If you and your company haven’t been hit with a sales tax audit yet, congrats. You should realize, though, that your luck might not hold out for much longer.

In TaxConnex’s recent market survey more than one in four (26.7%) top finance professionals in a variety of industries report seeing an increase in state sales tax audits in the past two years. Among other findings:

  • Almost half (48.5%) of respondents expect sales tax audits to become more frequent in the next two years.
  • Nearly one in five (18.5%) cite being audited as one of their chief worries for 2022. 
  • 12% of respondents say they’re likely to have to outsource management of sales tax audits next year.

The Sales Tax Institute reports that Maine, Illinois, California, Massachusetts, Wisconsin and Washington have been the most aggressive states in sending notices and audit requests. Industry observers look for New York, Ohio and New Jersey to soon intensify enforcement.

California, to cite one state, audits about one percent of active accounts each year (at least so far), “concentrating on those most likely to be inaccurate in their tax reporting.” In just one recent year, the state’s sales and use tax audit program disclosed net deficiencies of $553 million. With tax revenue more desirable as the pandemic continues, there’s no reason to believe more states won’t jump on the sales tax audit bandwagon

Like we said, your luck might be running out. How can you prepare – and what should you do and not do if you are audited?

Sales Tax Audit Triggers

Many events can ignite a sales tax audit. One of your customers undergoing their own audit might produce one of your invoices, resulting in the auditor possibly contacting you for an exemption certificate or other documents. A state may find that you didn’t charge the client sales tax on transactions, or an audit of one of your suppliers could turn up one of your exemption certificates for a transaction that the auditor may think is taxable.

Your industry or competition could also be a factor. Auditors know that competitors tend to have similar business models and that some industries are more susceptible than others to tax deficiencies. Audits of similar companies in your industry may lead state tax authorities to run comparison data on you and your competitors.

And don’t forget a whistle blown by a disgruntled former employee – or just plain bad luck.

What if you do get caught? A slap on the wrist? Probably not. Punishments can range from assessments, penalties and liens to use of collection agencies for past due taxes. And with no statute of limitations for unfiled returns, you could be looking at some considerable damage to your business.

The notice arrived – now what?

Pulling paperwork together for the auditor, managing the audit, answering the questions and negotiating an outcome can be time-consuming at best and risky at worst. But don’t panic – and don’t mishandle the process.

An audit doesn’t necessarily mean the end of your business even if the auditor finds non-compliance. It’s important to handle the situation well right from the start, and here are your most important initial moves:

Assess your records. Get to work on this first and fast. Documentation typically required by an auditor can include invoices, exemption certificates, summary reports, tax returns and more – and many companies’ documentation is poorly organized. Missing documentation complicates an audit and may cause penalties that you may not actually owe.

Treat the auditor respectfully. Your first response under audit might be to hit the roof. Keep your cool and realize your actions could sway an auditor’s outlook and decision.

Control the tone. Many sales tax audits are done using a sampling methodology – either statistical or a block sample. The method will vary from jurisdiction to jurisdiction. You need to understand the historical cycles of your business and evaluate the proposed sampling method before accepting.

Assign one person from your company to manage the relationship with the auditor. That person will essentially be the auditor’s point of contact, which can reduce confusion and miscommunication. Other employees shouldn’t answer any questions from the auditor unless requested and agreed upon.

Disclose insignificant items proactively. Auditors are not your advocates. The auditor’s job will be to find discrepancies and determine financial penalties. Guard what you say and what information you offer.

Still, disclosing errors to the auditor allows you to build rapport and show that you’re willing to help in the audit process. This could result in less scrutiny when reviewing the rest of your situation. Work with the auditor to understand their thought process and decisions; there may be room for negotiation before the final assessment.

And of course, maintain a good relationship with the auditor in case of future audits.   

(Check out our eBook, “Top 10 Tips for Managing Sales Tax Audits”.) 

TaxConnex can help you prepare for assist you in your sales tax audits and ensure you’re set in an already compliance sales tax process before the audit notice arrives. Contact us to learn about the latest developments in sales tax and what they mean to you and your company.

Robert Dumas

Written by Robert Dumas

Accountant, consultant and entrepreneur, Robert Dumas began his public accounting career on the tax staff at Arthur Young & Co., followed by a brief stint at Grant Thornton. In 1998, Robert founded Tax Partners, which became the largest sales tax compliance service bureau in the country, and later sold it to Thomson Corporation. Robert founded TaxConnex in 2006 on the principle that the sales tax industry needed more than automation to truly help clients, thus building within TaxConnex a proprietary platform and network of sales tax experts to truly take sales tax off client’s plates.