When taxpayers are faced with an audit, they naturally feel some anxiety and concern. See below 10 general tips of what to do and what not to do when dealing with a sales tax audit.
- Familiarize yourself with the taxability of your products and services. While this seems obvious, businesses change over time and so do tax laws. Even small things like changes in product mixes and how you invoice your customers can impact the taxability of your products. Similarly, exemptions can be enacted, repealed or interpreted differently over time, especially where technology is concerned. For example, software-as-a-service was once considered not taxable, but now is considered taxable data processing service (taxed at 80% of the sales price), rather than taxable software (taxed at 100% of the sales price).
- Keep things professional. If an auditor asks about missing documents or asserts that tax was collected but not remitted, that should not be taken as a personal insult or accusation to any specific individual. If somebody will take the auditor’s findings personally, consider having a representative handle the audit to eliminate that friction from the process.
- Plan ahead of the initial visit. Gathering documentation and reports can be time-consuming tasks, especially if you are relying on a third party. While you will be given ample time to obtain such documentation during the audit, external events can always ruin the best-laid plans. For example, if you know you need an exemption certificate from a customer, get it now, rather than wait a few months when that customer could be out of business or otherwise unreachable.
- Communicate with the auditor, even if it is to say that you cannot meet a particular deadline. Believe it or not, auditors appreciate that you have a business to run, and are willing to work with taxpayers, especially with the hurdles created by COVID-19. Auditors will almost always grant extensions of time, as long as they are in good faith.
- Use the audit as a learning experience. If an audit leads to a surprising result, it is quite possible that a similar issue exists in other states as well. Use the audit as a way to help minimize future exposures and quantify existing risks.
- Provide anything that the auditor did not ask for directly. Trying to be helpful by providing extra invoices or email exchanges can lead to new questions and issues. Similarly, if an auditor asks for something that does not seem relevant, ask why it is needed or what the consequences will be if you do not provide it.
- Assume that the auditor is always right. Auditors do not know every nuance of every exemption and tax law. Like all of us, auditors (and their supervisors) make mistakes, and just because an auditor insists some transaction is taxable, that does not mean you have no way to challenge his assertion. The appeals process offers many opportunities to correct any mistakes made during an audit. Do not be shy in asking for legal support for any of the auditor’s assertions.
- Assume your colleagues in the industry are always right. Another company could be doing the same kind of work, but for some reason or another, they could be treated differently for tax purposes. For example, two construction contractors could expect dramatically different sales tax consequences depending on how they invoice their customers, or who their customers are, even if they perform the same work.
- Pay the assessment without considering an appeal. Just because the auditor was not sympathetic to your arguments, that does not mean that your argument is lost. Auditors are always going to lean towards taxing transactions, so having a different audience to hear your arguments may be all that you need to succeed.
- Forget about the potential liability/reimbursement of your vendors/customers. Sales tax is owed by both the purchaser and seller, and if one party pays the tax, both parties’ liabilities are satisfied with the State. In other words, you can still go back and collect any sales tax that your customers should have paid. While there certainly may be valid reasons not to try to collect the tax, it would be a mistake not to consider that option. Similarly, if your customer (or vendor) already paid the tax (on their own sales and use tax return or on their own audit assessment), you should not owe the tax (that would be double taxation).