Here are some key details about sales tax audits, including information on how they work, how to prepare for an audit, and how to make sure an audit doesn't turn up any issues that could cause problems for your organization.
Forty-five states and Washington, D.C., collect sales tax. Some local areas, such as counties and cities, also impose a sales tax (in addition to the state tax).
State and local departments of revenue want to ensure that businesses are collecting and remitting these taxes if they have physical or economic nexus in the state. Physical nexus is simply a physical presence, such as an office, a warehouse, or employees, in a state. Economic nexus is reached when a company makes a certain number of, or earns a certain amount from, sales there (these amounts vary from state to state).
Departments of revenue sometimes conduct sales tax audits to make sure that companies are complying with regulations and paying what is owed. Being notified that your company will be audited can be alarming, but if your business is in compliance with state and local regulations, there's nothing to worry about.
What is the purpose of a sales tax audit?
A sales tax audit is similar to any other type of audit that the IRS or an accounting firm might conduct. It's simply a careful examination of your business records.
In the case of a sales tax audit, the goal is to:
- Make sure that your records line up with what you're reporting to the state or local revenue department about your sales.
- Confirm that you are collecting and remitting the appropriate amount of sales tax on all taxable transactions that take place within the state, county, or city performing the audit.
How are businesses selected for a sales tax audit?
There are many reasons your company might be selected for an audit, including the following:
- Random selection: Some departments of revenue conduct random audits periodically to ensure compliance with tax rules. The premise is that the threat of a random audit encourages every company to follow the rules, since they never know when they might be audited.
- Suspicious filings: If a local department of revenue believes that there is something unusual or inconsistent about your tax filings — such as numbers that don't line up or an above-average number of exempt sales — it may decide to conduct an audit.
- Business associations: If your company does a lot of business with a supplier, customer, or competitor that is audited, you may also be selected.
- Location: Departments of revenue may target particular locations for an audit.
- Flagged data: Most departments of revenue have technology that performs automated records reviews. Your company could be flagged if a data review shows that you have a physical presence or that you sell a lot of goods locally and aren't submitting the correct tax filings.
- Business type: Sometimes, specific kinds of companies or specific industries are targeted because those companies have a higher risk of non-compliance with sales tax requirements.
You can’t control whether you are selected for an audit, but you can avoid suspicious behaviors that could catch the attention of state or local revenue officials and increase your chances of being chosen.
Who conducts sales tax audits?
State and local departments of revenue (or other taxing authorities) are responsible for conducting audits. The agencies tasked with collecting sales tax conduct these audits in order to make sure companies are complying and to confirm that all required sales taxes are being paid.
Where do sales tax audits take place?
When you're notified that you’re being audited, you'll be informed of the next steps — including how to set up the location for your audit to occur.
Audits often occur at the office of the department of revenue, at your business location, or in your accountant or attorney's office if you retain professional help during the process.
What should I expect at the start of an audit?
A sales tax audit usually starts with a letter from a department of revenue or another state or local taxing authority. The letter informs you that you're being audited and provides details on the business information and records you must provide. This is your official notification that your business records are being investigated.
Is it possible to prepare for an audit?
Preparing for an audit ideally starts before you're audited, since you never know when your company will be asked to produce records or to provide proof you've collected and paid all of the sales taxes you owe based on the goods and services you've sold.
You should make sure that you’re in full compliance with state and local sales tax rules anywhere and everywhere you have a physical or economic nexus. You'll also need to keep detailed documentation so you can prove that you are following the rules and regulations for sales and use tax in jurisdictions where you’re located or doing a lot of transactions.
When you’re notified of an audit, it's time to start gathering all the documentation that you have on file related to sales and use tax. Your notification will explain how long you have to respond and what types of information you'll need to provide, and you want to be prepared and ready.
It can also be a good idea to consult with a professional after being notified of an audit. Attorneys and accountants can both help guide you through the audit process and maximize the chances of a favorable outcome.
Are internal audits worth it?
If you are selected for an audit by a department of revenue or by another state or local taxing authority, you will need to follow the process they set out. This means you must allow their auditors to review your records. In this situation, you can't just audit your own documents and send them the results.
You can however conduct regular internal audits in order to make sure that you are following the rules and fulfilling your sales tax obligations. In fact, it's advisable to routinely conduct internal audits, because it's far better for you to find a problem and fix it than for tax authorities to discover a problem during an audit — because that will result in you owing back taxes, interest, and penalties.
What records do auditors want to see?
There are many different records auditors may want to see, including:
- Sales tax returns
- Invoices for sales
- Purchases invoices
- Invoices from vendors
- Till receipts
- Resale certifications
- Bank statements
Some states use a process called stratified sampling, which involves digitally downloading all of your data from the audit period. The state will then filter the transactions based on specific criteria to determine which ones should be reviewed.
Auditors may also go beyond just collecting information from you. They may also gather details from other sources about your operations, such as from vendors you do business with.
How far back do sales tax auditors look?
The lookback period for sales tax audits differs by state. In some jurisdictions, auditors review records and sales tax returns going back three for years. In others, they go as far back as seven or eight years.
If there's reason to suspect fraud, some states will actually review your entire business history.
What happens after a sales tax audit?
The audit process can vary by state. In general, however, auditors will review your records and then prepare preliminary schedules and sub-schedules. These documents should include:
- Purchases
- Expenses
- Sales tax amounts
- Information on where you were out of compliance
You'll have an opportunity to provide a reply to the auditor, who will then create a revised audit schedule based on the information that you’ve provided. This process will continue, sometimes with multiple back-and-forth negotiations, until the auditor has determined that the schedules are complete and correct.
You'll receive the schedules and information on any changes that you must make or rules you must follow (that you aren't currently in compliance with).
You'll also have a set period of time —often around 30 days — to become current by paying any unpaid sales tax and interest that was discovered during the audit. If the audit reveals that you’ve overpaid, you may receive a refund or get a credit toward your next sales and use tax bill.
What about audit assessments?
When an audit has been concluded, the auditor will provide a proposed assessment or final assessment. The assessment includes information on the amount of money you owe the state or local agency that conducted the audit. You'll need to pay as required if you agree with the assessment.
If you don't believe the assessments are accurate, you can continue to negotiate with the auditor or you can appeal the decision —in which case you could potentially end up in court.
What might trigger an audit?
Many things can trigger an audit or can raise red flags about non-compliance with sales and use tax rules. This can include:
- Failure to file sales tax returns in a location where your company has an economic or physical nexus.
- Applying the incorrect rates to sales tax collection and remittance.
- Failure to understand all of the local laws in your area, including any state and local rules for sales tax.
- Failure to correctly classify your products and apply the correct sales tax codes.
- Problems with exempt sales, such as missing or undocumented exemptions.
- Overlooking use tax, as many more people are familiar with sales tax than use tax, which applies to goods or services used or stored in a particular jurisdiction where they aren't taxed when sold.
How long does an audit typically take?
It can take several months to complete a sales tax audit, depending on the complexity of your situation. You can aim to improve speed by having your documents ready.
Where should I look for help?
Lawyers and tax professionals like CPAs are often in the best position to help you with an audit. Look for a firm that has stood up to state and local revenue departments in the past, and that is ready to fight for you if a problem should occur.
What happens if I fail a sales tax audit?
If an auditor discovers problems with your operations, you'll be expected to remedy them and to make your business compliant. This could mean that you are required to pay past-due taxes, fees, and penalties.
In rare cases, you could be criminally charged for failure to comply with the rules. However, this is very rare.
How can Numeral help with sales tax?
Using the right software program makes sales tax collection and compliance much easier. The right software can:
- Integrate with your sales platforms and track transactions.
- Calculate the correct amount of sales tax due for each transaction when you sell goods or services.
- Identify when you've hit economic or physical nexus in a state.
- File tax forms on your company's behalf.
- Remit tax payments on time.
Numeral takes care of all of this and more. Numeral will manage all the logistics of collecting and paying sales tax. You can spend just five minutes a month on compliance once you have Numeral working for you, and you can easily review your sales tax situation at any time on the software's intuitive dashboard to make sure everything is on track.
Numeral also stores past sales tax filings for easy access, and it can integrate with tools you're already using, such as sales platforms and accounting software, so you'll have all of the necessary records at your fingertips if you are audited.
Try Numeral today to see how easy sales tax compliance really can be — and to make sure you're ready if a department of revenue wants to look at your records.
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The bottom line
Being notified of a sales tax audit isn't the end of the world. In fact, if you've done everything right, you don't have to worry about it at all — you just need to submit your records and show that you've complied with the rules.
The key is to remain in compliance, and to keep careful, detailed records so you can prove you've filed and paid as required should the auditors come knocking at your door. The right tools, including the right software, can make this easy and efficient.
