How not to tank your sales tax audit (part 1)

If you are a business that must collect and remit sales tax, an audit is probably one of your biggest fears. Rightly so: Sales tax audits can find fault with a variety of your operations and can cost you big– if the determination goes against you.

But as usually happens in business, you can take steps to protect yourself and, in fact, not make the situation worse.

We’ve determined 10 things to avoid in order to minimize the risks associated with a sales tax audit. This will be a two-part blog series, the first part will focus on ensuring you have your sales tax obligations in order, and the second will look at how to help your audit go smoothly.

1. Not assessing nexus. Determining where you have nexus is key to determining your sales tax liability. Nexus is your company’s connection with a state or other tax jurisdiction that’s substantial enough for you to be accountable to that state’s sales tax laws. States can vary widely in ever-changing nexus laws, so it’s best to verify with a sales tax professional.

You can easily overlook the thresholds and qualifications in the jurisdictions where you have significant sales (economic nexus) or where your company does business in person (physical nexus). Using a marketplace facilitator can also give you physical nexus if they store inventory in a tax jurisdiction. Additionally, in many states, the sales activities via a marketplace facilitator will contribute to the nexus thresholds.

2. Not knowing your taxability. Similar to pinning down nexus, understanding the taxability of your company’s products or services is also important. If you sell items considered tangible personal property (e.g., physical items), things are a bit easier, as these items are likely taxable for sales and use tax purposes. Similarly, services are generally (but not always) exempt.

But many states still don’t address how some digital products are taxed; software as a service (SaaS) is subject to a myriad of rapidly changing tax rules; and telecommunications companies are in a realm of their own.

3. Neglecting ‘zero-due’ filings. Always file “zero tax due” returns by your due date even if you didn’t collect sales tax from your buyers over the taxable period. Some states will levy a penalty on you for failing to file a zero return.

4. Not expecting an audit. Why would you get tagged for audit? A lot of reasons, all of them possible: Jurisdictions target certain industries that have new or complex tax laws (service industries are big recently); an audit of one of your customers may result in the review of your invoices and a determination that you’re not charging tax appropriately; or a disgruntled employee may report you. There are other reasons – sometimes it’s just chance and bad luck – so always expect an audit.

5. Not having good paperwork. Once hit by an audit notice, companies often fail to immediately assess their sales tax records and documentation – which in some companies is poorly organized and hard for an auditor to interpret. Documentation typically required can include invoices, exemption certificates, summary reports, tax returns and more. Missing documentation complicates an audit and may cause penalties that you may not in fact owe.

You should make every attempt to identify your exposure prior to the audit. For example, you may recognize that you lack the appropriate exemption certificates on file. Identifying this issue proactively may give you time to go back to your customers and secure the missing certificates. If you discover a problem with your accounting system or a significant gap in taxability during a specific period during the audit statute, you will want to avoid sampling that period(s) if possible.

At TaxConnex, our goal is to take sales tax off your plate. Laws are constantly changing, and now it’s even more important to have a resource to help you understand your sales tax obligations. If you have a question, please reach out.

And stay tuned for part 2 of our blog - we’ll look at proactive steps you can take and mistakes to avoid once the audit starts.