Sales and use tax audit triggers
Now that every state has adopted some form of legislation around economic nexus, we are coming up on the three-to-five-year statute of limitation periods that states would consider a sweet spot for sales and use tax audits and compliance reviews. Many of these laws were established between 2018 and 2020, and states would now have a complete lookback period for audits to be “fruitful.”
Of course, the states would need the resources and internal processes to audit all of the new businesses that were required to register and report as a result of meeting their threshold limits. States might rejoice at having a larger pool of audit candidates to select from including your business, but thousands of other businesses have also recently joined that potential audit pool.
Should you be worried? No, just be prepared, and avoid drawing unneeded attention to yourself.
Audit red flags
There are many reasons a company would be targeted for a sales and use tax audit, whether directly or indirectly. Being aware of the following red flags that could trigger an audit or increase its likelihood will help you sail through the process and reduce your compliance risks.
1. Registering for sales tax and never filing a return
During the registration process, you probably indicated your gross sales and the business start date, so the jurisdiction is expecting a tax filing with a potential tax liability. Disregarding the filing requirements and ignoring the nonfiling notices will surely add a company to the potential audit list.
2. Failure to register in a state where you already have another active tax account
More states now have the technology that allows them to compare income tax and withholding accounts to sales tax registration lists. If your company is reporting revenue and/or has employees in a state but does not have a sales tax account, the state may send a discovery notice to determine your audit potential.
3. Filing inconsistencies in tax liabilities
States can run queries to identify companies with reporting anomalies such as extreme fluctuations in their tax patterns or not reporting use tax. Depending on the industry and time of year, random tax variances greater than 50% from one period to the next may result in an inquiry. Also, it’s expected that companies have some level of periodic use tax to report. Filing a zero-use tax report every period may signal a deficiency.
4. Customer/supplier audits can indirectly refer companies to the audit list
If your customer is undergoing a sales tax audit and your invoice is selected for review, the customer or the auditor may contact you to determine whether you have an exemption certificate on file. If you reply that you do not have a properly completed exemption certificate on file and it was an error, the auditor may send a referral to his or her audit selectors. If this happens on multiple occasions, then you may be selected for an audit. If your supplier is under audit and the auditor sees an exemption certificate provided by you for something they think is clearly taxable, they may also flag you for audit.
5. Industry issues and comparisons
If a department of revenue has audited other companies in your industry and found significant taxes, it may use its data warehouses to identify companies with the same NAICS numbers. It may also compare your percentage of taxable sales to other companies in your industry.
6. State and federal government information-sharing
Many states receive customs reports from the federal government. If the purchasers do not report use tax on a business or even an individual level, the state will trigger audits. If a home state does audit a company that sells high-ticket items, it may share that data on sales outside the home state. Departments of revenue may match registration for titled items (e.g., motor vehicles, airplane, boats, etc.) to determine whether improper exemptions have been claimed.
If your company receives an audit notice, the best thing you can do is understand the audit process and be prepared. Each state is different in the way they conduct audits, so it is important to be aware of the audit procedures from the beginning.
How Wipfli can help
Sales and use tax audits are often inconvenient and can be intimidating. You are not alone, and now that the audit pool has increased, your chances of an audit have also likely increased. Our team of professionals have decades of experience in assisting companies undergoing state sales and use tax audits as well as conducting overpayment reviews. Learn more about our sales and use tax audit services.
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