Getting Audit-Ready: A Checklist for Sales and Use Tax Audits

In a previous post, I described some leading practices to prepare for a successful outcome if you receive an audit notification for sales and use tax. Here’s a quick five-step overview of how audits typically are preformed along with some related actions to consider performing:

1. Be ready to explain how your business works: In any audit, the auditor will have conducted some research into your business, which may not always be accurate. You’ll want to think about when and how best to explain your business model. Providing a consistent narrative that shows how your data fits into the sales workflow will make the audit run more smoothly. You may want to create a standard overview that you can provide to any state, with options to slot in state-specific information, which you can provide up-front upon audit notification.
2. Be prepared to describe your systems: The auditor may lack familiarity with your selling systems; consider providing an overview. Maintain a log of system history, including significant changes and the dates they went live. Be prepared to explain the sales tax settings and connections of your systems. Know what reports and data elements your systems can produce. Review these capabilities before meeting with the auditor so that you can provide solutions and options that minimize effort for your organization while enabling the auditor to feel confident in your systems and records. Assess the volume of data and understand how it aligns to company growth and any business model changes.
3. Understand your processes: Know the tax types your business is filing in the state, including sales and use tax, seller’s use tax and any special fees such as retail delivery fees. Review any special sales tax rates or rules that apply, such as the Texas Single Local Tax or the Louisiana Remote Seller tax. Map your compliance process and be ready to show how data flows from ledger to return, as well as how you handle adjustments, credits and amended returns.
4. Evaluate your records: Review documentation for exempt sales. Gather all the documents you need prior to the audit. Test your tax rate calculations and reconcile data from General Ledger to returns. Ensure that you are following best practices for record retention.
5. Review nexus: States are increasingly focusing on their sales tax income and tax revenue collections. Maintain a current list of your registration dates and regularly evaluate unregistered states for nexus activity. Keep in mind that states and auditors are interpreting nexus more broadly. You may need to justify your view of when nexus was created and, if registration was not timely, be ready to explain why. Consider the nexus implications of remote employee hires and any use of professional employer organizations. States are challenging companies’ claims that their first nexus was created by economic nexus. For example, Texas regards downloaded software as establishing physical nexus, and Arizona considers software licenses and SaaS to be leasing activities. 

Proactive audit preparation reduces risks and streamlines the process. Maintaining clear documentation, understanding systems and processes and monitoring nexus—especially breaks in physical or economic nexus—helps businesses stay compliant. Standardized audit readiness not only ensures smoother audits but also strengthens tax governance and process improvements.