At any moment, you could be notified of a state sales tax audit by any one of the many states you do business in – even if you don’t have physical nexus. That’s why ecommerce companies need to be ready. In this post, we’ll cover the auditing process and tips to get you through each step unscathed.
Nobody likes being under audit. Receiving that state sales tax audit notice may put a pit in your stomach, but you don’t have to fear. Instead of feeling defenseless, know that there are steps you can take to get prepared.
And it pays to be well-prepared. According to Avalara, the average cost of an audit is more than $14,000. And if you’re doing business in all 50 states, you could be under multiple audits at once or back-to-back. It adds up quickly. Stay ahead of the game and get to know the audit process. That way there are no surprises when—not if—you are audited.
What Does a State Sales Tax Audit Look Like?
You’re taking the first step by reading this blog. Just being familiar with the process will help you make it through a sales tax audit without damage done.
The audit process boils down into four high-level stages.
- Sampling Methodology
- Post-Assessment Period
#1. THE PRE-AUDIT PROCESS
Before any audit letter arrives, you should regularly review relevant state tax law changes and conduct self-auditing procedures to shore up any weaknesses.
As soon as you get the notification letter, the pre-audit phase begins. Here’s what’s involved:
- Answer the letter and provide all the requested information. Be as up-front as possible with the auditor.
- Appoint an internal audit coordinator. This person – whether it’s a team member or outside sales and use tax advisor – will be your company’s only point of contact with the auditor and should have a strong knowledge of your business as well as sales and use tax laws. This role is designed to facilitate the entire auditing process without interrupting your company workflow – not to mislead the auditor. The next few steps are handled by this audit coordinator.
- Review old audits and relevant documents to alert your company about possible exposure. You might be able to get ahead of some problems before the audit even starts.
- Schedule the timeframe of the audit. But do not commit to an audit appointment until you know the following:
- The scope of the audit (one state or many)
- Whether you have the personnel available to obtain and provide the information requested
- The availability of suitable office space
- The schedule of other ongoing audits
- Audit location
- Whether you should use a consultant and what their availability is
- Applicable statute of limitations
- Whether the auditor is traveling
- Whether the audit raises sensitive exposure concerns
#2. SAMPLING METHODOLOGY
Especially with large businesses, it’s simply not feasible for an auditor to examine each sale or purchase invoice. Instead, the auditor chooses a sample of those documents that they think will be representative of the entire invoice population.
The audit sample is a complex but critical part of the audit process. And a mistake here could cost you. So, it’s important to know the sampling method the auditor will use.
There are two methods auditors will use: statistical and non-statistical sampling. In statistical sampling, risk is quantified. In non-statistical, risk is left up to the judgment of the auditor.
You can negotiate the sampling method with the auditor before they pull the documents. If given the choice, you should go with statistical sampling. Either way, you should thoroughly discuss the sampling methodology so you can reach an acceptable agreement with the auditor.
The preparations done in the first two stages go a long way to fueling your success here.
The fieldwork stage is where the auditor comes to your office and does the work. Your audit coordinator needs to be ready to facilitate this work, so that it goes as smoothly as possible. Have requested records and information ready. Assert control over the situation while being cooperative, knowledgeable and professional. Taxpayers who appear disorganized give a bad first impression, and those impressions are usually the strongest and can stick with you all the way through the audit.
When it comes to negotiating, don’t be timid but don’t be overly aggressive. Adopt a middle-of-the-road strategy. Be firm about your rights because if an auditor senses you don’t know the procedures, they are likely to cut corners in their audit, leaving you with a greater penalty.
#4. THE POST-ASSESSMENT PERIOD
When the main fieldwork ends, the auditor will address final items they feel tax should have been paid on. There may also be outstanding items for which you were missing documentation. You’ll need to find those outstanding documents before the auditor turns in the audit for processing.
Auditors are usually eager to turn in their audit, especially if the fiscal period is ending. You can use that urgency to your advantage. Some auditors may be willing to accept less documentation if they feel it would help resolve everything sooner.
If you need extra time to wrangle in outstanding documentation, ask for it. The auditor will go through the appeals process and try to “agree to disagree” on some items. Take note of the appeals process, but also be sure to try to resolve every item before the audit is turned in. The appeals process will take up more time, and we find that it’s better to get everything solved before the audit is turned in.
State sales tax audits can be overwhelming, but with the right preparation, response plan and internal and external support, you can make it out unscathed. Whether you’re currently under audit or just preparing for the inevitable, knowing the process can save your business a lot of money (and headaches).
Need help navigating a sales tax audit? We’re here for you. Fill out our short What’s Next questionnaire to get in touch for a free 45-minute consultation.