State & Local Tax Blog

Top 7 Causes of Sales Tax Audit Deficiencies and How To Fix Them

Cause #1: Missing Documentation

In some ways, you are actually guilty until proven innocent in a sales tax audit. The burden of proof is on you, the taxpayer, to demonstrate you complied with the law.

So how much “proof” is sufficient? Will your word suffice? How about a crafty or compelling argument? Maybe detailed explanations of your business procedures will do it. When it comes to fighting sales tax audits, proof has nothing to do with pudding, but everything to do with adequate documentation.

You need actual paper or actual digital versions of paper. Things like: vendor copies of invoices showing tax paid, valid resale or exemption certificates, audit schedules showing certain transactions in this audit were audited previously, and more will suffice. Without it, you can’t expect much.

Fix: The answer is obvious. Maintaining a proper paper trail is imperative. But what if you have problems now? Well you wouldn’t be the first to find yourself in this position. The documents listed above are a good start to supplying the “burden of proof.” We also have many other (legal) methods to provide acceptable documentation, some of which may or may not apply to you. If you’re in audit trouble. Give us a call. We’ll help if we can.

Cause #2: Resale/Exempt Certificates

Know this: When you sell something taxable you must collect one of two things from your customer. Either you collect the sales/use tax due OR you collect the proper resale or exemption certificate in lieu of the tax. “Yeah, yeah” you say, “I already knew that.” Yet missing, inaccurate or incomplete exempt certificates plague many companies. Auditors seem to be even more aggressive lately in refusing to accept certificates that have the slightest technical errors.  

Fix: There are lots of options to maintain certificates, ranging from a manual system to fully-automated one.  You’d be well-served to evaluate all the alternatives. We’d be glad to give you some ideas. A good place to start is conducting a review of your certificates on-hand before you get audited.

Cause #3: Accruals on Purchases

If a tree falls in the forest and no one is around does it make a sound? If you buy something out-of-state and no tax was charged is tax still due? These are not deep philosophical questions and we are not sages, but the answer is (at least to the second question) “yes”. If an item you buy is for your own use and is not used in an exempt manner, then yes, it’s taxable. Realtors have their sayings and so do state and local tax consultants. We say: Details, details, details. It’s all in the details. Sales tax is by the transaction. It’s very difficult to have your hands in every transaction, but that’s where the problems come. You need to have a good system for catching purchase transactions that should have been taxed but were not.

Fix: Set up and maintain a good accrual system. There are good ideas out there, if you need suggestions we’ve got some great ones you can do on your own.

Cause #4: Auditor Errors

Auditors are not robots — they do make mistakes. Our relationships with auditors have always been characterized as professional and respectful, however, experience has taught us to “trust but verify.” Often times the verification part yields benefits for our clients.

Fix: Don’t assume your auditor is the only (or best) source of accurate interpretation of state law. And while they will largely be equitable and just in their assessments, their job is not to look out for your best interest. We’ve said it many times, an auditor’s main objective is to bring revenue to the state, not to hand out credits. Our advice: if something doesn’t make sense, look into it. Need another opinion? We’re on your side, and there’s no fee just to talk on the phone.

Cause #5: Bad Sample

Sampling in sales tax audits is common, but if the sampling method used is inappropriate or the sample selected does not take into account your business cycles or fairly represent the population, you could be hurt. Each item in the sample represents many others, so a rare large taxable purchase in the sample could cost you big time. So what sample is best? Block sample? Stratified sample? Statistical? The answer is…it depends. We’ve handled hundreds of audits for clients and we can help you evaluate the proposed sampling method to determine if it is fair for you.

Fix: Your auditor should discuss with you beforehand the sample selection process and sampling procedures before the audit begins. We emphasize that you should thoroughly understand the impact of the sample selection and determine if it accurately represents your business cycles before agreeing (i.e. petition to eliminate  large, outlying transactions, slow or heavy time periods, and be sure to optimize your credits by including exempt transactions in the sample). Remember, auditors don’t know about your business procedures so don’t assume their sample is best for you.

Cause #6: Didn’t Collect Tax (or Enough Tax) on Taxable Sales

This may seem over-simplified, but it’s common for companies to make mistakes when deciding the tax treatment of their transactions. Even if your tax matrix is spot-on perfect, or your rates table is current as of today. Come tomorrow or next week or next month they could all be outdated and invalid, and your personnel will make errors when invoicing.

Fix: A regular taxability review of the products you sell, or an update to your tax matrix, or upgrade to an automated rates engine or training your A/P department can avoid this unnecessary liability.

Cause #7: Didn’t Remit Collected Tax

Tax collected and not remitted is usually viewed as “fraud” and carries with it very heavy penalties. So why wouldn’t a company send in tax collected? We’ve come across many reasons why this happens, but by far the biggest reason is because the company is not registered in the jurisdiction. If you have nexus in a state, have taxable sales and you collected the tax, you’re playing Russian Roulette. It’s not a matter of if, but when, the State finds you with a fistful of their money in your hand.

Fix: You’d think getting registered is the best choice here, but in fact it may be the worst thing you could do. Why would it be the worst? Because, shortly after you register, you can expect to be audited for the back taxes plus penalty and interest, including a fraud penalty for not remitting the tax. Unregistered companies are not subject to state statutes of limitations, so it’s possible for them to assess you back to the date of your first sale in the state. The good news is, many states have voluntary disclosure programs for companies to anonymously negotiate the terms of their registration up front.  However, once a state contacts you or you them, the deal is most likely off. We suggest you contact us to discuss your options.

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