The best way to survive a tax audit is to avoid one in the first place. SMB retailers should learn the nine points of the Sales Tax Compliance Checklist:
- Know your nexus
- Maintain sales tax and business licenses
- Know the tax rates
- Understand product taxability rules
- Recognize the difference between origin vs. destination based sales tax rules
- Collect and maintain exemption certificates
- Charge proper tax type
- Know the risk on sales and use tax returns
- Understand audit triggers
Learn more details in this interview with our Director of Operations & Product Management, Chris Livingston.
Audit Triggers can include:
- A significant percentage of exempt sales
- The purchase or sale of a large amount of exempt items or services can trigger an audit, because there can be misinterpretation of the law, taking an exemption on an item in error, and sometimes just outright noncompliance.
- Large changes (either increase or decrease) in sales tax
- A large increase or decrease in sales volumes can cause a voluminous amount of errors and omissions are a red flag.
- Late returns filings
- Consistently filing sales and use tax returns after the due date and remitting the tax payment in a non-timely manner will trigger an audit.
- Incorrect math
- Math errors may draw inquiry, and many times lead to a full-blown examination, particularly if the errors are very frequent in nature. A large increase in sales can increase the potential of errors and omissions.
- Nexus but no registration
- Not being registered for sales tax but paying another kind of tax in a state can increase the probability of an audit. A state sales tax audit division just has to check with the other tax audit division.
- Not filing and remitting Use Tax
- Filing and remitting sales tax but never filing and remitting use tax is another red flag
- Current vendor audit
- If one of your vendors is being audited and that vendor has not charged you sales or use tax or has charged you incorrect tax, this will likely trigger an audit.
- Current customer audit
- If one of your customers is being audited and you have not charged the proper sales or use tax, this can also trigger an audit.
- A whistleblower can be a disgruntled employee, an unhappy customer, a competitor, or businesses in the same location as you that know or suspect that you have not paid your fair share of taxes.
- Resale Certificates
- Issuing resale certificates to vendors and suppliers in a state but not being registered for sales and use tax in the same state.
- Drop in taxable sales
- A drop in taxable sales is one of the biggest riggers for a sales tax audit.
- Requesting a refund
- A refund request, especially a large refund request will trigger an audit.
- Industry type
- Companies in a certain particular industry that frequently under report sales and use tax, or industries that traditionally have a high use tax liability are often targeted for an audit.
- Luck of the draw
- Some states have random ways of selecting companies for audit.
- Not found in state system
- Companies that have a website, are listed in the phone book, or appear in a newspaper, magazine or online news report can trigger an inquiry regarding their registration status.
If an SMB retailer must submit to a sales tax audit, the auditor will usually ask for a list of nontaxable or exempt sales transactions; invoices and associated exemption certificates; and backup documentation. A use tax audit is similar; Auditors will request purchase invoices, use tax accrued and paid, and any direct pay permits.
Other documentation that will be needed:
- Chart of accounts
- Trial balance
- Nexus questionnaire
- List of locations
- Review of all exemption certificates
- Fixed asset purchases (use tax)
- Non-asset purchases (use tax)
- Review of all returns (federal, state, and local)
For more information read 5 Steps to Simplify Sales and Use Tax for Retailers.