No matter how careful your business has been with its tax-related activities, it is possible that you will be audited. A sales and use tax audit is a nerve-wracking prospect, and many companies do not know what they should do to make the process successful and avoid penalties.

Most large corporate taxpayers are accustomed to dealing with audits on their sales tax-related activities, but smaller companies may be surprised when they receive an audit notice from their state or municipality.

One of the more common causes of tax audit selection is actually customer-related audit. When auditors review the vendor invoices to identify sales or use tax liability, they frequently discover invoices where sales or use tax was charged incorrectly or not at all. These vendor invoices can be the basis for the auditor’s next sales and use tax audit with that particular vendor.

States and municipalities have their own systems for deciding which returns trigger an audit. Many states use sales volume, size, and complexity of returns to determine whether or not an audit will take place. Other business activities like filing a refund claim or amended return, bankruptcy, dissolving the business, and closing certain locations may cause an audit as well.

Companies that are worried about having their sales and use tax activities scrutinized should have a system in place for this potential development and know how to avoid a tax audit in the first place. Below, TaxConnex has listed concrete steps that a business should take to prepare for a sales tax audit, including what auditors will look for and process specifics.

The following eight steps should help companies of all sizes understand what to expect from a sales tax audit and how to be successful during the process. Proper preparation is key when it comes to avoiding negative consequences.

1. Have Relevant Documents Ready: All taxpayers should maintain a thorough audit trail for all taxes charged, reported on a return, and paid to a jurisdiction – including any items that are returned resulting in some type of sales tax credit. It’s common for an auditor to request sales tax returns, Federal income tax returns, general ledger detail, fixed asset schedules, sales journals and purchase journals. Knowing which of these types of documents to provide and when is important.
   
   
2. Prepare Your Employees: Align an auditor with one person within your organization for all questions, communication and information requests. If the auditor is on-site (which has become less common), be sure all employees are aware the auditor is present so they don’t inadvertently say something that the auditor may overhear.
   
   
3. Check With Vendors: One way in which companies are able to mitigate an audit assessment is to verify that their customer paid the sales tax either under audit or self-assessed and reported the use tax due; or if their supplier paid sales taxes under audit. Generally, sales tax will not have to be paid again on the same items, though you should check state laws and make sure this applies to your situation.
   
   
4. Understand Your Products and Services With Respect to Sales and Use Tax: Before the audit, you will need to know whether the products and services you provide to your customers are subject to sales and use tax. Sometimes products and services that a company believes are exempt will be taxable. This could depend on a variety of factors including sales tax taxability rules, who you are selling to, and how your customer is using the particular product or service. For this reason, an experienced sales tax firm should always be consulted well before an audit has been called.
   
   
5. Provide Accurate Records: Your auditor may request various documents as noted above. It is your responsibility to provide the relevant documents and to make sure they are accurate. Providing a steady flow of information to the auditor indicates your willingness to work with them. However, you may choose to delay providing certain documentation and wait for the auditor to ask again before providing it. This is a delicate balance as you don’t want to appear uncooperative and raise suspicion with the auditor. This could cause the auditor to scrutinize your records in more detail – potentially costing you money.
   
   
6. Make Sure Your Exemption Certificates Are Up-to-Date: If you have exempt sales then you need to maintain the applicable exemption certificates. Buyers will submit their exemption certificates to you; however, the burden of proof generally falls on the seller to comply with the law.
   
   Sellers need to know the required details for each exemption form. Trouble can come when the form contains errors or when the form has expired.
   
   The MTC Uniform Sales and Use Tax Exemption/Resale Certificate is accepted by the majority of states, but states’ requirements change frequently. States may only accept the certificate in certain cases.
   
   
7. Keep Checking for Audit Notices: Keeping track of notices from state Departments of Revenue is absolutely necessary. Firms must act on these notices in a timely fashion. To this end, it is imperative that you make sure your company name, address, email, and phone are current. It is best to receive notices both by email and by mail if the option exists. This way, you have your bases covered if one of the notifications is lost.
   
   
8. Understand Marketplace Facilitator Agreements: If you are selling your goods through a marketplace facilitator, like Amazon or Etsy, it’s common to conclude that your sales tax requirements are being handled by the facilitator. This is not entirely true.
   
   As an example, for most states, the sales through a marketplace facilitator will contribute to the revenue thresholds leading to economic nexus as outlined in the South Dakota vs. Wayfair case.
   
   The South Dakota vs. Wayfair Supreme Court decision of 2018 created economic nexus rules whereby a seller with no physical presence in a state may be required to collect and remit sales tax. Sales through a marketplace will generally count toward the economic nexus in a state (even though the marketplace facilitator may be required to collect and remit the applicable sales tax). Once you have nexus you are required to collect and remit the sales tax on any sales not through the marketplace – for example, on your own website.

• Know Your Nexus: Auditors sometimes identify situations where a business has sales tax nexus but did not realize it. Businesses holding consigned inventory in Amazon or other third-party-logistics facilities are inadvertently creating sales tax nexus via the physical presence of inventory in a jurisdiction. Additionally, businesses selling over the Internet may be especially vulnerable as the economic nexus rules post-Wayfair can create a sales tax collection obligation.
• Don’t File Late: Late filings can draw jurisdictions’ attention to your business and potentially trigger an audit. Companies need to make sure that they are filing on time and complying with the applicable rules.
• Don’t Forget Use Tax: Too many companies neglect to file use tax with states or municipalities. Use tax differs from sales tax in that it applies to out-of-state transactions where no sales tax was paid. Be sure to review your purchase transactions and identify any invoices from your suppliers where sales tax has not been charged. This could indicate a requirement for you to self-assess and pay use tax.
• Be Calm and Professional: Managing the relationship with the auditor can be as important as the documentation you provide. Don’t treat the auditor poorly. If at all possible do not leave the auditor alone where they might engage in conversations with other employees who may inadvertently disclose information about your business operations. Be professional with the auditor and let them know you are willing to help.