How to prepare for the cost of a sales tax audit

• Sales tax audits can cost thousands of dollars in back taxes, interest, and penalties.

• Hidden costs like staffing hours for audit work can increase the burden of assessments.

• Securing financing options now gives you flexibility to pay for an audit without diverting funds from other necessary operations.

Each state audits a percentage of registered businesses each year for sales tax compliance. What they uncover can result in assessments that require payment of back taxes and more.

Are you ready for a sales tax audit?

Audit preparedness is about good recordkeeping. But it’s also about assessing potential exposure risks and financial resources like funding before an audit creates urgency or limits your options.

Auditing agencies don’t charge a fee for initiating an audit. The cost comes from what the audit uncovers.

An assessment after a sales tax audit can cost thousands of dollars. One survey found that these kinds of audits cost $14,000 on average. Back taxes, accrued interest, and penalties or other fees all add up, particularly if multiple expired tax exemption certificates are uncovered.

A history of back taxes uncovered in audits also opens an organization up to more risk: Audits are more common for companies that have already had them, and those penalties can add up over the years if the foundational workflow isn’t resolved to avoid outstanding liabilities.

The potential financial impact of a sales tax audit breaks down into:

• Potential liabilities from back taxes or unresolved exemption certificates

• Adjacent costs that result from diverting business funds or hours to the audit assessment

To estimate your potential liabilities, you need to know the relevant jurisdictions your company operates under and where you have nexus. If you understand your potential liabilities, you’re better prepared to minimize them, and you’re also poised to correct expired certificates or other errors.

Each state has unique requirements for sales tax exemption certificates and expiration timelines. Each state also has unique tables for interest accrual and fees for noncompliance or other penalty categories. Consult your tax advisor to determine what obligations and penalties for noncompliance may apply in your jurisdictions.

The workflow and time dedicated to an audit can create even more financial impact than most organizations realize. Staffing hours can be diverted to auditing efforts — sometimes for weeks — which can add up to a significant amount. Hiring outside assistance from a tax or audit professional may add to the cost.

The earlier you understand the potential costs of an audit, the more time you have to evaluate your reserves and compare funding options to pay for an assessment, should one come due.

Your final payment totals after an audit assessment don’t come from underlying tax obligations alone. Sales tax audit penalties complicate the math with fees and interest.

The specifics vary by state, but penalties can include:

• Assessment penalties for substantially underpaid tax

• Escalating late penalties that grow the longer tax remains unpaid

• Negligence, evasion, or fraud penalties on egregious or purposeful nonpayment

• Penalties for unremitted taxes when taxes were collected from customers but not remitted to the state

Penalties are often, though not always, calculated as a percentage of the unpaid taxes. So the larger the tax obligation, the larger the associated penalties can be.

If, after an audit, you are given an assessment with a significant balance, you need to figure out how to pay. Many companies may first want to turn to any cash reserves they have. But even companies with sufficient cash reserves need to think about whether that’s the right payment method.

Using up cash reserves comes with opportunity cost.

Back taxes aren’t the only unexpected expense a business may face. Depleting cash reserves can leave a company less prepared to handle unforeseen costs, such as damaged inventory, equipment failures, or payroll shortfalls. It can also limit the funds available for strategic investments and other business priorities.

A smarter way is to evaluate all your funding options. Compare the process of paying with cash reserves with the process of using a state payment plan, bank loan, or other financing method. Look at total cost, timing, business cash flow impact, and repayment terms.

Learn more about financing back taxes, including how to pay back taxes over time.

Make a plan before audits force one onto you.

With Avalara Capital, Avalara customers can finance unexpected audit assessments without depleting operating reserves. Qualifying customers access a revolving line of credit, automated repayment, and scalable funding limits.

Get started with Avalara Capital today.