Top 5 sales tax audit risks for small businesses
The last thing a small business owner needs is an audit tying up time and resources. And while income tax may first come to mind when you think of an audit, business owners are much more likely to be subject to a sales tax audit.
States are using lots of investigative tools for their audit selection, but your actions can make the decision easy for the state. Sales tax can be complicated, so it can be easy to make mistakes that can increase your chance of audit. Here are some of the most common sales tax compliance mistakes that can lead to a greater audit risk—and how to avoid them.
1. Filing returns late.
When you register with a state for a sales tax permit (sometimes called a license), you’ll be told how often you must file a sales tax return (your filing frequency). How often you file is usually based on the amount of sales tax you are projected to owe, which for a new business can be a guess. Many businesses are required to file monthly, but it could be quarterly, yearly or at some other time. You’ll also be given a specific date in the month by which the state must receive the return.
Keep in mind that due dates may be adjusted according to holidays and weekends. For example, in many states the 20th of the month is the due date, but if the 20th is a Sunday, the deadline could actually be Monday the 21st.
You will almost certainly not get a notice of when your tax is due, so it’s important to be aware of both your filing frequency (how often you must file) and your specific due date to make sure you file on time. If you are not paying attention, failing to file on time will result in late penalties. Repeatedly filing late raises a red flag. There can be only so many red flags before the state decides to pay you a visit.
The more states you file in, the more complicated it gets keeping track of the various filing frequencies and due dates. If you want to reduce your audit risk, it’s imperative to meet all your deadlines.
2. Making payments late
Your payment deadline is generally the same as your filing deadline. Most states are pushing businesses to electronic filing and to make an electronic payment. In most states, if you file electronically you are required to also pay electronically. Regardless of whether you pay by check or electronically, you’ll need to take the extra step of either enclosing your payment with your paper return or submitting your payment electronically.
If you are paying electronically, make sure you know your deadline for submitting your payment, as payment processing can take some time. If your payment cannot be credited immediately, you may end up with a late payment even if you’re paying on your due date.
Like filing late, paying late is a red flag. Too many red flags lead to audits.
3. Making calculation errors
Be sure to double-check your math when you are manually completely a return. And make sure the numbers you put on the return match up. For example, the amount owed on the return needs to be exactly the same as the amount that you are remitting.
Many states look at calculation errors as more than bad math, but as reasons why there may be taxability or rate errors as well. A state can only determine by an audit whether you are making taxability or rate errors.
4. Failing to document reasons for exempt sales
You may sell exempt products or have exempt customers. These are normal sales but for some reason or another there is a state law that allows you to not collect sales tax. A sale may be exempt because the product is exempt by law, such as clothing in Minnesota, or an otherwise taxable sale may be exempt because your buyer is a reseller rather than an end consumer. In addition, a sale may be exempt because your customer is exempt from paying sales tax because they are exempt, such as a government entity.
In every sale where a taxable product is exempt because of the buyer’s status, you must get an exemption certificate so you can prove why you didn’t collect sales tax. You must collect an exemption certificate the first time a new tax-exempt customer is buying from you, or when a certificate you have on file for an existing customer is invalid or about to expire.
Each state presumes you will collect an exemption certificate at the time of the sale. However, whether you collect them at the time of sale or get them later it is critical they be kept on file. You will be held liable for the missing tax in an audit if you do not have that exemption certificate.
5. Using ZIP codes to determine tax rates
If you are charging the wrong sales tax rate, your customers will complain to the state. When a state gets this type of complaint, it gives the auditors a reason to zero in on your sales tax compliance. Many small businesses use ZIP codes to determine sales tax rates, but this may not always result in the correct rate. Tax jurisdictions and ZIP code boundaries don’t necessarily match and one ZIP code can contain several different tax jurisdictions. For example, in Colorado, the ZIP code 80111 includes at least five different sales tax rates.
Geolocation — pinpointing the correct location of the transaction using data such as latitude and longitude — is the best way to make sure you are getting tax rates right for every location.
Don’t give sales tax auditors any excuses to take a second look at your business. Avalara’s sales tax software can help you avoid audit-inviting mistakes, save you time and allow you to file your sales taxes with confidence. And special pricing for small businesses makes it very affordable. Learn more here.
The 2021 sales tax changes report: midyear update
Your guide to navigating the complicated world of tax compliance and preparing for the future
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