Business owners and their CPAs are at a general disadvantage during the sales tax audit process because they lack familiarity, especially compared to the knowledge of department of revenue agents and auditors. This disadvantage is most apparent when the auditor presents you with confusing forms to sign, providing little context on their consequence to your audit or assessment. While each state has the potential for unique sales tax audit forms, you’re likely to encounter the following six forms before, during, and after your audit. Knowing what these forms mean and how they affect your rights as a taxpayer, is essential for obtaining a fair tax assessment and knowing when to seek professional sales tax help.
1. A Nexus Questionnaire
A nexus questionnaire form is a survey that state departments of revenue use to determine if a business should be paying, or at the very least, reporting on its sales and use tax. Since the Wayfair Decision, the use of nexus questionnaires has become more common as a way for revenue departments to initiate communication with ecommerce businesses that don’t have a physical presence in a state but that might have economic nexus. Your response to the questionnaire could determine if you have an obligation to file a sale and use tax return, which could lead to a future audit or assessment.
If you have concerns about your business’s sales tax obligations to a state and the possibility of receiving a questionnaire form, then a nexus study may be appropriate. A nexus study involves answering many of the same questions as the questionnaire but is done through your sales tax professional. The benefit being that you can take the results of the nexus study to consider next steps like filing for a voluntary disclosure agreement (VDA), which comes with several benefits discussed below. Businesses that wait for a nexus questionnaire from the state aren’t usually eligible to participate in the VDA process.
2. A Voluntary Disclosure Agreement (VDA)
Almost every state with a sale and use tax has what is known as a voluntary disclosure program. The state’s revenue department is responsible for its oversight. The program allows taxpayers with sale and use tax liability to voluntarily disclose their tax debt and settle it through a binding VDA. The state usually limits participation to businesses that are not already registered with the state to file a sales tax return and that are not currently under investigation or audit. States encourage participation in the program by offering several benefits to taxpayers, which usually includes the following:
- Waiver of accrued sale and use tax penalties (and sometimes interest depending on the state).
- Limitation of the lookback period on your sales tax liability (most states limit this to the preceding three years)
- The state forgoes its ability to conduct a sales tax audit on your business for the years subject to the VDA.
Participation in a voluntary disclosure program often makes sense for businesses with a long period of sales tax liability (i.e., longer than three years) and with a significant amount of liability. For help submitting or reviewing a voluntary disclosure agreement, work with our sales tax professionals.
3. A Waiver or Extension of the Statute of Limitations
If your business becomes the target of a sale and use tax audit, the next form you might encounter is a waiver or extension of the statute of limitations. Most states have laws that limit the number of years the department of revenue can audit your business and make an assessment for unpaid tax, which are known as statutes of limitation.
The exact statute of limitation period could vary from state to state but is generally three years from the date of the filed return. For example, the state might only have until 2026 to audit and assess for sale and use tax on return you filed in 2023. If the statute of limitation period is close to expiring but your audit is ongoing, the auditor may request you sign an agreement that waives or extends the limitation period so the state can preserve its right to further assess your business.
Agreeing to the waiver or extension is always a business decision that depends on your potential sale and use tax liability along with other factors. Declining the state’s request for a waiver or extension usually results in an immediate (and often exaggerated assessment) that you would have to pay or appeal. Complying with the state’s request, in comparison, keeps the audit process going and maintains your dialogue with the auditor.
Consultation with our sales tax professionals could be helpful in evaluating the merits of waiving or extending the statute of limitations and making an informed business decision.
4. Agreement to the Terms of a Field Audit or Sampling Methodology
When your business is under audit, the state auditor will likely request different financial records necessary to determine your taxable sales and calculate any underpayment. However, when the auditor claims to have insufficient records, they could demand a field audit along with one or more sampling methods to estimate your taxable sales. In these cases, the auditors have a variety of methodologies and observation tests they rely on using third-party data sources and other assumptions to create your audit report.
Before pursuing a particular methodology, the auditor will request your signature on a form where you agree to its terms. Unfortunately, not all these audit tests are objective and not all provide a fair representation of your business’s sale and use tax obligations. For example, the auditor may extrapolate sales data from an unusually high-volume month during your busy season or could fail to consider nuances of your business when determining markups on COGS. Get a consultation from a sales tax professional beforehand who can help negotiate a better sampling method. Alternatively, if the auditor already performed a sampling method, consider your appeal options and other opportunities to redo the test.
5. The Sales Tax Audit Report and Findings Statement
After the audit, you will receive an audit report or another findings statement that details the work of the auditor, including their proposed assessment (or refund in rare cases). The auditor usually holds an exit conference to provide the report and will request your signature agreeing to the findings. While signature does not preclude you from the ability to appeal, it does close the audit. This means you forgo further opportunity to work with the auditor before the department of revenue issues an official notice of determination or assessment. Having a sales tax professional available during the closing conference is helpful for raising issues with the audit findings as opposed to making more formal objections during an appeal process in administrative court.
6. An Offer in Compromise or Another Settlement of the Sales Tax Assessment
Every state revenue department has an appeal process, an important part of which is the potential for a settlement (i.e., an offer in compromise). A settlement will usually involve you and the department of revenue meeting somewhere in the middle on your assessment. The availability of a settlement for your sale and use tax assessment might depend on factors, such as the following:
- The economic hardship facing you or your business because of the assessment.
- The department of revenue’s confidence in its ability to collect allegedly unpaid tax.
- The merits of your case and the chance of succeeding at judgment from the administrative court or a state-level court.
Meet with a Sales Tax Professional Before Signing an Audit or Assessment Form
At every level of the sales tax audit process, your business will face a choice on acquiescing to the department of revenue during its inquiries or findings. Each of these decisions has the potential to compound, for better or worse, the amount of sale and use tax you ultimately pay the state. This includes avoidable payments of penalty and interest as well as costs for administering your sales tax. Having independent, professional sales tax help when weighing the pros and cons of agreeing to the auditor’s forms could be the difference in making an objective decision on your company’s sales tax or paying more than you should.
Get in touch with our sales tax professionals today with a free consultation.