How to prepare for a sales tax audit

Tax season is upon us and that means that it is time for you yearly pre-audit tax review! A sales tax audit is no fun. You may be wondering why you need a pre-audit. It make things simpler! Why Pre-Audit? Most importantly, pre-auditing gives companies a chance to catch and correct accounting errors on their own before they are caught by an independent auditing agency, such as the IRS. Do you think you need a sales tax audit? Do you have questions about your return? Check out this checklist to help you prepare: That’s why we have put together these 10 tips to help prepare you for and ensure a successful sales tax audit.

Know what you sell (pre-audit) 

Whether you are a small business owner or only deal with the accounting and tax issues for a small business, you should always understand what it is the business is selling in relation to the sales tax rules. Sometimes what you think is exempt, for example, might actually be taxable, depending on the jurisdiction. Alternately, if you provide a service along with the sale of your goods, the service may be included in the tax base, but the same service may be exempt when provided alone. The key point is to know what you are selling and check state taxability rules to avoid audit assessments down the road.

Establish an exemption certificate process (pre-audit) 

Not all sales that qualify for an exemption are exempt on their face. Often, exemptions apply based on the buyer (e.g. non-profit) or the intended use of the goods sold (e.g. resale). To support the exemption in these instances, a seller must obtain a properly completed exemption certificate from its buyer. And make sure to pay attention to the details of the exemption form, trouble arises when the form is wrong or the exemption period listed on the certificate has expired. 

If you have exempt sales based on receiving properly completed exemption certificates, then establish a process for storing these certificates and before any audit, make sure the certificates provided are ones your state will accept. If there are errors, reach out to your buyer(s) to correct the document before the audit begins. Otherwise, you could be stuck paying for uncollected tax, plus penalties and interest. 

Review marketplace facilitator agreements (pre-audit) 

Review and understand any agreements you might have with a Marketplace Facilitator, to ensure you are collecting, reporting and paying on your sales via the facilitator, as required. 

Establish a process for business purchases and know your use tax exposure 

Did you purchase goods for use in your business without paying any tax? If so, you may have an obligation to self-assess use tax on the purchase. Continued failure to report use tax can trigger an audit. It is key to set up a process to catch and report use tax on purchases, as required. 

Receive, timely review & respond to audit notices (pre-audit) 

You never want to miss a DOR notice or fail to timely act on the notice as required, especially an audit notice. If you have an online DOR sales/use tax account, make sure your business name, address, phone and email are always current. If you authorize the DOR to send notices via the online account, set-up a process to also receive hard copies by mail. Once you get a notice, read it and respond by the date required on the notice. 

Set an agreeable audit start date 

Auditors are typically reasonable. If you receive a notice of audit, there is usually an initial audit conference scheduled to review the overall audit plan. Prior to that conference, figure out how long you will need to formally prepare and gather the documents needed for the audit, then work with the auditor to set an agreeable audit start date. The auditor may request you sign a statute of limitations waiver. There are pros and cons to signing. The extension may give you more time to prepare and make the auditor less aggressive in their assessment. Whereas, the failure to sign could have an impact on the underlying assessment or the appeal process. Whatever your decision, it is a best practice throughout the audit to keep all communication in writing and always respond to an auditor’s inquiries, even if it is just to ask for more time. 

Gather the audit documents 

Gather your returns and related sales/purchase documents before the start of the audit. Review past notices and issues. If there was a prior audit, it is likely the same issues that arose in the past will be the target of the new audit. Check for tax rate errors. If an auditor finds those, you are likely going to have to pay for that expense. On the flip side, use any audit as an opportunity to review your records for overpayments/refunds and seek reimbursement for those. 8. Designate an audit spot & go to contact If an auditor plans to be on-site and you have a small but busy office, find a spot for the auditor to sit that is away from the hustle and bustle (and chatter) of the other office team members. Further, to avoid any miscommunication between the auditor and other staff in the office set clear ground rules as to who can engage with and answer the auditor’s questions. Remember here as well that it is best practice to keep all audit communication in writing. 

Understand auditor relationship and your boundaries 

Many tax authorities outsource audit roles to third parties. It helps to understand that relationship and what recourse you may have during and after the audit with regard to any issues with the third party auditor. Also, always do the following: During the audit, check in frequently for updates; If your business is seasonal and the audit sample is during your high season period, request a different sample process; If the auditor finds one-time errors, request he/she remove those from the sample pool; Before the auditor issues their formal assessment, make sure you get time to review the audit work-papers in detail and try to negotiate any issues before a final assessment; Finally, if the preliminary audit detail is looking bad, consider seeking help immediately from a tax advisor. 

Review assessment and appeal if needed 

Once the audit is complete, the auditor issues their assessment. If you agree, then simply pay the assessment and move on. If the assessment relates to a tricky tax agency rule, review the actual statute behind the rule to make sure there is no misinterpretation. The bottom line is that if you do not agree with the assessment, then follow the state’s guidelines for an appeal. If you feel in over your head, seek the advice of a tax advisor or lawyer experienced with indirect tax matters to help you obtain the best outcome and allow you to get back to managing your business. Whether you appeal an assessment or not, however, make any changes to your business that are needed to avoid future assessments. 

Please keep in with the sales tax compliance to avoid an audit!