Sales Tax Audit Process
You Received a State Sales Tax Audit Notice, Now What?
Whether your company is small or large, tax compliant, or disastrously organized, or you sell within or outside of the state, you can expect to be audited by the state at some point. As the new Wayfair ruling has driven economic nexus laws to become prevalent, you can expect more audits by other states if you sell across state lines. There is no need to panic, rather, having a deliberate and organized plan will allow you to successfully work through a state sales tax audit and reduce your sales tax exposure.
Being Located Outside of State Will Not Save You
Most businesses don’t realize it, but the state has offices located across the country to audit businesses headquartered elsewhere to audit out-of-state companies selling into the state For example, in late 2018, more than 2,500 online retailers received audit notices from California’s CDTFA. Florida’s Department of Revenue has auditors based in Atlanta, Chicago, Dallas, Houston, Los Angeles, New York, and Pittsburgh. In Texas, nearly 1/5 of its some 600 auditors are based outside of its borders. Even smaller taxing jurisdictions, like Washington, have auditors in Iowa, Illinois, Indiana, Michigan, Minnesota, Ohio, Western Pennsylvania, and Wisconsin, and Wisconsin boasted that nearly $80 Million was collected from out of state companies.
States also leverage information sharing to hunt down perceived out of state noncompliance and capture online retailers in their web. The states share information with the federal government, and they have developed their own networks to more efficiently audit companies nationwide, including:
- Midwestern States Association of Tax Administrators (MSATA) (Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, Oklahoma, South Dakota, Wisconsin)
- North Eastern States Tax Officials Association (NESTOA) (Connecticut, Delaware, District of Columbia, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont)
- Southeastern Association of Tax Administrators (SEATA) (Alabama, Arkansas, Florida, Georgia, Kentucky, Louisiana, Mississippi, North Carolina, South Carolina, Tennessee, Virginia, and West Virginia)
- Western States Association of Tax Administrators WSATA (Alaska, Arizona, California, Colorado, Hawaii, Idaho, Montana, Nevada, New Mexico, Oregon, Texas, Utah, Washington, and Wyoming)
Additionally, national organizations like the Multistate Tax Commission (MTC) help streamline and accomplish more audits with limited resources.
Significant Cost of a State Sales Tax Audit
It would be a colossal misstatement to say that state sales tax audits are cheap. A recent study by Avalara showed that hiring a professional, paying tax, penalty, and interest can easily be over $100,000. In fact, according to their study, and average sales tax audit costs around $115,000. That does not include the cost of future compliance, as just filing returns can be thousands per month. Both the audit itself and future compliance can be a significant expense and generally hiring a professional can save the company both in the short term and in the long run.
The first “OH NO” moment is usually when your business receives a state notice that says you have been chosen for audit. It is often accompanied by a questionnaire that the state says you MUST fill out. While you might have to in some states, it is not required to be completed in most places. There is also generally a period before the audit begins that statutorily, the state cannot start the audit. DO NOT waive the grace period as it is to your advantage to take your time and get your records organized.
Hire Your Audit Manager
When you receive that initial notice, you want to hire or chose your quarterback, or your sales tax audit consultant as quickly as possible. If it’s someone internal, they should be communicating with the auditor directly, and no one else should. They should coordinate all responses on behalf of the company and serve as the point of contact to discuss matters with the auditor, as it is important to speak with one voice.
Tackling it alone has its pros and cons but how you proceed is a question of the overall strategy. One school of thought is to play nice with the auditor. That would involve a thorough response as quickly as possible to the auditor’s initial questions. However, the auditor is not your friend and we suggest treating the state tax auditor as a business relationship, not a friendship. You want to be respectful, courteous, and honest, but you do not have to volunteer too much either. We generally recommend setting up a meeting to answer their initial questions verbally and succinctly, nothing more, nothing less. If no one internally is well versed in sales and use tax, hiring an external sales tax pro might be the right route for you.
If you want to go the external consultant route, you generally do not need a sales tax attorney at this point. Someone with experience in state sales tax audits is important but a sales tax lawyer is not necessary. Not only does Sales Tax Helper take the pressure off you, but we act as the liaison between the company and the state auditor. It is very helpful when asked a question that we can credibly say “I don’t know, I’ll get back to you,” whereas such a response is not believable when coming from the company. Our company can assist with managing the initial communication and pre-audit discussion with the state. Having a sales tax audit professional on your side is a huge advantage. Just as you are a pro in your field, our field is sales tax audits and we know how to handle them better than anyone.
As part of our process, we will send the auditor a power of attorney when hired along with the following message:
Please find attached the power of attorney for the audit of ABC Co. I will be handling the audit on behalf of the company. Please direct all future correspondence and communications through me.
– Sales Tax Helper
Whether it is internal or external, your audit manager must know your business inside and out. Describing your business in the wrong light can create a whole host of problems. Properly describing and streamlining communication with the auditor is important for you to get the best results. As state auditors are evaluated on efficiency, it is often favorable from their point of view to have a professional accustomed to handling sales tax audits on the other side as well.
Is Hiring a Professional a Red Flag?
We often get the question as to whether hiring a sales tax professional or sales tax lawyer is a red flag for the auditor. Some businesses believe having a state tax attorney involved sends the message that something must be wrong. In our experience, having a sales tax professional involved has the opposite effect. For a variety of reasons, auditors prefer to have someone on the other side providing logical responses with organized information so they can effectively and efficiently do their job. Having a sales tax consultant as the audit manager for your business is helpful not only for your business but from the state auditor’s point of view as well.
Complete a Diagnostic
Before the audit begins, you, your sales tax pro, state sales tax lawyer, or better yet your Sales Tax Helper consultant should do a pre-audit diagnostic to identify areas of issues and concerns. For most companies a diagnostic consists of:
- Comparing the yearly sales tax return against the annual federal tax return. If there is a difference, reconcile the difference, as unreconciled discrepancies will usually be treated as unreported taxable sales.
- Pre-audit at least 1 month of exempt sales. Do you have resale/exemption documentation on file? Review the law or agency rules on whether you followed the exemption rules.
- Review your sales tax payable account. Can you easily reconcile your sales tax payable account versus your sales tax payments? Sales tax collected and not remitted is a crime and you should be sure you don’t turn records to the auditor to admit you’ve committed a crime.
- Analyze whether sales tax was paid on fixed asset purchases. Fixed assets are easy to review and a few mistakes can be worth the squeeze for the auditor.
- Locate your key expense accounts that represent taxable purchases and be sure you can prove tax was paid on your purchases, especially the out of state ones.
This self-audit diagnostic is important for a variety of reasons. It should help hone you in on areas of exposure. If you know the problems before they exist, you can begin working them and develop a strategy for you or your sales tax lawyer or professional to present them to the auditor in the most favorable light. It is also important to help fix problems, so they do not continue in the future.
What if I Overpaid Tax?
In some cases, companies actually over-collect and/or overpay the state sales tax. The auditors are trained to ensure you paid the proper amount of tax, so technically they are supposed to look for refunds and overpayments. Unfortunately, as most sales tax lawyers or professionals will attest, unless you are aware of a refund you will not get it unless you bring it to the forefront as a practical matter.
Initial Meeting Goals
The preliminary meeting should be just that – preliminary and to get organized. It is important to develop a relationship with the auditor and have them view your audit manager as someone they can work with. It is also important to establish trust to facilitate the completion of the audit. In fact, contrary to popular belief, auditors are often evaluated on the number of audits closed, not revenue generated. Therefore, there is an advantage to working with the auditor to ensure efficient completion of the audit. Preliminary scheduling and length of the audit should also be discussed at the first appointment. An audit plan should also be developed. It’s your business and your audit to control, not the state auditor.
Where Should the Audit Take Place?
When you have Sales Tax Helper on your team, we arrange the location of the audit, and that location will be electronic/remote or at our office, not yours. We strongly advise not allowing an auditor into your business; make the auditor come to your tax professional’s office. We know how to “control” the audit, so the auditor does not go on a witch hunt or get out of bounds by hunting for ways to accuse your business of underpaying taxes. Additionally, by keeping the auditors out of your offices, they must direct all record requests and fishing questions regarding your business and accounting methods though us, which keeps your staff free to focus on what matters. Often the auditor will ask for things that they have no right to access or will pressure the taxpayer to sign documents that the taxpayer does not have to sign. We know the games the state auditors play and how to defend you and your business against them.
Audit duration can vary dramatically from state to state and from business to business. Waiver issues aside, an audit generally takes 3-7 months to complete. Surprisingly, some audits can drag on for a few years. Time factors usually swing on the size of the company, the ability to produce reliable and organized documentation, and the level of sophistication of the business.
There should be plenty of time for the auditor to review your records and produce a preliminary assessment. There should also be time left for you, your sales tax professional, or a state sales tax lawyer to have an opportunity to work things out with the auditor. Most audits are resolved on protest or appeal, but documentation type issues can be worked out with the auditor to avoid time and money over the long term.
As you can see just getting ready for an audit is tricky and art in of itself. Although you probably do not need a sales tax lawyer, you should have a sales tax consultant or professional on your side. Establishing a relationship with the auditor and serving as a liaison is an important asset for a company going through the guiling state sales tax audit process. More important, your sales tax pro knows when to cooperate and when to push back against an auditor overstepping its bounds. Taking on this daunting responsibility yourself can be costly in the long run, not only in the tax bill but also in professional fees paid later on to clean up the mistakes you made earlier.
At Sales Tax Helper, we provide audit representation for your business in sales tax audits, including those conducted by the state. Most companies do not need a state sales tax attorney. At Sales Tax Helper we strive to match your business with the level of assistance that you need to manage your sales tax audit.
Q:What triggers a sales tax audit?
A:You inadvertently waived a red flag or your company landed in the small percentage selected for a random sales tax audit. These red flags include: Cash-based businesses, prior audits that resulted in owed sales tax, your sales reported to the state didn’t match what you reported to the IRS, a high volume of exempt sales, filing a refund claim, or a high number of credits. There’s also a possibility that your business happens to be in an industry that your state suspects rampant under-reporting. Often times, they will target industries effected by complex sales tax laws.
Q:How do I prepare for a sales tax audit?
A:1. RESPOND to the notice; 2. Get organized; 3. Identify/hire your audit manager; 4. Notify your auditor of who they will be corresponding with; 5. Compare your sales tax returns against the federal tax return; 6. Test at least 1 month of exempt sales; 7. Reconcile your sales tax payable account versus your sales tax payments; 8. Review your fixed assets purchased — did you pay sales tax on them?; 9. Review your purchases on your key expense accounts to ensure tax was paid on your purchases.
Q:How long do sales tax audits last?
A:Audit duration can vary dramatically from state to state and from business to business. Waiver issues aside, an audit generally takes 3-7 months to complete. Surprisingly, some audits can drag on for a few years. Time factors usually swing on the size of the company, the ability to produce reliable and organized documentation, and the level of sophistication of the business.
Q:Can I do this myself or should I hire a sales tax lawyer or a sales tax consultant?
A:We all enjoy the occasional DIY project, especially when it saves us money. Before opting to go that route, consider the risk vs. rewards involved. Avalara recently conducted a study and found that the average sales tax audit costs around $115,000. When facing a sales tax audit, it is beneficial to have someone with knowledge of the financial implications on your side. That is where sales tax professionals, such as those at Sales Tax Helper LLC, can save you a lot of heartache and money by avoiding a few missteps.
Q:What accounting software and services do you work with?
A:TaxJar, Vertex O Series, Avalara, Vertex Cloud, Quickbooks, Proconnect Tax Online, Canopy, ONESOURCE, Sovo Intelligent Compliance Cloud, Intuit Lacerte, CCH SureTax, SS&C Advent Axys, Vertex Payroll Tax Q Series, Bloomberg Tax Advantage, VATBox, CSC Corptax Compliant, Oracle Tax Reporting Cloud, TaxCloud, Fast Enterprises, GenTax, Fast Enterprises FastUI, SAP Tax Compliance, Taxify, and ESKORT Compliance Solution.