Your survival kit for a sales tax audit

Fear frequently motivates all tax compliance. And with sales tax, as with most other kinds of tax, that fear is of an audit.

This unwanted (and sometimes seemingly random) scrutiny from tax jurisdictions can terrify small companies. Fact is, reasons for an audit can vary from a jurisdiction’s unique methodology to audits of one’s customers or vendors to simple bad luck. A recent survey of just-audited businesses showed that top reasons why sales tax audits occurred included missing resale certificates, not charging tax on taxable products, missing sales tax permits and calculating tax incorrectly.

Around half (41%) of businesses surveyed were audited by their home state, 45% by other states. of businesses had an audit from out-of-state. Seven states made up 60% of out-of-state audits in the survey: Alabama, Arizona, California, Colorado, Georgia, New York and Texas. Top states for in-state audits were Alabama, California and Texas. More states are also leveraging technology to conduct virtual audits.

Whatever the reason and however the method, audits are a worry, according to our own latest annual sales tax survey of top finance execs. Though most respondents (85%) had already gone through a sales and use tax audit, there was a growing lack of confidence in audit preparedness in more than one in every five (22.53%) respondents. Almost half of respondents said they’re unprepared or only somewhat prepared for an audit.

How to get ready

Assume you’re going to get hit with a sales tax audit sooner or later. How to stay ahead of that nasty eventuality?

Review your nexus and taxability. Sales tax problems can fester when companies don’t keep on top of such possible tripwires as economic nexus, your remote connection to a tax jurisdiction.

Though thresholds vary state to state for dollar amounts and volumes of sales, we recommend taking a sharper look at your nexus footprint when your company hits $100,000 of annual sales in state. Also know your physical nexus, which, depending on the state, can include offices, reps or service personnel, warehoused inventory or, as is becoming more common, simply remote employees.

Are your products even taxable in a state where you might have nexus? That can depend on what you’re selling and to whom, but always make sure your on-file exemption certificates from buyers are up to date.

Review the paperwork. Audits – both the auditors’ accusations and your defense – hinge on documentation. Auditors routinely request sales tax returns, federal income tax returns, G/L details, fixed asset schedules, sales journals and purchase journals. See if you’ve got a thorough audit trail for all sales tax charged, reported on a return and paid to a jurisdiction.

The audit itself

Take charge of the information flow. Audits typically examine a set time span. After verifying your paperwork and records, make sure all documentation concerning the audit period is in order; have it clearly organized to present to the auditor and present it steadily and with apparent willingness. This can foster a positive relationship should you eventually want to understand (and negotiate) the auditor’s findings. Disclose insignificant items before the auditor asks, as this shows you’re willing to help the audit process, which could result in less scrutiny of the rest of your sales and use tax obligations.

Do not, however, volunteer any significant records that the auditor doesn’t ask for.

Prepare your employees. Assign one and only one of your staff to work with the auditor for all questions and information requests; this greatly helps you control communication. If the auditor is on-site, be sure all employees are aware of that so they don’t inadvertently say something that the auditor may overhear. If possible, don’t leave the auditor alone where they might engage in conversations with employees.

Always be professional and treat the auditor with respect and dignity.

Moving forward

Create a processing system. First and most obviously, never file a sales tax return late; this is a bright red flag for jurisdictions that can well trigger a future audit.

Keeping track of notices, including audit notices, from states is vital. Dedicate a staffer or department to watch for and handle these notices, and make sure that states have your correct company name, address, email and phone. It’s best to receive notices by both email and snail mail, if possible.

An audit and its aftermath aren’t the end of your business – but they both go a lot easier if you’re prepared.

(See our eBook about how to prepare your company for a potential audit.)

TaxIt’s critical to have a resource to help you stay ahead of and survive a sales tax audit. If you have a question, please reach out.