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 sales tax audit, auditors from the state tax agency or department of revenue look through financial documents and tax returns to compare total sales revenue with what was reported and remitted in sales tax. 

Sales tax is a major source of revenue for states, so they take sales tax auditing seriously to ensure companies follow the rules and the state collects the correct amount of revenue. 

Being selected for a sales tax audit isn’t a sign of guilt; it’s merely a sign that the sales tax agency wants a closer look at a company’s financials. Common triggers for a sales tax audit include the following:

• A business related to you was audited. State tax agencies often flag certain companies or industries to audit. A company has a greater chance of being audited if their suppliers, competitors, or customers have been audited. This is even more likely if a supplier or customer was audited and the auditor noticed repeat invoices or sales to another company. 
• Inconsistent filings. A business with a high number of exempt sales or inconsistencies in their filings can trigger an audit. If a company has higher income than its competitors or unusual financials, it can also trigger an audit. 
• High-risk or complex industry. Some industries have a reputation for underreporting sales taxes. Even if a company has a solid track record of accurate sales tax reporting, just being in an industry can be enough to trigger an audit. Similarly, companies in industries with complex sales tax regulations, such as oil and gas, are more likely to be audited because of the nuanced sales tax regulations.
• Business change. Any type of notable change to the business, such as opening or closing a location, merging with another company, or filing for bankruptcy, can trigger an audit to ensure the company correctly collects sales tax with its new structure. Some states conduct sales tax audits on new companies to ensure they have strong tax processes in place before they grow. 
• Report or complaint. An outside group or person can report suspicious sales tax activity to the state sales tax agency, which could lead to an audit. 

And there’s also the chance that it was a random choice. State auditors don’t need a particular reason to audit a company. Many state tax agencies cycle through companies regularly or choose other companies randomly to audit. However, if you have been audited previously, and the state found a deficiency, you will very likely be audited again.

State sales tax agencies or departments of revenue typically alert businesses that they are being audited by sending a letter to request records or other company information. Companies are responsible for responding to notices in a timely fashion. The audit typically takes place over a few days or weeks, depending on the size of the company and how much documentation the auditor needs to access. 

During the audit, the auditor looks for discrepancies between sales data and sales tax returns, including checking that the business charged the correct amount of sales tax on transactions and calculated sales tax for the correct products. The auditor will also look at sales tax returns to ensure the correct totals were remitted. 

If a company is found to have sales tax deficiencies, they may have to pay penalties or interest on the under payments. Companies could be required to pay past-due taxes, pay penalties, and potentially face criminal charges if the auditor finds that the company was aware that it was underpaying sales tax. 

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.