So you have received a notice from a state informing you that your company is being audited for sales (and use) tax compliance. The first question that usually comes to mind is “Why me?”
The Most Common Triggers for a State Audit Exam
Mark Friedlich (Vice President, U.S. Government Affairs, Wolters Kluwer Tax & Accounting North America) interviewed many state revenue authorities across the country, as well as companies that have been through a sales and use tax audit over the past 12 months. These interviews and additional research surfaced a top 10 list of the most common sales and use audit triggers across most industries and states.
Here are the top 10 triggers for audits:
1 Prior sales and use tax audit liabilities – some taxpayers don’t learn or falsely believe that once audited, the odds of being audited again are slim.
2 Pattern of late or irregular sales and use tax filings – this is like waving a red flag. The taxpayer is demonstrating that it lacks proper procedures.
3 Amount of exempt sales compared to gross sales reported on sales and use
tax returns – states use analytical studies to compare your exempt sales to total sales for your industry. If the percentage of your exempt sales to total sales is greater than the norm, the state will want to understand why.
4 Industries that are frequent sales and use tax audit targets – certain industries may receive a large percentage of their sales revenues in the form of cash rather than credit card sales. The former is prone to under-reporting and would be of a greater interest to state sales tax auditors.
5 Type of business entity – historically, sole proprietorships are subject to greater scrutiny than corporations.
6 Changes in a state’s sales and use tax law – some businesses do not have or provide for the necessary resources to track sales tax rate changes and changes to exemptions and taxable items. The Supreme Court’s Wayfair decision very significantly changed the nexus rules as to how states can tax businesses.
7 Business closure, dissolution, or bankruptcy – the clock has begun on the time when the state can audit a taxpayer as the taxpayer may not be found going forward. There is no time like the present in such situations.
8 Supplier or vendor sales and use tax audits – if one of your business “partners” is audited, the state may have found something of interest and wishes to audit your business, or your business “partner” “ratted you out” rather than take the responsibility for the transactions between you both.
9 Regularly scheduled audits for a state’s largest taxpayers – some states like to periodically audit those taxpayers who remit the highest amount of taxes, especially if prior audits resulted in sizable assessments.
10 Whistleblowers or referrals from third parties – don’t be surprised if a competitor or a dissatisfied customer shares your practices with a state authority, especially if there is a monetary reward for doing so. Many states belong to state compacts and share audit information with other states. It’s possible that an audit in Oregon of another taxpayer could generate an audit of you by your state.
Tax Tip #1
Tax laws are constantly changing. Periodically, engage your tax professional to review you business operations to determine if you have established nexus in a state that previously you did not have nexus with, check for revised sales tax rates for your state(s), and review your internal procedures on how you are identifying and capturing taxable sales tax transactions.
Tax Tip #2
If you were audited by a state and were assessed for unpaid taxes, take immediate action to review your current procedures with the state auditor and request guidance as to how best to get in compliance. Then work with your tax professional to implement those changes.
Tax Tip #3
Immediately upon receipt of an audit exam notification letter, share it with your tax professional and consider engaging your tax professional to represent you. The tax professional can provide invaluable advice regarding audit techniques, sample audits, scope of engagement, and negotiating penalty abatement.
Tax Tip #4
Work with your tax professional to create a sales tax operating manual that spells out taxable versus non-taxable transactions, how invoices need to constructed to avoid non-taxable sales being treated as taxable sales, support needed to support your sales tax returns and for how long these supporting documents must be maintained by the business.
Tax Tip #5
If a customer claims to be exempt from sales tax, work with your tax professional as to how to properly document that exemption and for how long you must retain that notice of exemption and how frequently you need to request that it be renewed.
If you would like to discuss your business or personal tax planning, tax preparation, audit concerns or other financial concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.
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BE SURE TO READ THE DISCLAIMER PAGE: Tax laws, IRS rules and regulations change frequently. Although we hope you’ll find this information helpful, this blog is for educational purposes only and should not be considered as the rendering of tax, legal or investment advice. The publisher shall not assume liability for any losses, injuries, or damages from the display or use of this information.
About F. Bryan Haarlander, EA, CTRS:
Bryan Haarlander is an IRS licensed Enrolled Agent and who owns and operates a specialized tax services firm serving clients in the western suburbs of Philadelphia, PA, which includes the cities of Chester Springs, Coatesville, Collegeville, Devon, Downingtown, Exton, Frazer, King of Prussia, Paoli, Philadelphia, Phoenixville, Pottstown, Radnor, Reading, Wayne, West Chester in Berks, Chester, Delaware, Montgomery and Philadelphia Counties, as well as clients in Delaware, New Jersey, New York and throughout the continental USA.
A Certified Tax Resolution Specialist, Bryan is well-known for his IRS tax resolution expertise and his book How to Resolve Your IRS Tax Debt Problems.