A sales tax audit notice can be an anxiety-filled event because of the uncertainty that comes with the process. You consistently file sales and use tax returns and think your company is compliant. Yet, the auditor could think differently after reviewing your business records and other available documents. This exchange of information is our focus today as it is a step that can potentially make or break your case when facing the risk of a sales tax assessment or penalty.
Handling record requests and disclosures are a skill and an art that requires an understanding of how auditors use these documents to draw conclusions about your tax liability. Below, you’ll learn more about common issues with managing the record disclosure process and why involvement of a sales tax professional at this early stage could be a promising strategy for positive resolution of your audit.
Consider the Original Basis for the Sales Tax Audit Notice
The reason(s) behind the state’s decision to audit you or your client’s business could vary based on the location. Sometimes the audit is the result of random selection, while other audits start from certain trends, noticeable changes, and other discrepancies in your sales tax reporting.
Aside from your tax returns, the state revenue department may be using information from a 1099-K or that’s gathered from other third-party sources and state agencies. For example, data from the DMV on vehicle registrations may trigger a sales tax audit for a car dealership reported as the seller.
With knowledge of the audit’s basis, you can perform preliminary reviews to assess potential outcomes and better navigate the remaining audit process.
What Types of Records Will a Sales Tax Auditor Want to See?
The audit notice could provide important context clues around the records the auditor may want to request for review. Specifically, the audit period and scope. The notice or subsequent communications may detail other information that sheds light on where the auditor wants to look in your records. For example, they may have questions on use tax from a major equipment purchase.
Remember that auditors only have a limited time to audit your business after filing a sales tax return. It’s important to confirm their initial audit request is legal and does not violate your rights under the applicable statute of limitations. Sometimes auditors will attempt to work around this issue by having you sign an extension or waiver agreement.
Depending on the audit’s scope, the auditor will likely want to review the following standard documents (or their comparable):
- The general ledger
- POS statements and reports
- Cash receipts, disbursement records, and other invoicing
- A/R ledger
- Purchase journal
In most cases, the auditor could have a legal right to inspect these items within reason. Ignoring the request or creating unnecessary delay in disclosure could lead to increased penalties or lofty assessments. Despite this fact, state sales tax auditors are not entitled to every financial document in your possession without good reason. Be cautious of requests for highly personal records or financials that have a looser connection to taxable sales. For example:
- Bank statements
- Personal financial records
- Other overly burdensome requests
What Happens If Your Sales Tax Records Are Lost, Destroyed, or Incomplete?
When business records are unavailable due to loss, destruction, or incomplete information, the auditor may take one or more different approaches to determine your sales and use tax liability. The precise method(s) will generally depend on the nature of the missing information and the state’s audit procedures, but could involve the following estimations:
- Taxable sales based on costs plus their mark up
- Gross profit and net worth analysis
- Mark ups from income tax returns
- Sampling methods during a field audit
- Averages from past sales tax returns
These methods are never perfect because they often rely on heavy assumptions and statistical modeling. For taxpayers, the concern becomes ensuring the auditor’s chosen method provides a fair determination of your sales tax obligations. It’s possible an auditor could rely on one method while another different calculation would result in a lower sales tax assessment. Additionally, you may be able to refine certain aspects of the auditor’s chosen method to better reflect taxable sales through a lower assessment. Knowing when these opportunities are available is a critical part of a strong audit defense.
Meet with a Sales Tax Professional Before Disclosing Records During an Audit
The review and disclosure of business records are foundational to any sales tax audit and is where many assessment challenges are won or lost. The process often requires striking a balance of being cooperative with the auditor while maintaining healthy skepticism of their record requests or sampling methods. The help of a sales tax professional can be an effective resource for managing these aspects of your audit and is an advantage of our audit defense services. The team at Sales Tax Helper can take the lead on communications with the auditor, including record requests, in an effort to limit unnecessary disclosures and protect your business interests.