Small business FAQ > Tax compliance management 101

Tax compliance management 101

Small business FAQ > Tax compliance management 101

Tax compliance management 101

Getting compliant and staying compliant are vital to reducing risk during an audit. If you’re feeling overwhelmed, don’t worry, you’re not alone. Below are some of the most common questions we get about how to manage day-to-day tax compliance.

Sales tax rates, rules, and regulations change frequently. Although we hope you'll find this information helpful, this page is for informational purposes only and does not provide legal or tax advice.

Understanding sales tax audits

A sales tax audit is a business review by a state tax authority. The auditors request information about your sales history and compare it against what they have on record to make sure your business is compliant with tax rules and regulations. It’s essentially the state verifying you’ve paid the sales tax you owe during a specific window of time.

The exact audit procedure varies for each state, however, you can expect the following basic process:

  1. You’ll receive a letter notifying you of your upcoming audit, including the information you’ll need to provide.

  2. The auditor will use your information and documents to prepare a preliminary schedule and subschedules for you to review.

  3. You provide feedback and, if necessary, the auditor revises the schedule. This process can happen multiple times.

  4. If the auditor determines you owe the state money, you’ll receive a proposed assessment.

  5. If you agree, you pay any owed taxes; if you disagree, you can appeal the assessment with the state.

There are many reasons businesses can be audited. The more obvious reasons are prior audit issues or filing irregularities. However, you can also be chosen if the state audits a supplier, vendor, or competitor; if you’re in an industry the state is looking closely at; or if it’s just your turn. 

Sometimes, companies are even audited at random. It’s important to know that being selected for an audit is not an indication that the state suspects you of wrongdoing.

The most important way to prepare for an audit is to maintain well-organized, easily accessible records. Auditors will send you a letter requesting certain types of information. The more quickly and completely you can provide the information, the faster and smoother the process will be. 

Getting your documents in order before you receive an audit notice is key. Having complete records will help you justify tax decisions and can help you avoid penalties and fees.

Yes. In fact, conducting internal audits is a great way to identify areas of improvement and establish processes that can make state audits less painful.

Audits can be stressful, but you don’t need to panic. When you receive your audit notification, pay close attention to the information the state is asking for. Collect all relevant records and have them ready for the auditor to review.

Reach out to the taxing authority if you have questions or concerns. You can also hire a tax professional who specializes in audits to help you through the process.

The statute of limitations on sales tax audits is different for each state. Most states have a standard 3- or 4-year look back period. However, like with most things related to tax, it’s not quite that simple. In some states, there are contingencies for 7- or 8-year windows. And if the state has reason to think something shady has occurred, the limitation may be significantly longer, if not indefinite.

Audits can take weeks or months, depending on how thorough the audit is, how quickly they receive the information they request, and how many rounds of review the schedules require. The more you prepare before the audit begins, the more likely it’ll be over quickly.

Exemption certificates and consumer use tax are among the most prevalent issues auditors find. Violations include:

  • Sales claimed as exempt without supporting documentation
  • Sales not reported on the sales and use tax return
  • Assessments made for purchases of tangible personal property from out-of-state vendors that did not collect use tax

In addition, auditors look for missing or invalid documents, filing errors, inconsistencies in bank statements, and invoicing discrepancies.

It depends on what information is missing. If you can use other documentation to verify your tax decisions, the consequence is likely minor, like additional time to complete the audit. 

For more severe issues, like missing exemption certificates, you may have to pay back taxes and even penalties. Unfortunately, any unpaid taxes that can’t be substantiated with the proper documents become taxes you owe.

You’ll receive an assessment from the auditor outlining the amount you owe. If you think there’s been an error, you can try working with the auditor to get the amount adjusted. If that doesn’t work, you can officially appeal the decision with the state. In most states, you’ll have 30 days to file the appeal.

If the assessment is correct, you’ll have to agree to abide by it and pay any back taxes, along with any penalties and fees imposed by the state. The payment deadline depends on the tax authority who conducts the audit.

There are tax professionals who specialize in helping businesses through an audit. Especially if you’ve never been through an audit before, it can be beneficial to bring on an expert to guide you through the process and answer any questions.

Not really. You can reduce your chances of getting audited by implementing sales tax compliance processes and filing correctly and on time. But because audits happen due to reasons beyond the control of a business, there’s no guaranteed way to avoid them altogether. 

Your best bet is to set yourself up for smoother audits by complying with sales tax rules everywhere you sell, maintaining good records, and filing on time, every time. Automation can help make each of these steps easier.

Learning about back taxes

You’ll need to review your sales activities and nexus triggers. Nexus is a term that refers to a connection with a state that obligates you to register, collect, and remit sales tax.

You may owe back taxes if you:

  • Don’t collect taxes everywhere you have nexus
  • Undercharge taxes on your sales
  • Neglect to file properly or on time
  • Haven’t remitted use tax as needed
  • Don’t have documents to substantiate exempt sales

If you’re unsure whether you owe back taxes, we recommend completing a business review to help you determine your risk and potential liability.

Most states allow for a voluntary disclosure agreement (VDA). VDAs are a proactive way of dealing with unpaid taxes and tend to make it easier to get squared away with a state. They also tend to limit the assessment period and states often reduce or waive penalties.

It’s important that you clear up unpaid tax issues prior to registering with a state, otherwise you could open yourself up to additional penalties.

The process varies from state to state. Generally, they will issue you a notice with their findings. If the assessment is small enough, you can remit the taxes immediately; for larger bills, it may be possible to work out a repayment schedule with the state.

A voluntary disclosure agreement (VDA) is a proactive way of dealing with unpaid taxes and working with a state to bring your business into compliance. VDAs tend to limit the assessment period and states often reduce or waive penalties.

Managing exemption certificates

An exemption certificate is a document that sellers collect in lieu of sales tax on exempt sales. Certificates typically apply in one of two scenarios:

  • The purchase is for resale, so tax will be assessed on the end user
  • The buyer is a nontaxable entity, like a government agency, a religious organization, or a nonprofit

Exemption certificates are typically collected for one of two sale types:

  • The purchase is for resale, so tax will be assessed on the end user
  • The buyer is a nontaxable entity, like a government agency, a religious organization, or a nonprofit

If you make one of these tax-exempt sales, you’ll need to collect a valid paper or digital certificate at the time of purchase. You’ll also have to store the certificate, so it’s accessible in the event of an audit.

While there are exceptions, states generally have their own forms and requirements for exemption certificates. If you sell to a company in multiple states, you’ll need to collect a certificate for each state you make a sale in.

Keep all transaction records until the statute of limitations for that state expires. Typically, the timeframe ranges from three to eight years, but some circumstances can extend that period. We recommend speaking with a tax professional for advice on your specific situation.

If a customer can’t provide an exemption certificate, you’ll need to charge them the tax on the sale. If you don’t collect a certificate or lose it, you’re responsible for remitting the sales tax. If you can’t provide the certificate during an audit, you’ll be assessed the unpaid taxes and possibly penalties or late fees.

Some certificates do expire. Again, this is something that varies from state to state. You can exempt tax on new purchases based on certificates you previously collected, but make sure they’re still valid on the date of each subsequent purchase.

Keeping up with tax rate changes

The short answer is frequently. For example, there were more than 40,000 rate and taxability updates in the U.S. and Canada in 2020 alone. The more places you sell to, the more likely it is that rate changes will affect you.

Each state releases its rate and rule changes as they’re enacted. But pouring over legislative documents is hardly an efficient way to stay compliant. If you sell a small number of items in one or two locations, it may be possible to check the relevant revenue department websites regularly and monitor changes. For more complex catalogs or a larger sales footprint, programs like Avalara Tax Research serve as an aggregator of rate changes.

Sales tax rates are independently determined and updated by each state. Websites for the relevant revenue department usually have the most current rates, as well as access to bills and resolutions that affect tax laws. You can also check aggregate sites if you need to check multiple state rates.

Most tax rate tables are updated fairly regularly, usually monthly. However, rates can change during the month, and if you miss a major update, you increase your risk. Cloud-based calculators or automation solutions are updated more often and tend to provide more reliable rates.

Maintaining licenses and registrations

That depends on your business. Some business licenses remain active as long as your business is open and you meet your license requirements. Other business licenses must be renewed either every year or every two years. Check on license requirements for your state to see if and when your license may expire.

In most cases, you only need to register for sales tax once in each state. This registration is specific to your business and the particular state. Most changes to your business, like changing your business name, address, or telephone number, require you to amend your existing registration. Sometimes, these changes may require the state to send you a new, revised registration.

You need to reapply for licenses and registrations if they lapse. Operating a business without a business license can have serious consequences and it’s illegal in most states to collect sales tax without a permit. At the very least, you’ll be asked to cease operations and have to pay a fine.

Simplifying the compliance process

Most people don’t start a business with the intention of managing sales tax compliance on their own. It’s time-consuming and complicated, with potentially serious consequences for getting it wrong. 

Luckily, there are a few options for folks looking to offload a lot of the day-to-day management, including:

  • Third-party tax professionals
  • In-house compliance specialists
  • Automation platforms

You may find one or more of these options to be ideal for your business.

You can automate most aspects of tax compliance with a solution like Avalara. Cloud-based programs provide regularly updated tax rates, document collection and storage options, sales threshold tracking, license management, returns preparation and filing, and more.

Generally speaking, an automated tax calculation program is going to be more accurate and efficient than managing compliance manually.

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Connect with Avalara for the answers you need to do tax compliance right.