Please note: This blog was originally published in 2019. It’s since been updated for accuracy and comprehensiveness.
The second you receive an audit notice, start getting ready. You’ll want to give yourself as much time as possible to find or reconstruct missing records, prepare your business for the audit process and possibly bring in expert help, like a CPA.
Collect basic documents
Because you can expect your auditor to request copies of basic accounting documents, such as financial statements, general ledger and journal entries, federal tax returns, and bank statements, you’ll want to prioritize getting these documents ready. You’ll probably also need to provide sales-tax-related documents like invoices, bills, list of exempt sales, resale and exemption certificates, sales tax returns, use tax returns, and shipping records. Having all these documents lined up and ready to go for the audit will not only speed things along, but your organization and level of compliance will also impress the auditor.
Exemption certifications are particularly crucial during a sales tax audit. If you find you’re missing exemption certificates for some of your customers, contact those business owners immediately and get copies of the certificates.
Speak with a professional
If you have a third-party tax advisor, consider setting up the audit to take place at their office. This will make the audit less disruptive to your business and make it easier for your tax advisor to represent you during the audit.
If your usual tax advisor is not thoroughly familiar with the sales tax regulations of the entity that is auditing you, it may be wise to hire a consultant to guide and represent you through the entire process. At the very least, you’ll want to familiarize yourself with the basic sales and use tax regulations for the particular state that’s auditing you as they relate to your business. Perhaps the biggest challenge of sales tax compliance is the huge inconsistency in how different states and localities apply sales taxes. You can expect your auditor to be familiar with what is and is not taxable, so you’ll be at a major disadvantage if you don’t have someone with equal or greater expertise on your side.
Carefully consider before signing a statute of limitations waiver
During the initial conference, the auditor will often ask you to sign a statute of limitations waiver. This document extends the usual statute of limitations for the period that’s being audited.
Although signing a waiver will give you more time to get your documents in order, it also allows auditors to take more time with the audit without losing a year’s worth of unrecovered tax to statutes of limitations. Keep in mind that, in most cases, interest on taxes due continues to accrue whilst the waiver period is in place. With a statute of limitations waiver, you are giving auditors more time to explore the caverns of your non-compliance.
Auditors typically work on multiple audits at once, so at the end of each year, they will likely prioritize audits that they do not have a signed waiver for in order to prevent taxes from hitting statutes of limitation. If you sign a waiver, you will likely have some degree of interest tacked onto your assessment due to your audit being deprioritized. Signing a waiver might relieve the stress of gathering documents, but be prepared to pay for it in additional interest. Your best bet is to get the documents together quickly and let the auditors rush to finish the audit in time to avoid statutes of limitations.
Be wary of agreeing to sampling methods
Auditors will frequently use various methods of sampling to expedite the completion of audits, but not all sampling approaches are created equal. Some of these methods, like block sampling based on filing period, could unfairly skew the projected findings of tax due and create a much higher liability than what you actually owe.
If possible, try to estimate your tax liability prior to the audit, either by yourself or with the help of a tax professional, so you have an idea of how accurate the auditor’s projections are and whether or not a certain sampling method would be favorable, fair, or unfavorable to your outcome.
Always ask for a waiver of penalty
In most states, a penalty is issued in addition to interest on any outstanding taxes due. In many cases, this penalty can be easily waived for auditees who have not encroached upon fraud or willful negligence in their non-compliance. Taxing authorities will often waive this penalty as an incentive for taxpayers to timely remit their outstanding tax and interest due. An interest waiver is much more difficult to obtain, since the statutes are much less forgiving in that respect.
What to do during an audit period
Remember that the auditor is neither an adversary nor a friend. They are just doing their job; treating them as a professional and showing respect and courtesy will usually get you equal courtesy back. However, don’t forget that their job is to get as much money as they can from you.
Isolate the auditor
Set the auditor up in reasonable comfort, but do what you can to give them as little contact with employees (or worse, customers) as possible. Make sure you have any requested documents ready and waiting for the auditor when they arrive, and consider personally escorting them to and from the room when they arrive and leave. You might also want to provide drinks and snacks for the auditor. After all, you don’t want them wandering around your facility looking for a drinking fountain.
Get everything in writing
Give the auditor what they ask for, but volunteer nothing — even if it seems harmless. Ask the auditor to provide all requests in writing so that you have a complete record of everything that transpires during the audit. If a request seems even faintly dubious, contact your tax advisor or another expert and find out whether you are required to provide such information. If not, politely decline the auditor’s request (in writing!) and include the exact regulation or tax code section that gives you the right to refuse such requests .Answer questions as succinctly as possible. Most people volunteer far more information than they need to without realizing what they’re doing.
Moving forward after an audit
Unpleasant though it may be, a sales tax audit is a huge opportunity to improve your business practices. Auditors will target transactions and procedures that they believe to be flawed, so you can use their findings to eliminate the issues they spotted. If your audit results in a painful tax assessment, you will certainly want to take steps to prevent such an occurrence in the future. But even if your audit ends well, you can still usually find ways to lessen the risk of future audits.
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