You just got notice of a sales tax audit. What now?
Ideally, you’ve done your homework and put in place processes to comply in those jurisdictions where you have nexus for sales tax purposes.
And not ideally? Wherever you are in your sales tax compliance, these steps will help your audit process run smoother.
- Don’t take it personally
Our third annual survey of financial professionals showed that although most companies (67%) reported that state sales tax audits have remained at the same level over the past two years, almost one in four respondents (23%) said they expect such audits to increase in coming months.
Many happenings can ignite an audit. One of your customers undergoing their own sales tax audit might unearth one of your invoices, resulting in the auditor possibly contacting you for a certificate of exemption or other documents. A state may find that you didn’t charge the client sales tax on transactions. An audit of one of your suppliers could turn up one of your exemption certificates for something the auditor may think is taxable.
Audits of similar companies in your industry may also lead tax authorities to run comparison data on you and your competitors, such as your percentage of taxable sales; even being off just a little bit could lead to you being audited. And sometimes, believe it or not, audits happen just by chance.
No matter how it happens, being audited also ranked among our survey respondents’ biggest worries when it comes to sales tax.
- Line up your people
Who can help you prepare for an audit? First, consider engaging a specialist such as a CPA or sales tax expert to both keep you clear of audit triggers and to prepare you in case the taxman does come knocking.
You may have such an advisor in-house or you may need to engage a third party; you can sometimes leverage the experiences of your individual business contacts and trade organizations in your industry.
Consultants generally provide audit support in one of three primary ways:
- Ad hoc support including answering questions and reviewing workpapers throughout the audit process;
- Analysis of findings at the conclusion of the audit to identify mitigation opportunities.
- Management of the audit/auditor - handling the day-to-day requirements of the audit and being the primary contact person with the auditor.
When engaging outside consultants, document beforehand the scope of their work and compensation.
You may be inclined to keep the audit from your staff. Bad idea: Explain the situation to your staff and assign a liaison between the auditor and your staff. The liaison should be the only person on your staff who communicates with the auditor – keeping all communication consistent and controlled.
- Read the notice
The audit notification should state the intended start date of the audit, the period under audit (usually at least 36 months) and will likely list the records that the auditor wants to see.
The duration of the audit will depend on, among other factors, the size of your company and the complexity of the data and issues. One of your first initiatives will be negotiating the terms of the audit, balancing the time you need to prepare and compile the data against the auditor’s deadlines. Auditors are usually accommodating when additional time is required to provide data – but it’s also common for the auditor to request a waiver, extending the time in which the auditor can complete their review of the data and not losing any periods to the statute of limitations.
- Organize your data
In an audit, knowledge is really power – make every attempt to identify your exposure before the audit. This will give you time to establish a plan to manage and address them during the audit. If possible, have an expert review your data/compliance process before the auditor arrives. Any documentation should be well-organized and easy to interpret: Missing documentation complicates an audit and may cause penalties that you may not actually owe.
You can expect to have to provide copies of your filed returns and supporting data (including sales journal, exemption certificates and general ledger data supporting the returns). There is usually flexibility in the volume of data required – sampling is common in sales tax audits.
Presenting your information is a balance. Providing a flow of information – especially proactively disclosing honest past errors – shows you are willing to help the process. This could result in less scrutiny when reviewing the rest of your situation.
But you may choose to delay providing certain documentation and wait for the auditor to ask for it a second or third time before you provide it; sometimes the auditor will be satisfied with what you have initially presented and won’t ask for the documentation again.
- Be professional
There is usually an initial in-person interview between your liaison and the auditor. During this interview, you’ll have an opportunity to explain your business model and describe your sales tax compliance process.
Depending on your business activities and maturity of your sales tax compliance process, this initial interview can give you an opening to influence the scope of the audit and the documentation required. Take notes in audit meetings and always treat your auditor respectfully and with courtesy.
Never forget: 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.
- Negotiate the findings.
You can probably work with the auditor to understand their thought process and decisions. There may be room for negotiation before the final assessment. Again, maintain a good relationship with the auditor in case of future audits.
For more, download our eBook, Top 10 Tips for Managing Sales Tax Audits.
TaxConnex can help you prepare for sales tax audits and assist you in establishing and maintaining effective processes in order to mitigate sales tax risk for your company. Contact us to learn more.