From data analysis to whistleblowers: How states uncover noncompliant sellers

Starting with what one knows can pay off. Marketplace facilitator and non-collecting seller use tax reporting laws enable state tax departments to identify out-of-state marketplace sellers that have had inventory in the state (in marketplace-owned or operated fulfillment centers) for years. That inventory creates a physical presence — and an obligation to collect sales tax.

California is among the states pursuing marketplace sellers for these uncollected back taxes. The California Department of Tax and Fee Administration can hold businesses liable for up to three years of back taxes.

Many states encourage citizens to identify businesses they suspect of tax evasion or fraud. For example, the Connecticut Department of Revenue Services has a referral form individuals can submit to report incidences of suspected noncompliance.

The Alabama Department of Revenue makes tax fraud personal: “Prosecuting tax evasion is about simple honesty and fair play between citizens that pay their fair share and those that willfully do not.” The department notes that tax evasion can lead to revenue shortages, which in turn “may inevitably influence tax increases on everyone.”

States often review businesses that change hands. If prospective owners don’t verify the company they’re buying is compliant, they could receive unwelcome attention from tax authorities after the sale goes through.

Tax departments in numerous states, including Arizona, Oklahoma, and Wisconsin, have hired additional auditors in recent years in an effort to find noncompliant businesses. Kentucky and South Dakota will soon do the same.

More staff translates to more audits. If suspected businesses are selected with care — through data mining, references, or other means — those audits can be particularly lucrative for states.

One of the simplest ways to determine whether an online seller is collecting sales tax in a state is to shop with them. Auditors sometimes do just that.

Not all remote vendors are required to collect sales tax in all states because most state economic nexus laws provide an exception for small businesses (e.g., those with less than $100,000 in sales or fewer than 200 transactions in the state in the current or previous calendar year). When auditors find online retailers that aren’t collecting tax, they may first contact the business to see if they’re aware of their potential collection responsibilities. Or they may go straight for the audit.

Numerous tax authorities in the United States and abroad use data analysis to help identify businesses with a high probability of noncompliance. According to a New York State Department of Taxation and Finance report, data mining provides a “more scientific data-driven approach to case selection” and helps discover “new patterns of non-compliance.”

Data mining techniques vary widely but all allow tax authorities to analyze massive amounts of data. Often used to identify anomalous behavior by registered vendors, data analysis is increasingly being used to identify out-of-state sellers that should be registered but aren’t. 

States share taxpayer information with each other through various regional information-sharing agreements; a business known to have significant sales in one state could have them in another state. States may also combine resources. Members of the Multistate Tax Commission can participate in its Joint Audit Program, which “helps states learn of any inconsistent reporting to different states by multistate taxpayers.”

The more information state tax authorities have, the better they’re able to locate noncompliant businesses.

Auditors can be most effective when they leave their desks: California sent auditors door to door for years to educate taxpayers and find noncompliant businesses; auditors in Idaho and Washington have approached entrepreneurial youth at their fruit and lemonade stands; and auditors sometimes attend trade shows to verify that exhibitors are registered as required.

It’s also common for state tax authorities to set up shop in other states. For example, the Oklahoma Tax Commission maintains divisions in other states and contracts with out-of-state private auditors to increase collections. And representatives from the Utah State Tax Commission travel nationwide to perform their work. 

This increased audit activity, or the threat of it, is starting to pay off. At last count, 5,715 businesses had registered through the Streamlined Sales Tax Registration System since the Wayfair decision. Thousands more have registered directly with individual state tax departments: some 5,026 in Illinois alone.

If you think you may have an obligation to collect and remit sales tax in states where you’re not registered, it’s time to find out for sure. Take Avalara's free sales tax risk assessment to learn where your sales may have created nexus.