What to Expect During a Sales Tax Audit

A sales tax audit is a review by a state or local tax authority to verify a business has collected and remitted the correct amount of sales tax. The objective is to compare the sales tax reported against the business’s financial documents to identify any discrepancies. Auditors inspect a company’s records to ensure it has correctly calculated tax and followed all applicable regulations. This verification helps maintain the integrity of the tax system.

Common Triggers for a Sales Tax Audit

A business may be selected for a sales tax audit for several reasons. A history of filing or paying late, or frequently submitting amended returns, can signal compliance issues. A high volume of non-taxed sales, such as sales for resale or to non-profit organizations, may also invite scrutiny if the proportion is unusually high for the industry.

Certain industries that handle a large volume of cash transactions, like restaurants and bars, are more likely to be audited. A company with prior audits that resulted in additional tax due is also more likely to be reviewed again. State agencies may want to confirm that previously identified issues have been corrected.

Discrepancies between the gross sales on tax returns and the revenue on federal income tax returns are another trigger. State and federal agencies often share information, and a significant mismatch suggests that sales or income has been underreported. Audits can also be the result of a random selection process as part of a state’s compliance program.

Required Documentation and Preparation

Before the auditor begins their review, a business should gather all necessary documents. Organizing records in advance helps ensure the process is as smooth as possible. For audits conducted on-site, preparing a clean and private workspace for the auditor can facilitate an efficient review.

Sales Records

Auditors will examine all sales-related documents to trace reported figures back to specific transactions. This includes:

• The sales journal, which provides a chronological record of all sales
• Summary reports from the accounting system
• Point-of-sale reports and individual sales invoices
• Detailed cash register tapes, or “z-tapes,” that summarize daily gross sales, taxable sales, and tax collected

Purchase Records

Auditors review purchase records to verify that the business has correctly paid use tax on taxable items purchased from sellers who did not collect sales tax. The auditor will examine purchase invoices for equipment, supplies, and other assets. This is to ensure that if sales tax was not paid to the vendor, the business self-assessed and remitted the appropriate use tax.

Exemption and Resale Certificates

For any sale where tax was not collected, the business must provide a valid exemption or resale certificate. Without a valid certificate, a non-taxed sale is considered a taxable sale by the auditor. A valid certificate must be fully completed, signed, and dated by the customer and accepted in good faith by the seller.

Bank and Financial Statements

Financial statements and bank records are used to reconcile reported sales with the revenue flowing through the business. Auditors will request complete bank statements for all business accounts for the audit period, along with deposit slips. They will also review the general ledger to cross-verify sales and purchase data.

Tax Records

A complete file of all tax returns filed during the audit period is required. This includes copies of all state sales and use tax returns and any supporting worksheets. Auditors will also request copies of federal income tax returns for the corresponding years.

The Audit Process Step-by-Step

A sales tax audit follows a structured sequence of events, from initial notification to the presentation of findings. Understanding this progression helps a business anticipate what to expect at each stage.

The Initial Contact and Opening Conference

The process begins when the business receives a notification letter from the state tax agency. This letter identifies the entity being audited, the tax type, and the audit period, which covers the last three to four years. An opening conference is then scheduled between the business’s representative and the auditor to discuss the audit’s scope, required records, and timeline.

Fieldwork or Desk Review

After the conference, the auditor begins the audit, either as a field audit at the business’s location or a desk audit at the agency’s office. Due to the high volume of transactions, auditors use sampling techniques. A common method is block sampling, where the auditor reviews all transactions from a specific period, and the error rate found is projected across the entire audit period.

Ongoing Communication

Throughout the audit, all communication should be managed by a single point of contact designated by the business. This person is responsible for receiving the auditor’s requests, gathering the necessary information, and providing it in an organized manner. This approach helps control the flow of information.

The Closing Conference

Once the review is complete, a closing conference is held where the auditor presents their preliminary findings. They will explain any proposed adjustments to the tax owed and the reasons for these changes. This conference allows the business to ask questions and present additional documentation before an assessment is issued.

Understanding the Audit Findings and Assessment

After the closing conference, the state tax agency issues a formal document, such as a Notice of Proposed Assessment, detailing the audit’s final results. This notice is the official statement of the additional tax the auditor believes is owed. The assessment provides a complete breakdown of the amounts due.

The primary component of the assessment is the tax deficiency, which is the additional sales or use tax determined to be due. The notice will also include applicable penalties, which are commonly assessed for negligence or failure to pay the correct amount of tax. Interest is also calculated on the unpaid tax, accruing from the original due date until it is paid.

To understand how the final numbers were derived, a business should request and review the auditor’s workpapers. These documents show the detailed calculations, sampling methodology, and specific transactions that were adjusted. Examining the workpapers allows the business to check for errors in calculations, misunderstandings of fact, or misapplications of tax law.

Responding to the Assessment

Upon receiving a formal assessment, a business has several pathways depending on whether it agrees with the findings. A decision on how to proceed should be made in a timely manner to preserve all available rights.

If the business agrees with the final assessment, it can pay the amount due by the deadline provided in the notice. Prompt payment will stop the accrual of additional interest and close the audit.

A business that disagrees with the findings may request an informal conference with the auditor’s supervisor. This meeting is an opportunity to discuss points of disagreement, present more evidence, and negotiate a resolution. The supervisor has the authority to review the audit and make changes if errors were made.

If the informal conference does not lead to an agreement, the business can file a formal appeal or protest. This legal process has strict deadlines, requiring a written protest to be filed within a specific period, such as 30 or 60 days from the assessment date. A formal appeal moves the dispute to the state’s administrative hearings system for review by an independent body.