What to know about sales tax audits. A Q&A with Cassie Divelbiss, CPA

Cassie Divelbiss - Edmond Life & Leisure

Nov 9, 2022

Cassie answers commonly asked questions about sales tax audits.

Q. Are business owners with online commerce obligated to collect and remit sales tax?
The U.S. Supreme Court decided a landmark case in 2017, South Dakota v. Wayfair, that set precedent for merchants handling online transactions and their obligations to collect sales tax on remote purchases. Other states responded with similar laws, creating standards for sales tax online sellers and consumers are now familiar with as part of doing business. Although physical location is the first consideration in determining when businesses are legally obligated to collect and remit sales tax for online purchases, most states have adopted “economic nexus” rules. A business’ tax obligations come into play when sales cross a set threshold in terms of quantity, dollar amounts or both.

Q. What factors increase the likelihood of an audit?
Receiving an audit notice from a state tax authority is sometimes part of owning a business, with the possibility of audits on tax collection, sales and use tax.

Several factors can trigger a sales tax audit. Many states use systematic methods and data analytics to identify businesses at risk for underreporting or underpaying their sales taxes. Thomson Reuters lists these five common factors that can trigger an audit:

Being in a high-risk industry with a reputation for substantial non-compliance
Operating in a complex industry with high revenue and transaction volumes
When a vendor or customer is audited, the financial trail may lead back to your business
A whistleblower reports your business to the tax authorities
Consistently filing sales tax reports late

Your business also might be randomly selected for audit. Although there is no failsafe way to avoid being audited, it is advisable to familiarize yourself with the sales and use tax laws in the states where you do business, analyze your nexus exposure and pay taxes on time in their designated jurisdictions.

Q. What steps can business owners take to prepare for a sales tax audit?
Taking prompt action is essential after receiving an audit notice. Gathering and preparing the appropriate records takes time, so you want to start the process immediately.

Gather business records. Identify the period selected for audit and start gathering the specified records. The audit notice typically includes an Information Document Request (IDR) that lists the records the auditor wants to review, such as bank statements, sales tax returns and work papers for the audit period, general ledgers, chart of accounts, sales and purchase journals, sales and purchase invoices, exemption certificates for any tax-exempt sales, federal and state income tax returns or franchise tax returns, depreciation schedules, shipping documentation and financial statements and trial balances for the audit period. Be prepared to explain any missing documents. If there is no IDR, set up a call to discuss the scope of the audit.

Review your records for potential exposure areas. Review your documents to identify any potential exposure areas, including source data that doesn’t tie to the general ledger, workpapers that don’t match sales and use tax returns, using the wrong sales tax rate or exemption certificates. Look for potential underpayments and possible overpayments, such as using a higher sales tax rate or charging tax on non-taxable items.

Develop a good working relationship with your auditor. Be professional, respectful and courteous, just as you would with any other business professional. Auditors have some discretion over penalties, so it is in your best interest to have a good working relationship

Get professional support. Sales tax audits tend to be stressful and time consuming. A professional who is adept at tax accounting and handling audit requests can help manage the process by conducting the initial record review, hosting the auditor and answering questions. Having an experienced professional’s help streamlines the process and can potentially save your business time and money.

Cassie Divelbiss, CPA, is a tax senior associate at Arledge, an Edmond-based public accounting firm. Arledge is a recognized leader in the accounting industry offering practical solutions in the areas of tax planning, auditing, consulting, accounting advisory services and client accounting.

This article contains general information only and does not constitute tax advice or any other professional services. Before making any decisions or taking any action that might affect your income taxes, you should consult a professional tax advisor. This article is not intended for and cannot be used to avoid future penalties that may be imposed by the Internal Revenue Service.