electronicscompanies.23

The draft sales tax nomination criteria furtherprovide that participating states should not nomi-nate a taxpayer for a joint sales and use tax audit ifthe taxpayer:

• is a large company with multiple operatingdivisions that reports ‘‘combined bases’’ on asingle return;

• requires special auditing procedures or hasvoluminous records; or

• is a manufacturer or wholesaler that sells prod-ucts for resale and has minimal physical pres-ence in the states.24

Though the MTC provides criteria for nominatinga taxpayer for an audit, it does not provide substan-tial elaboration of the criteria. For example, theincome and franchise tax audit guidelines provide

that a taxpayer’s activity must be more than deminimis, but each state will determine whether ataxpayer’s activities are substantial. Thus, a tax-payer’s activities in one state may be considered deminimis but similar activities in another state maybe viewed as substantial.25

After the participating states nominate a tax-payer for audit (by applying the above criteria), thesecond step requires a vote by the participatingstates (by tax type).

The above-described audit selection process forboth income and franchise tax and sales and use taxpurposes can span several months.26 In July theaudit director sends out audit nomination forms tothe participating states, which the states must re-turn by September. In November the audit directordistributes to each state a summary of the auditcandidates, and the states must supply informationon all candidates by February of the next year.Finally, in March the Audit Committee votes on allcandidates and ultimately selects the audit inven-tory.

Joint Audits — Step by Step

Waivers

The MTC has policies and controls in both theIncome and Franchise Tax Audit Manual and theSales and Use Tax Audit Manual that addresswaivers and statutes of limitations issues that mayarise under the Joint Audit Program.27 In general,the MTC’s policies and controls serve two purposes:(1) to protect states against the inadvertent expira-tion of statutes of limitations; and (2) to offer somelevel of transparency to multistate taxpayers nomi-nated under the Joint Audit Program. All the pro-gram’s auditors must discuss the MTC’s audit poli-cies at the opening conference with the taxpayer.28

In the context of an income and franchise taxaudit, the MTC declares, ‘‘an audit should not bestarted by an auditor if the [statute of limitations]on the first year of the audit period is less than a

21Id.22See Multistate Tax Comm’n, ‘‘Sales Tax Audit Nomina-

tions’’ [Discussion Draft v. 1.5 2-26-13] (emphasis added).23Id.24Id.

25Despite the uncertainty created by those guidelines, theSupreme Court upheld the compact’s provisions and thecommission’s audit authority because states are able to del-egate any permissible audit authority to the commission. SeeUnited States Steel Corp. v. Multistate Tax Comm’n, 434 U.S.452 (1978) (upholding the MTC’s validity under the compactclause, the commerce clause, and the due process clause).

26See, generally, ‘‘About the MTC Audit Program — AuditSelection Process,’’ http://www.mtc.gov/Audit.aspx?id=1912.

27Multistate Tax Comm’n Income & Franchise Tax AuditManual, Rev. Mar. 2013, ch. 4; Multistate Tax Comm’n Sales& Use Tax Audit Manual, Rev. May 2010, ch. 4.

28Multistate Tax Comm’n Income & Franchise Tax AuditManual, Mar. 2013, section 4.03(a); Sales & Use Tax AuditManual, Rev. May 2010, section 4.02.

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year.’’29 The MTC has not adopted a similar policy inthe context of a sales and use tax audit, presumablyas a result of the differing tax periods between thetax types. In either case, the auditor will ‘‘makeevery effort to complete the audit before the expira-tion of the current [statute of limitations] timeperiod.’’30

If the effort to complete the audit proves futile, anMTC income and franchise tax auditor will ask ataxpayer to sign a waiver at least three monthsbefore expiration of the limitations period.31 AnMTC sales and use tax auditor will ask for a waiversix months before the statute’s expiration.32 But, ifthe taxpayer refuses to sign a waiver within threemonths of the limitations period expiring, the audi-tor, the audit supervisor, and ultimately the JointAudit Program director will estimate the sales anduse tax liability ‘‘with the best information avail-able’’ for the period(s) at issue and submit thoseamounts to the states.

The income and franchise tax auditguidelines provide that ataxpayer’s activity must be morethan de minimis, but each statewill determine whether ataxpayer’s activities aresubstantial.

The MTC has issued waiver forms for use in theJoint Audit Program, but, as with other forms issuedby the MTC, not all states accept the waiver forms.For example, Missouri and New Jersey will notaccept MTC Waiver Forms 400-A and 400-B, whichlist the states joining the audit and the filers bystate, to extend the limitations period in an incomeand franchise tax audit.33 Rather, Missouri and NewJersey require a separate waiver form for eachtaxpayer filing income tax returns in those states.34

Similarly, in sales and use tax audits, Georgia,Louisiana, and Washington each require their ownwaiver form.

Initial Contact and Opening ConferenceAfter the MTC nominates a multistate taxpayer

for an audit, the auditor assigned to the accountshould reach out to the taxpayer by telephone.35 Thetopics discussed are what one would expect, includ-ing:

• confirming the appropriate point of contactwith the taxpayer;

• informing the taxpayer that it has been nomi-nated under the Joint Audit Program andwhich states are participating and those thatmay participate;

• determining a handful of dates for the openingin-person conference (that is, the ‘‘audit ap-pointment date’’);

• providing general information about the JointAudit Program;

• discussing the need for an audit plan; and• in the case of sales and use tax audits, describ-

ing the ‘‘Commission’s preference in auditingthrough the use of electronic data and statisti-cal sampling procedures.’’36

The auditor provides an ‘‘engagement letter’’ thatwill include participation authorizations from eachstate and, in sales and use tax audits, sampling-related guidelines.37

Once the audit appointment date is set, the audi-tor and the taxpayer’s representative(s) will meet inperson to discuss the following issues:

• waiver policies of the MTC and taxpayer;• the initial audit plan, subject to modifications

and agreement by the taxpayer;• the MTC’s information and document request

(IDR) policies;• steps in the audit process;• additional persons who may be involved in the

audit process, for example, the MTC’s ‘‘com-puter audit specialist’’ for sales and use taxaudits and any taxpayer representatives, in-cluding attorneys or other consultants;

• the taxpayer’s policy relating to e-mail corre-spondence and copying of documents; and

• general procedures for safeguarding the tax-payer’s documents at the taxpayer’s location.38

Information and Document RequestsThe MTC regularly issues information document

requests as part of its Joint Audit Program. TheMTC uses IDRs to obtain documentation from the

29Multistate Tax Comm’n Income & Franchise Tax AuditManual, Rev. Mar. 2013, section 4.02.

30Multistate Tax Comm’n Income & Franchise Tax AuditManual, Rev. Mar. 2013, section 4.02; Multistate Tax Comm’nSales & Use Tax Audit Manual, Rev. May 2010, section 4.02.

31Multistate Tax Comm’n Income & Franchise Tax AuditManual, Rev. Mar. 2013, section 4.03(c).

32Multistate Tax Comm’n Sales & Use Tax Audit Manual,Rev. May 2010, sections 4.02, 4.03(a).

33Multistate Tax Comm’n Income & Franchise Tax AuditManual, Rev. Mar. 2013, section 4.03(d).

34Id.


36Id.37Multistate Tax Comm’n Income & Franchise Tax Audit

Manual, Rev. Mar. 2013, section 5.03; Multistate Tax Comm’nSales & Use Tax Audit Manual, Rev. May 2010, section 5.03.


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taxpayer in order to establish a ‘‘foundation for issuedevelopment and earlier resolution of issues,’’among other things.39 As with any other audit,taxpayers subject to a joint audit by the MTC shouldclearly delineate the scope of IDRs at the auditappointment date.

Although generally similar, the MTC’s IDR poli-cies for income and franchise tax joint audits differslightly from those for sales and use tax joint audits.First, the Sales and Use Tax Audit Manual providesmore insight into the MTC’s purpose and policiesregarding IDRs than does the comparable Incomeand Franchise Tax Audit Manual. Second, and froma more practical perspective, the Income and Fran-chise Tax Audit Manual calls for a 30-day responsedate for taxpayers to respond to an IDR or give anexplanation as to why the taxpayer cannot or willnot respond to the IDR.40 It is unclear how theauditor should respond if or when the taxpayercannot meet that deadline. In contrast, the Salesand Use Tax Audit Manual provides a more flexible‘‘realistic response date’’ on which the auditor andtaxpayer can agree that the IDR will be due.41

Moreover, the MTC’s sales and use tax auditors mayuse ‘‘good judgment in granting extensions of time[for a taxpayer to respond to an IDR] and allow themwhen appropriate.’’42 A sales and use tax auditor isauthorized to send a non-responsive taxpayer a14-day demand letter.43

Dealing With Disagreements Over theApplication of State Law

Under the joint audit manuals, when confrontedwith complex questions that may involve incorrectapplication of state-specific laws, the MTC encour-ages taxpayers to provide an auditor with a memo-randum in support of its position.44 In those cases, ataxpayer should consider asking the auditor to con-tact the state liaison in the jurisdiction at issue.45 Inany event, a taxpayer should not hesitate to contactthe audit supervisor or the director of the JointAudit Program if it believes the auditor is misapply-ing a participating state’s law. If the taxpayer andthe auditor cannot work out any disagreements onthe front end, the taxpayer is entitled to review and

respond to the MTC’s preliminary audit schedule.46

If no adjustments are made to the preliminary auditschedule, a taxpayer that still disagrees with theresults of the audit may request a closing conferenceto more fully understand the MTC’s position and toclearly convey the taxpayer’s position regarding thecontested issue(s).47

The MTC then conducts an internal audit reviewof the audit.48 The field audit supervisor conducts areview of all audit-related documentation, includingthe narrative, schedules, and exhibits.49 The goal ofthat review is to ensure that those documents ‘‘aresufficient to support the findings in the event of ataxpayer protest or of derivative litigation.’’50 Thefield audit supervisor will pay particular attentionto contested questions and especially to those thatthe taxpayer will likely protest.51

A taxpayer should not hesitate tocontact the audit supervisor or thedirector of the Joint Audit Programif it believes the auditor ismisapplying a participating state’slaw.

At the conclusion of that review, the MTC willprovide the taxpayer a hard copy set of the auditschedules and a brief cover letter explaining theadjustments.52 The MTC will not provide the tax-payer a copy of the audit narrative or an electroniccopy of the audit schedules.53 The MTC will then

39See Multistate Tax Comm’n Sales & Use Tax AuditManual, Rev. May 2010, section 5.06(b).

40Multistate Tax Comm’n Income & Franchise Tax AuditManual, Rev. Mar. 2013, section 5.06(b).

41Multistate Tax Comm’n Sales & Use Tax Audit Manual,Rev. May 2010, section 5.06(b), (c).

42Id.43Id.44Multistate Tax Comm’n Income & Franchise Tax Audit

Manual, Rev. Mar. 2013, section 5.06(c); Multistate TaxComm’n Sales & Use Tax Audit Manual, Rev. May 2010,section 5.06(d).

45See, id.

46See Multistate Tax Comm’n Income & Franchise TaxAudit Manual, Rev. Mar. 2013, section 5.07; Multistate TaxComm’n Sales & Use Tax Audit Manual, Rev. May 2010,section 5.07.


Manual, Rev. Mar. 2013, ch. 17; Multistate Tax Comm’n Sales& Use Tax Audit Manual, Rev. May 2010, ch. 13.

49Multistate Tax Comm’n Income & Franchise Tax AuditManual, Rev. Mar. 2013, section 17.01(a), -(b); Multistate TaxComm’n Sales & Use Tax Audit Manual, Rev. May 2010,section 13.01(a), (b).

50Multistate Tax Comm’n Income & Franchise Tax AuditManual, Rev. Mar. 2013, section 17.01(b); Multistate TaxComm’n Sales & Use Tax Audit Manual, Rev. May 2010,section 13.01(b).


Manual, Rev. Mar. 2013, section 17.02; Multistate TaxComm’n Sales & Use Tax Audit Manual, Rev. May 2010,13.02.

53Id.

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provide each participating state hard and electroniccopies of the complete audit package and recommen-dations.54

Working With Participating StatesEach participating state is responsible for review-

ing the audit package and the MTC’s recommenda-tions.55 Each state then issues an assessment (orrefund) based on those recommendations that thestate ‘‘deems appropriate.’’56

Once the audit is closed by the MTC, neither theauditor nor any other MTC representative or em-ployee is allowed to provide the taxpayer with theaudit narrative.57 Instead, the taxpayer must re-quest the audit narrative from each participatingstate. The participating states also issue the taxbills and handle any protests regarding the MTC’sjoint audit, although the auditor may be involved inthe individual state’s protest process.58

Because each participating state handles its ownassessment and protest processes, a taxpayer sub-ject to a joint audit may be confronted with volumi-nous administrative appeal obligations that couldoverwhelm its tax department. For that reason,taxpayers may request that the MTC stagger theassessments. In so doing, the taxpayer is able toaddress common issues (for example, nexus, forcedcombination, and so on) across the participatingstates, more efficiently respond to IDRs, and other-wise ensure that the joint audit process is moremanageable.

Subpoena Me? Subpoena You!Under Article VIII, part 1 of the compact, the

MTC may examine any books and records on behalfof the ‘‘party’’ state and may enter into agreementswith party states for assistance in performance ofthe audit. Also, the MTC may require any person toprovide relevant testimony in the state where theMTC is conducting the audit.59 To enforce thosepowers, the MTC may directly apply to any courthaving power to issue compulsory process for orders

(for example, subpoenas) in aid of its powers andresponsibilities.60 There are no reported incidencesof the MTC independently exercising subpoenapower to compel taxpayer participation in an audit.However, MTC audit staff have publicly stated thatthey have forced taxpayers to comply with IDRs andother audit requests by asking a participating stateto issue a subpoena.

Information Sharing and ConfidentialityThe MTC’s auditors perform joint audits as

though they were part of the participating state’saudit staff, and therefore are subject to each state’sspecific confidentiality and information sharingrules.61 Article VIII, part 5 of the compact provides,‘‘information obtained by any audit pursuant to thisArticle shall be confidential and available only fortax purposes to party States, their subdivisions orthe United States.’’ Also, as explained by severalstate courts, ‘‘availability of information shall be inaccordance with the laws of the States or subdivi-sions on whose account the Commission performsthe audit and only through the appropriate agenciesor officers of such States or subdivisions.’’62

As explained in the Income and Franchise TaxAudit Manual, ‘‘as a representative of each state, theCommission staff is bound by the confidentialitylaws of each state [and may] [r]equest only informa-tion that is pertinent to the Audit based on eachstate’s requirements.’’63 Also, state courts imposethe same limitations on MTC auditors as their statetax agencies’ auditors. For example, in PacifiCorp v.Dep’t of Revenue, the Montana Supreme Courtfound:

Because MTC derives powers from and onbehalf of its member states, it exercises nomore power than the states already possess.Kinnear v. Hertz Corp. (Wash. 1976), 545 P.2d1186. The MTC’s audit information is not sub-ject to any greater burden of confidentialitythan Montana law commonly imposes on taxinformation gathered by the DOR.64

Similar to general state taxpayer confidentialityprovisions, the compact’s member states are alsosubject to their respective state laws concerninginformation sharing.65

54Multistate Tax Comm’n Income & Franchise Tax AuditManual, Rev. Mar. 2013, section 17.03; Multistate TaxComm’n Sales & Use Tax Audit Manual, Rev. May 2010,section 13.03.

55Multistate Tax Comm’n Income & Franchise Tax AuditManual, Rev. Mar. 2013, section 17.05; Multistate TaxComm’n Sales & Use Tax Audit Manual, Rev. May 2010,section 13.05.


Manual, Rev. Mar. 2013, section 5.07(c); Multistate TaxComm’n Sales & Use Tax Audit Manual, Rev. May 2010,section 5.07(c).

58Multistate Tax Comm’n Income & Franchise Tax AuditManual, Rev. Mar. 2013, section 5.07(d), (e); Multistate TaxComm’n Sales & Use Tax Audit Manual, Rev. May 2010,section 5.07(d), -(e)

59Multistate Tax Compact, Article VIII, part 2.

60Multistate Tax Compact Article VIII, Part 3.61See, e.g., Multistate Tax Comm’n v. Merck & Co., Inc.,

617 P.2d 1371, 1374 (Ore. 1980), discussed supra.62Multistate Tax Compact, Article VIII, Part 5; see also,

Merck, supra note 8.63Multistate Tax Commission, Income and Franchise Tax

Audit Manual (rev’d June 2010).64PacifiCorp v. Dep’t of Revenue, 838 P.2d 914, 918 (Mont.

1992).65MTC Agreement on Exchange of Information; see also,

section 213.053(8)(f), F.S. (‘‘the department may provide . . .State tax information to the Nexus Program of the Multistate

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(Footnote continued on next page.)


Perhaps more frightening than information shar-ing from the MTC as a result of the Joint AuditProgram, some states may share with the MTC theinformation obtained through an individual stateaudit and, therefore, perhaps encourage nominationunder the program. In Harley-Davidson, Inc. v. Dep’tof Revenue, for example, the Oregon Department ofRevenue requested that the taxpayer produce busi-ness records to determine whether the taxpayer wasentitled to Public Law 86-272 protection. In refusingto comply with the state’s requests and requesting aprotective order, the taxpayer asserted that it didnot want information about trade secrets, customerlists, and employees to become public information.The DOR further indicated that it would, if asked,share the requested information with other statesand the MTC. The Oregon Tax Court noted thatunder state law the information could be sharedwith another state only ‘‘for tax purposes,’’ and onlyif the other state ‘‘has a provision of law which meetsthe requirements of any applicable provision of theIRC as to confidentiality.’’ The tax court deniedHarley-Davidson’s motion for protection, stating ithad not demonstrated that the request would cause‘‘annoyance, embarrassment or oppression’’ withinthe meaning of Oregon law.

After the Fact? State Adjustments Post-JointAudit

Taxpayers should be aware that participatingstates may make their own adjustments in additionto the MTC’s recommendations following the closingof the joint audit. For example, the state tax agen-cies in West Virginia and the District of Columbiaraised questions in State Tax Comm’r v. ConAgraBrands, Inc. and Microsoft Corp., Inc. v. Office of Taxand Revenue that were not raised by the MTC in ajoint audit for the periods at issue.66

In ConAgra, for example, the West Virginia Su-preme Court of Appeals held that the taxpayer wasnot subject to corporation net income tax and fran-chise tax on royalties earned from the nationwidelicensing of trademarks and

Because the taxpayer exerted no ‘‘purposefuldirection’’ under the due process clause andhad no ‘‘significant economic presence’’ for pur-poses of the commerce clause. The impetus ofthe ConAgra litigation was a joint audit by theMTC in 2006 for the periods from June 1, 2000to May 31, 2003. In that joint audit, the MTC’sauditor recommended that West Virginia as-

Tax Commission pursuant to any formal agreement for theexchange of mutual information between the department andthe commission’’).

66State Tax Comm’r v. ConAgra Brands, Inc., 728 S.E.2d74 (W. Va. 2012).; Microsoft Corp., Inc. v. Office of Tax andRevenue, OAH Dkt. No. 2010-OTR-00012 (May 1, 2012).

Appendix A.

State

Income TaxJoint Audit

Program

Sales TaxJoint Audit

Program

Alabama X X

Alaska X

Arkansas X X

Colorado X X

District of Columbia X X

Georgia X

Hawaii X X

Idaho X X

Illinois X X

Kansas X X

Kentucky X X

Louisiana X

Massachusetts X X

Michigan X X

Minnesotaa X X

Missouri X

Montana X

Nebraska X

New Jersey X X

New Mexico X

North Dakota X X

Oregonb X

Utahc X X

Washington X

West Virginia X

Wisconsin X XaAs a result of Gillette, and potential for similar compactelection litigation, the Minnesota Department of Revenue isadvocating for a repeal of the compact in this year’sMinnesota Omnibus Tax Bill, but retains the state’sauthority to participate in the Joint Audit Program. See TheGillette Co., et al. v. Franchise Tax Bd., Cal. Ct. App., Dkt.No. A130803, Dec. 2, 2012, 209 Cal App 4th 938, 147 CalRptr 3d 603 (2012); Cal. S. Ct., No. S206587, petition forreview granted Jan. 16, 2013.bAs of the date of this publication, the Oregon State SenateFinance and Revenue Committee approved proposedamendments to SB 307, which would repeal the MultistateTax Compact from the Oregon Revised Statutes and reenactthe compact except for the election and the apportionmentformula provisions in light of Gillette.cUtah’s governor signed legislation (SB 247) on April 1,2013, that repeals the compact then reenacts mostauthority sections (including the authority to participate inthe Joint Audit Program) other than the election provisionand apportionment formula. The law provides for fullwithdrawal from the compact by July 1, unless theLegislature addresses the compact election issue.

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sess ConAgra corporate income tax. Interest-ingly, however, the West Virginia State TaxCommission also asserted that ConAgra wassubject to tax.

In Microsoft the District of Columbia’s Office ofTax and Revenue raised an entirely new subject —transfer pricing — that the MTC did not raiseduring its prior joint audit of the taxpayer. Thetaxpayer ultimately prevailed in that case.

Practice PointersIn advance of receiving notification of an MTC

audit, multistate taxpayers should consider takingseveral steps to minimize potential problems thattypically arise in the Joint Audit Program. Forexample, an MTC member state often does not join aparticular joint audit because the taxpayer is rou-tinely audited separately by that state. If the on-going audit relationship with that state is good andthe audits result in few changes, taxpayers shouldencourage that state to relate the experience to theother participating states. Even though the partici-pating states may be limited to a specific number ofstates, the MTC and the participating states havethe ability to share information with other, nonpar-ticipating states. There is no reason that sharedinformation should exclude positive experiences be-tween the taxpayer and the participating states.

Moreover, tensions between taxpayers and MTCauditors often arise when the auditor issues the firstIDRs. Taxpayers should be cooperative, but at thesame time limits must be established. For example,if a taxpayer possesses customer information thathas heightened privacy protections under state orfederal law, the taxpayer may require an adminis-trative subpoena before producing those records.That may require the auditor to get separate sub-poenas from each participating state.

Multistate taxpayers should also consider thefollowing in the context of the Joint Audit Program:

• Taxpayers should develop an audit plan thatincludes a list of participating states, dates forfieldwork, and policies for granting waivers (orthat waivers will not be granted).

• The MTC’s income tax auditors often seek a51-state (including the District of Columbia)apportionment spreadsheet. Sutherland is ofthe view that that sort of spreadsheet is notuseful to the MTC’s auditors. Rather than pro-viding the detail of that spreadsheet, Suther-land believes that a listing of the aggregatedsales to nonparticipating states is all that isneeded by an MTC auditor.

• Taxpayers should review the MTC’s audit re-sults before completion of the audit and oftenrequest an opportunity to discuss the resultswith the participating states.

• Taxpayers should request an acknowledgmentfrom the participating states that the MTCaudit will be the states’ only audit of the tax-payer for the specified audit period. A failure toagree to that single audit concept may result inserial audits and not produce an efficient auditprocess.

• Taxpayers that believe that the treatment of atransaction may vary from state to state shouldconsider providing the MTC auditor with ananalysis of the states’ laws that supports thedifferential treatment.

ConclusionJoint audits by the MTC involve many of the

same matters confronted by taxpayers in individualstate audits.67 However, those issues are com-pounded as a result of the scope of joint audits. Also,the Joint Audit Program creates unique concerns fortaxpayers, such as a state’s authority to participatein the audit, extensive information sharing, theincreased importance of taxpayer confidentiality,misapplication of a participating state’s law, and —last but not least — the potential that an individualstate will follow up on the MTC’s audit with newadjustments. Thus, it is even more important for acompany that is likely to be nominated for a jointaudit to establish best practices and policies beforecommencement of the audit. Given the complica-tions presented under the Joint Audit Program,taxpayers should consider adjusting their existing‘‘normal’’ audit best practices and policies to avoidunnecessary headaches after receiving the initialphone call from the MTC’s auditor. ✰

67See, e.g., Jonathan A. Feldman, Kathryn E. Pittman,and Maria M. Todorova, ‘‘Considerations When ExecutingWaivers,’’ State Tax Notes, Mar. 18, 2013, p. 843.

Jeffrey A. Friedman and Todd A. Lard are partners andCharles C. Kearns is an associate with Sutherland Asbill &Brennan LLP’s State and Local Tax Practice. Sutherland’sSALT Practice is composed of more than 25 attorneys whofocus on planning and controversy associated with income,franchise, sales and use, and property tax matters, as well asunclaimed property matters. Sutherland’s SALT Practicealso monitors and comments on state legislative and politi-cal efforts.

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Demystifying the MTC Joint Audit Program - Sutherland Asbill

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