Surviving an Audit of Your Amazon Seller Central Business
- April 1, 2015 | Ryan O'Donnell
When it comes to taxes, the once dreaded thought is that of an audit. We're not in the business of spinning doom-and-gloom scenarios, but thought it would be valuable to offer some background on how Amazon sellers can prepare and survive an audit.
Before we begin, it's important to remind you that audits are generally aren't the beginning of the end. Unless a business has been knowingly breaking the law and collecting (and keeping) a large amount of tax dollars, an audit is just a bump in the road. We’ll review what a sales tax audit is, how it can impact your business, and how to be prepared for an audit.
What Are Audits For?
Audits are conducted to ensure taxpayers are in compliance with sales tax reporting requirements as defined by state Department of Revenue laws and guidelines. Audits are conducted in all 50 U.S. states and can focus on a variety of taxes including sales, excise, and business tax.
It’s important to recognize each state Department of Revenue is under pressure to drive revenue - just like businesses. Audits are a way of recouping lost tax dollars.
Sales Tax Audits for Amazon Sellers
First, it’s important to understand your Amazon Seller Central store is associated with Amazon in name only. While you may be leveraging their ecommerce and fulfillment systems, an audit of your business is just that - an audit of your business, not Amazon.
In many ways, selling via Amazon puts businesses in a very good position for an audit as Amazon offers enterprise level documentation, information storage, and tax calculation / collection. From a sales tax perspective, the real questions will likely focus on whether or not you properly managed the sales tax you collected and met your obligations around filing and remittance.
What Triggers an Audit?
There are many potential triggers for a sales tax audit. Some are within a business owners’ control while others are not. We'll mention both below. Remember, the goal of this post is to help you understand audits and the associated process to help you be better prepared.
- Timing: Sometimes, it’s just your time to get audited. Audits are cyclical and most companies get audited on a regular, consistent basis. Sorry.
- Industry: At times, state governments will target specific industries. If your business is in such an industry, the chances of being audited go up significantly.
- Association: Audit by association happens when a company you do business with is audited and your relationship with them leads tax authorities to your door.
- Competitors: What better way is there to feel good about an audit than by tipping off the auditor to a competitor you know is in the wrong?
- Location: Some states are more heavily audited than others.
- Chance: Your business was randomly selected for audit by an auditor or by the software used by DOR to analyze sales tax data.
- Registration: Failure to register in states where you are making sales and collecting sales tax is a sure fire way to raise some DOR eyebrows.
- Remittance: Sloppy sales tax reporting is going to catch the eye of the state or local tax jurisdiction. Be sure to fill out all forms completely and sign / date accurately.
- Exemptions: If you're selling taxable goods you're bound to have a tax exempt customer sooner or later. Have a process and be diligent about managing sales tax exemption certificates.
- Falling Behind: Sales tax rates and laws change every day. If you think the managing your sales tax exposure is a "set it and forget it" task, sorry. It's up to you to stay on top of your sales tax responsibilities.
The probability your business will be selected for audit depends on a number of factors, but every business regardless or size or value can be selected. Businesses are contacted for routine audits all the time so don’t think being selected means you’ve made egregious mistakes or are under suspicion for breaking the law.
State auditors are authorized to examine the books, records, papers and equipment of your business to determine if the correct sales tax was collected and remitted to the State. Generally speaking, auditors are tax professionals familiar with the application of state laws to your business. As such, they are well versed in understanding the nuances of your business vertical.
Once a business has been selected for an audit, a notification letter is dispatched along with a questionnaire. Typically, the business being audited has approximately one month to complete and return the questionnaire. Failing to return the completed questionnaire results in the auditor asking the business to complete it during the initial meeting. Likely not the best way to get an audit underway...
Once an auditor is in the field and the onsite audit has begun, their goal should be to complete the audit in a timely manner with limited interruptions. As the business owner, you have the right to expect such efficiency and task focus.
Review of Documentation
To perform an audit, an auditor will examine certain business records including, but not limited to:
- sales invoices
- purchase invoices
- accounting books
- general ledgers
- bank statements
- computer records
The records needed by an auditor is typically defined by the complexity and size of the business. Regardless, any business undergoing an audit is required by law to comply with all records requests from the auditor.
The length of the audit “look-back” period is impacted by whether or not the business has filed sales tax returns before. If so, the look-back period is generally more limited so it pays to be on top of sales tax management. Businesses who fail to file sales tax year after year expose themselves to an increasing level of risk due to penalties and compounding interest on outstanding sales tax.
Scheduling the Audit
When scheduling an audit, there are several questions a business should consider. First, audits can be complicated and taxing on company resources. If possible, it’s best to avoid having multiple audits happening at the same time. Aim to schedule them when you have the full resources of your company at the disposal of the auditor. The same holds true for major projects and initiatives. If your company is migrating its sales data to a new database system or spinning up a new ERP, this would not be a good time to schedule an audit.
Before starting the audit, businesses may want to negotiate the following points.
- Start date. Don’t rush into an audit. You need time to gather your paperwork, look into any outstanding tax issues, and get organized. At least one month lead-time is common.
- Selected test period. Many businesses are making improvements to their systems and business practices all the time. If that is the case for you, aim to set the test period in line with when the improvements were in place.
- Missing documentation. It’s unlikely your business will have every bit of paperwork for every sale during the selected test period. Be sure to determine how the auditor will allow you to deal with missing invoices or exemption certificates.
Once you have done your final preparation and scheduled your audit, pay attention to the auditor’s travel plan. If the auditor is traveling to your location just for your audit, then you are on the hook for travel expenses. If, however, your audit can be coordinated with other audits in the area, the travel cost will not fall on your shoulders.
Should you have to pay for the auditor’s travel, focus on being very efficient so they can get in, complete the audit, and head home. Small businesses want to avoid paying for multiple trips whenever possible.
During a sales tax audit, you should be prepared to offer the auditor access to the following documents:
- Sales Tax Returns
- Sales Invoices
- Sales Journals
- General Ledger
- Exemption Certificates
As we mentioned before, Amazon stores virtually everything about your business. That should put you in a good place with regard to producing evidence of sales, tax collected, tax exempt purchases, and refunds. Hopefully you have been equally diligent with your business paperwork.
In the end, the #1 piece of advice for any Amazon merchant targeted for an audit is to get professional help. Avalara Professional Services is one option to consider.