The “The Ultimate Guide to Fighting Your Sales Tax Audit” is for business owners and professional tax advisors that want to minimize the total cost of a sales tax audit for themselves or their clients.
Most executives and business leaders understand that businesses get audited for sales and use tax, but only a small percentage are aware of the material impact to their company should a state auditor come knocking on their door.
Unless you’ve been audited in the past, you might not know:
- Why states target certain businesses
- The most common errors auditors look for
- How much it might cost the business
A sales tax audit occurs when a state agency inspects the books and records of a company. Specifically, they’ll evaluate the correctness of sales tax paid on invoices and use tax accrued on invoices. Sales tax paid on invoices can occur in two areas:
- Sales tax paid on invoices for company purchases
- Sales tax charged and collected on invoices for company sales
This Ultimate Guide will assist you in handling the audit and in keeping the assessment to a minimum. We do not advocate evading taxes that are legally due and we don’t see auditors as your enemy or ours.
We do understand the sales tax audit process thoroughly. Through our experience in handling hundreds of audits, we know how state auditors work. We’ve worked for companies with revenues of less than $1 million to companies with revenues over $100 billion. We’ve saved our clients over $61 million in audit assessments. That means our clients were over assessed in the first place by $61 million.
It should come as no surprise that state auditors aren’t looking for companies that are managing their taxes correctly. After all, audit penalties and assessments provide enormous revenue and help shore up budget deficits. According to a recent California State Board of Equalization (BOE) in a 2013-2014 report, the state generated over $21 million in revenue from their managed audit program.
What Companies Get Audited and Why?
Sometimes it’s a case of bad luck. But the data suggests most state auditors don’t select companies at random. They evaluate them by a number of factors, which include:
- Past audit history
- Volume of sales reported to the state
- Volume of exempt sales claimed
- Ratio of exempt sales to total sales
Most of these factors might seem obvious. States often target companies with histories of negative until the audits no longer produce results for the state. High revenue companies, on the other hand, find themselves in a perennial audit. Even if they’re meticulous with their compliance processes, any number of auditors from multiple state agencies will set up residence at their headquarters.
It’s also not surprising that companies that report a high ratio of exempt sales to total sales raise a flag, especially if that ratio isn’t consistent with their industry peers.
What’s less evident to most people is the first criteria: industry. This factor seems to be accounting for more and more audit activity across the U.S. And it doesn’t show any signs of slowing down. Here’s why.
Targeted industries – error prone or opportunity for the state?
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 auditors target certain industries is that historically they don’t adhere to regulations. State and local sales and use tax laws are complex and ever-changing. It takes internal accounting and finance teams a ton of research and due diligence to keep up with.
There are many ways a company can make a mistake in their compliance, but as the data from the California BOE indicates, the following account for the majority of errors (see Figure 1):
- Untaxed purchases from out-of-state vendors
- Unsupported sales for resale
- Additional sales based on markup of cost
In the 2013-2014 fiscal year (according to the CA BOE report), the top three industries (see Figure 2) found to have large assessments were Retail, Food Service, and Manufacturing.
Interestingly, the data told a slightly different story in Texas. While retail and manufacturing remained high, like California, Texas also targeted the construction industry and wholesale/distributors (see Figure 3).
It boils down to this: the State views everything you buy as being subject to tax. In other words, you’re guilty until proven innocent. We all know not everything is taxable, but you have to be able to prove all of that to an auditor. Your best bet is to keep the auditor from scheduling items in the first place. It’s easier to keep it off the auditor’s schedules than to get it taken off later.
In many cases, using an expert advisor to help will ensure you get the best results. However, it’s also possible for you to handle much of this process yourself. Click below to get started reading our online guide or use the form above to download a PDF version.