Receiving a state sales tax audit notice inevitably sparks the question, “but why am I being audited?”
Sometimes the state might provide an explanation as to why you’re under audit. But often, there are a number of complex and shifting factors at play. Because of this, it’s difficult to identify a single reason.
It’s easier to think of it as a game of probability. There are a number of factors that affect your odds of being audited. But, unlike a lottery, if they draw your name you might lose thousands of dollars.
With that in mind, here are the five most common factors that influence your probability of being audited.
Some industries get audited more than others. If you’re in an industry with a high risk for audits, this might be why you received an audit notice.
Certain industries tend to put themselves at risk of an audit in two ways.
The first is based purely on how the industry operates: For example, bars, restaurants, grocery and liquor stores are all cash-based businesses, and auditors are all too aware of how cash goes unreported. However, while cash-based businesses routinely put themselves in compliance risk, the effort to find the errors might be too high for many auditors to even bother investigating, especially if it’s a small operation.
The second main reason certain industries get targeted is that historically they don’t adhere to state and local sales and use tax regulations, which are complex, ever-changing, and require a lot of research and due diligence on the part of the company’s accounting and finance teams. If your industry has a history of non-compliance, auditors are more likely to question whether you’ve been remitting your sales tax.
The California BOE Annual Report 2013-2014 should give you a good idea of industries that are susceptible to audits:
Sometimes an audit of your suppliers, competitors or customers can direct attention your way. States might find a transaction or record of interest to your business. Now, there’s no guarantee this will happen. But an audit of your business partner can quickly turn into an audit of your business.
Some states are aggressive with the number of audits they conduct every year. If you happen to develop economic or physical nexus in a state with a greater number of audits, your chance of being audited increases significantly.
For example, Texas conducts thousands of sales tax audits every year, and their audits have a reputation for being among the toughest. They employ hundreds of auditors. They even have offices and auditors stationed in other states so they can conduct more audits. If you were to establish sales tax liability in Texas, your chances of getting audited will increase.
When it comes to state audits, it’s not a matter of if, but when. Most businesses with notable nexus presence are due for regular, periodic audits. The longer you go without an audit, the more likely you are to get one.
Often, businesses get audited based on probability and random bad luck. After auditing companies they have reason to believe are underpaying sales tax, some states will audit other companies at random to fill out the schedule.
If states across the country increase the number of audits they conduct each year, your odds of being audited increase. The frequency at which states audit is fluid, and changes more than you might think.
For example, after South Dakota v. Wayfair introduced economic nexus in 2018, states started auditing more frequently, going after businesses that may have had economic nexus and didn’t know it. In 2020, this trend is still in effect. We also think some states might conduct more frequent sales tax audits to make up for monetary losses during the coronavirus pandemic.
Once you understand why you’re under audit, you probably have another question: “What do I do next?”
The sales tax audit process is lengthy and complex. The first step we recommend is finding more resources and setting up consultations with audit defense experts. This gives you some direction as to what you should do next to prepare.
However, there is one quick mindset change you can make that will have a dramatic impact on your audit:
You’re not being audited. You are fighting an audit.
This may seem like nitpicking, but the difference in mindset can have a major impact on your audit outcome. When you fight an audit, you’re using all of the resources at your disposal to find offsetting overpayments, review estimates, appealing decisions and actively shape the results of the audit in your favor. This can result in a better outcome and save your business thousands.
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