How to reduce the risk of sales tax audits?

According to state revenue data, certain industries are more likely to be audited solely because of how sales and use tax restrictions affect their business. The more intricate the rules, the more potential problems or omissions may occur. These errors can be costly for states that lose tax income and companies that fail to comply.

Maine, Illinois, California, Massachusetts, Wisconsin, and Washington are a few of the most aggressive states in sending notices and audit requests since the U.S. Supreme Court’s 2018 Wayfair decision. 

In this article, you will get answers to questions like

  • How does the IRS audit get triggered?
  • What sales tax audit strategies can your organization use to prevent tax penalties?

When does a sales tax audit gets triggered?

A sales tax audit gets triggered when the organization fails to report sales tax to the Internal Review Service (IRS) or if there is a possible data mismatch. There are many possible reasons why a sales tax audit occurs. For example, a customer undergoing an audit may produce one of your invoices, leading the auditor to contact your company for the exemption certificate. Another example can be that your supplier may turn up with an exemption certificate for sale termed taxable, according to the auditor.

If you are flagged, the punishments can range from high sales tax audit penalties to an assessment being issued. But first, let’s examine what happens when the IRS initiates a sales tax audit.

Sales tax audit procedure

The sales tax agency intimates the organization by sending a notice to alert the organization regarding the upcoming audits and sends the expected timelines for the same.

The audit typically can be broken down into two stages:

Stage 1 Procedures
For this stage, the IRS audit will compare the current sales and use tax filing with the sales information identified from the ledger. The historical sales information records can include bank deposits, federal tax returns, procurement documents, and sales tax payable records.

Stage 2 Procedures
This stage may occur at the same time as the first stage or at a later date. The main aim of this stage is to review the additional information about sales tax returns. Other calculations relating to current sales tax are also done during this stage.

Risks involved in sales tax audit

Risks are part of any audit. A sales tax audit involves three types of risks: inherent, detection and control risks. The inherent risks can be identified quickly and can be corrected internally. Detection risks arise due to improper planning. There are limited chances of identifying this risk internally. The control risks get inculcated due to errors made in the numbers to avoid tax remittances. Having a hired consultant can help mitigate the control risk.

Resolving risks associated with sales tax

The sales tax audit penalties can be mitigated by following common strategies:

  • Reporting sales accurately.
  • Assessing and calculating correct sales value.
  • Asses and review previous audit reports for any findings and correct the same proactively.
  • Maintain relevant sales exemption certificates.
  • Review records thoroughly without any discrimination before submission.
  • Take inputs from the applicable tax guidelines.
  • Validate pre and post-acquisition taxes in case a new business acumen is purchased.
  • Disclose known errors upfront to the auditor without hiding gross negligence.
  • Negotiate if necessary and understand the pending sales tax as applicable. 

Automation: Key to seamless tax compliance

Companies with significant turnover will have different compliance requirements than small businesses. The states normally impose a sales tax collection and remission duty on a seller whenever a certain number of sales transactions into or within a state, or a specific monetary amount of sales into or within a state, is fulfilled. Thus, customized sales tax audit strategies based on your business size are essential.

With automation, you can manage the audit effectively, preventing the risk of incomplete exemption certificates and incorrect use of tax figures. Cloud-based solutions offered by Avalara foresee the sales tax liabilities of numerous jurisdictions and quickly update itself to the latest changes. This helps eliminate and reduce the risk of exposure to penalties when an audit is initiated. 

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