How To Prepare for a Sales Tax Audit

Sales tax can be complex and especially stressful when a sales tax audit occurs. Companies of all sizes and in all industries are subject to sales tax audits to ensure they calculate, collect, and remit sales tax correctly. How should you prepare for a sales tax audit, and what steps can you take to prevent costly penalties? This article will dive into everything companies need to know about sales tax audits. 

Understanding Sales Tax Audits

A sales tax audit determines if a business has correctly collected and paid sales tax within a state. During a A sales tax audit determines if a business has correctly collected and paid sales tax within a state. During an audit, state tax agency auditors review financial documents and tax returns to compare total sales revenue with reported and remitted sales tax.

Why States Conduct Sales Tax Audits

Sales tax is a major revenue source for states, so they take auditing seriously to ensure compliance and proper tax collection.

Common Triggers for a Sales Tax Audit

1. Business Connections – If a related business, supplier, competitor, or customer is audited, your company may also be flagged.
2. Inconsistent Filings – High numbers of exempt sales, unusual financials, or discrepancies in filings can trigger an audit.
3. High-Risk or Complex Industry – Some industries, like oil and gas, are more frequently audited due to complex tax regulations.
4. Business Changes – Mergers, location changes, or bankruptcy filings can trigger an audit to verify proper tax collection.
5. Reports or Complaints – Suspicious sales tax activity reported to tax agencies can result in an audit.
6. Random Selection – Some audits occur at random or as part of a state’s regular review process.

What to Expect During an Audit

Businesses are typically notified of an audit through a letter requesting records or company information. Audits can take days or weeks, depending on company size and documentation needs.

The Auditor’s Review Process

Auditors compare sales data with tax returns, verifying that businesses charged and remitted the correct sales tax on transactions.

Consequences of Sales Tax Deficiencies

If discrepancies are found, businesses may face penalties, interest charges, or legal consequences if underpayment was intentional.

Preparing for a Sales Tax Audit 

After receiving notification of a sales tax audit, companies need to prepare and gather the correct information. Taking steps to prepare can lead to a smoother audit and less disruption to normal business activities. 

Consult a Specialist

In many cases, it can be helpful to bring in a specialist to walk the company through the audit and negotiate the terms. This person can be a sales tax expert, CPA, or tax professional who specializes in sales tax. A sales tax specialist can also likely get more details about the audit, including how far back the auditor wants to look and their area of focus. 

Collect Documentation

A major step in preparing for a sales tax audit is to gather documents for the auditor. When a business can clearly present records, invoices, and tax returns and is organized with its documentation, the entire audit process is likely to be much smoother. Most states have a statute of limitations for sales tax, meaning auditors are limited regarding how far back they can look. In most states, auditors look at the last three to four years of sales and use tax returns. However, some states look as far back as eight years. If an auditor suspects fraud or serious tax miscalculations, the statute of limitations no longer applies, and they can look back at tax returns for the business’s entire history. 

Make sure documents are organized and easily accessible, either electronically or with physical copies, including the following records:

• Sales tax returns
• Sales invoices
• Purchase invoices or records
• Bank statements
• Exemption certificates
• Return documents with sales tax credits to customers
• General ledgers
• Fixed asset schedules

The auditor will ask for certain documents, so companies don’t need to submit everything upfront. Working professionally with the auditor and having information readily available when asked can create a better relationship and a smoother process. 

Select a Representative and Prepare Employees 

Audits can be nerve-racking for employees. Alert employees that a sales tax audit is occurring and be sure that all employees know who the auditor is, even if they aren’t directly involved in the audit. Employees need to be careful not to say anything that the auditor could use against the company. 

It can be helpful for a business to have one person as the key point of contact with the auditor. This person can answer questions, retrieve and provide documents, and point the auditor in the right direction if they have other questions. Before the audit, this person should become very familiar with the business’s products and services, especially if there are any sales tax exemptions or special circumstances. 

Understanding the Post-Audit Process

A sales tax audit involves some back and forth, and every state has a unique schedule of how fast each process takes. In general, after the auditor has the chance to look through records and dive into areas where they suspect sales tax wasn’t collected properly, they will deliver an audit assessment. The company or its representative can provide comments or additional information. The auditor will consider the new information, potentially request more records, and come back with any additional comments or questions. That back-and-forth process continues until the auditor feels the information is complete. 

After the audit has been finalized, businesses usually have a set period of around 30 to 60days to formally request an appeal or redetermination, or make any additional payments. 

Steps To Avoid Costly Audits

While some sales tax audits are completely random, the majority are triggered by some kind of company or industry action. 

Companies can reduce the risk of a sales tax audit by following these five preventive steps:

• Keep accurate records. One of the top things companies can do to avoid costly audits (and penalties) is to keep accurate records. Organized documents don’t guarantee that a company won’t get audited, but it makes the process much smoother if an audit happens. 
• Review for discrepancies before submitting tax returns. Most sales tax issues aren’t done intentionally. Companies need to know their tax rates and calculate them correctly. This includes double-checking sales and calculations before remitting sales tax accruals. 
• Train staff. Sales tax compliance isn’t the responsibility of one person–it requires the dedication of every employee. Companies should make sure all employees know at least the basics of sales tax, including how to calculate and collect it correctly. 
• Self-audit regularly. Performing periodic internal audits helps companies check that everything is compliant. Self-audits run through the same basic steps as an official sales tax audit and can alert companies of areas for improvement or make the official audit process smoother if it does occur. 
• Leverage technology. Sales tax rates and regulations vary by state and change regularly. Instead of running the risk of mistakes by calculating by hand, companies can lean into technology to automatically calculate and collect sales tax for a smoother, more accurate process. 

If you want to learn more about sales tax and how to prepare your business with a smooth sales tax process, no matter where you're located, contact The Sales Tax People to get started with a customized sales tax system for your business needs.