Any growing company can expect to hit the department of revenue’s radar at some point. Since it may be inevitable, it’s important to be prepared for sales and use tax audits.
“Each state has its own criteria that guide its decision to conduct an audit,” says Cheryl A. Fields, sales and use tax manager at Clarus Partners. “Sometimes it can be a noticeable change in what would be normal business activity that will trigger an audit; other times it’s because a company is doing business in a state but is not registered to do so. With all states and localities trying to balance budgets, they are carefully looking to ensure each business is paying its fair share of tax.”
Smart Business spoke with Fields about preparing for and surviving a sales and use tax audit.
What typically triggers a sales and use tax audit?
States consider different criteria as they scan the market for potential sales and use tax audits. For instance, states are looking more closely at internet-based businesses and transactions. Sometimes an audit is instigated by a phone call from a customer questioning the taxability of a transaction or a specific business practice. Other times an auditor may discover an irregular transaction during their daily activities and choose to investigate further. Regardless of why an audit is initiated, every company could be subject to one.
What are auditors looking for?
Auditors primarily dig in to a company’s financial records to make sure everything has been reported correctly. They’ll look carefully at any exempt sales to make sure the company has documentation showing the exemption is valid. An auditor will check expenses, both capital and recurring, to make sure everything that should have sales tax on it does, or the business paid the corresponding use tax.
Who is required to charge sales tax differs in each state. Companies that execute sales through the internet should keep track of the changes in the nexus requirements for each state and the changes in business activities, such as marketing efforts and expansions, where the sales personnel are located, to stay compliant.
What happens if the auditor finds issues?
If there are issues discovered through an audit, the department of revenue will issue an assessment. The company under audit, however, has a chance to review the findings prior to an assessment being issued.
If it is your first audit, many jurisdictions will waive the penalty associated if the assessment is not a result of fraud or gross negligence. Most states and localities will assess the interest. Penalties can be assessed at 25 to 30 percent of the tax involved. A fraud penalty will be greater.
How can companies prepare for an audit?
Keep communication with the auditor open, but give him or her no more information than what they request. Document the process and keep a log of all of the audit activity, i.e. when documents were turned over to the auditor, when they call, etc. This information could be helpful if there’s a need to challenge the assessment later. Also, remember that auditors are not trained to look for overpayments of sales and use tax. Therefore, it is necessary to review your records for sales and use tax paid in error so it will be included in the audit results. This may reduce any assessment or the state may issue a refund.
Challenges are common because the statues/laws are subject to interpretation. Read the law and make sure they are applying it properly.
What common mistakes do companies make that lead to penalties?
Most companies get in trouble when they don’t have the needed documentation. What’s important is that the company addresses the issues upfront with the auditor and agrees on an acceptable method to complete the audit.
There’s no need to be afraid of a sales and use tax audit. Establish a good working relationship with the auditor so that the audit will not become unnecessarily difficult. Never be afraid to challenge an assessment because the laws are subject to interpretation and you know your business better than the auditors. Consider it a routine part of doing business.
Insights Accounting is brought to you by Clarus Partners