Your Guide to a Texas Sales Tax Audit

Facing a Texas sales tax audit can feel intimidating, but with the right preparation and understanding of the process, you can navigate it confidently.

In this guide, we’ll break down the three key stages of an audit: preparing for it, surviving it, and protesting if necessary.

How to Prepare for a Texas Sales Tax Audit

The key to surviving a sales tax audit is documentation. In Texas, you are considered guilty (taxable) until proven innocent (non-taxable), and for many types of exempt sales, the only acceptable documentation is a resale or exemption certificate, a contract, or another supporting document. Keeping thorough, organized records will make the audit process much smoother.

Here's how to prepare:

Establish Procedures

Ideally, you have procedures in place that look at the sales tax consequences of all sales and purchase transactions.

Purchases

• Non-taxable transaction: The most common reason is a purchase for resale. In that case, you don’t need supporting documentation, but you must ensure that 100% of the items on all invoices are indeed for resale. In other situations, a contract or additional documentation may be required.

• Taxable transaction not taxed: The transaction was taxable, but the vendor did not charge sales tax. In that case, you should accrue and remit “use tax” and report the amounts on your next sales tax return as a taxable purchase.

Sales

Verify that tax collection is correct:

• Ensure proper taxable amounts, factoring in discounts, rebates, and trade-ins.

• Confirm the correct local sales tax rate (up to 8.25%).

• If tax was not collected, you should receive a resale/agricultural/exemption certificate that is fully completed and signed. You only need one certificate per customer.

• Tip: One of the most productive things you can do prior to an audit is to collect missing certificates. You never know when a customer will go out of business or disappear.
  
  

Voluntary Disclosure Agreement (VDA)

Suspect prior tax exposure? A VDA allows you to report and pay up to four years of back taxes anonymously in exchange for a waiver of all penalties and interest, along with forgiveness for prior periods.

How to Survive a Texas Sales Tax Audit

Once the audit begins, understanding the process helps reduce stress:

1. Notification

You’ll receive a letter stating you’ve been selected and requesting a completed questionnaire.

2. Entrance Conference

A brief phone call may be scheduled for the auditor to understand your business, accounting procedures, and any other relevant history.

3. First Visit & Confirmation Letter

The auditor will schedule a formal first visit, establish the audit period (typically the previous 42 months), and issue a “confirmation letter” requesting specific documents.

The requested documentation typically includes financial records (bank statements, financial statements, general ledgers), tax documents (sales tax returns, supporting workpapers, chart of accounts), and other detailed materials such as exemption or resale certificates, invoices, contracts, and deal jackets.

• Responsibility Reminder: You are responsible for sales tax on both purchases (even if the vendor didn’t charge it) and sales (even if you didn’t collect it). While you have the legal right to recover sales tax from customers, this may not always be practical. When in doubt, the safest approach is to collect the tax.

• Commonly Overlooked Taxable Purchases: Commonly overlooked taxable purchases include cleaning services, software, SAAS, and certain online services Texas classifies as “data processing services,” such as web hosting or subscription-based online tools.

4. Providing Documentation

Once you submit the requested documents, the auditor will focus on specific invoices or vendors they believe are taxable, and may ask for supporting documentation or explanations for any disputed items.

5. Reconciliation

In addition to reviewing specific items, the auditor will perform a reconciliation of your books and records against your sales tax returns to ensure they match.

For example, if your sales tax return reports less tax than what is recorded in your sales tax payable account, the auditor will ask for an explanation. If a valid reason isn’t provided, additional tax may be assessed.

6. Ongoing Communication

You will continue exchanging documentation and explanations with the auditor until the review is complete, even if you still disagree with some of the findings.

How to Protest a Texas Sales Tax Audit

Once the auditor completes their fieldwork, you’ll move into the exit and protest process. Here’s how it works:

Exit Conference

After the fieldwork is finished, you and the auditor will have a (virtual) exit conference to review the audit. The audit is then submitted for processing.

At the exit conference, you can request an Independent Audit Review Conference (IARC). This involves a non-Audit Division Comptroller employee joining to bring a fresh perspective and try to resolve any disagreements. A report with recommended changes will be issued afterward.

Note: IARCs rarely favor taxpayers, so most businesses do not use this option.

Notification of Audit Results

About six weeks later, you’ll receive the official Notification of Audit Results. You will have 60 days to pay or protest.

• If you protest, you do not have to pay until the appeals process is complete, which can take months or years. Interest will continue to accrue on the amount due.

• You may choose to pay all or part of the assessment at any time.

• Payment plans and settlement agreements are also options.

Filing a Protest

When protesting, include a clear explanation of why you disagree with the assessment, and be prepared to provide supporting documentation if needed. This leads to a back-and-forth with the Comptroller’s Office through their appeals process. 

The appeals process typically works like this:

• An appeals officer issues a Reply Letter in response to your protest.

• You respond, and the officer replies again.

• If still unresolved, you can escalate to an Administrative Law Judge (ALJ). ALJ hearings can be virtual, in person, or via written submission. They have their own procedural rules.

• If you disagree with the ALJ’s ruling, the next step is district court, which concludes the administrative appeals process.

Common Topics for Protest

Some common reasons to protest (each requiring documentation or support) include:

• An exemption certificate was obtained after the audit ended.

• Additional documentation was obtained to support your position.

• A legal dispute exists with the Comptroller over tax interpretation of the law.

• The auditor misunderstood the transaction in question.

• Your vendor or customer was audited and already paid the tax.

• Your vendor or customer voluntarily corrected an error and paid the tax.

How to Take Action

Don’t wait until an audit notice arrives. Start preparing your records today. Review your sales and purchase transactions for compliance, organize all resale and exemption certificates, and consider consulting a tax professional if you suspect prior exposures or complex issues.

If you have questions or need guidance on navigating a Texas sales tax audit, reach out to our State and Local Tax (SALT) specialist.

Our team can help assess your current compliance, identify potential exposures before an audit, guide you through the audit process or a voluntary disclosure agreement (VDA), and provide strategic support if you need to protest an assessment. 

To learn more about LGT and how we can serve you, contact us here.