Sales Tax 101

Sales Tax Audits: Why Me?

by Jerry Donnini

Sales Tax Audit

This guest post is brought to us by Jerry Donnini, an associate in the law firm Moffa, Gainor, & Sutton, PA, in Fort Lauderdale, Florida.

There are few things more stressful than receiving a sales tax audit notice from your state’s revenue department.  Following the initial reactions of panic, many companies often wonder, why were we chosen?  Did we do something wrong to spark the audit notice?

While receiving the audit notice can occur from a myriad of reasons, our firm sees recurring trends as to why companies get audited in the first place.  Many large companies with high volumes of sales get audited regularly, which is largely unavoidable.  However, for many small and medium sized taxpayers, there are a number of ways to reduce the likelihood to receive that dreadful sales tax audit notice.

Audit Trigger: Discrepancies between State and Federal Reporting
Discrepancies between a company’s sales and use tax returns and its federal income tax return is probably the most frequent way it can wave a flag to a state to audit it.  For example, most tax professionals or in-house company controllers do not reconcile the 12 monthly sales and use tax returns and the income tax return.  Many companies believe it will not make a difference for state purposes, so it nets out exempt sales on its monthly sales and use tax returns and only report taxable sales on a monthly basis.  However, simply not reporting exempt sales will produce drastically lower gross sales on the state sales tax return than on the federal income tax return. Unfortunately, most states will treat the excess sales on the federal income tax return as taxable sales.  Internal control issues aside, a company’s failure to reconcile state and federal tax returns is a great way to get flagged for audit.

Audit Trigger: Discrepancies in 3rd Party Reporting
Do you sell on eBay, Amazon or Overstock? The government may be collecting data on your sales from the marketplaces you work with.

With advances in technology, any industry with readily available third party reporting can be on the hit list for state revenue departments.  Many states have figured out a way to quickly and easily pull records from various sources and compare them against a company’s sales and use tax returns.

For large big-ticket items, most states revenue departments are tied in with agencies that check products that cross state lines.  If a revenue department gets wind of a big ticket tax free sale coming into its state, then the selling company can expect an audit notice.  In addition, most states have agreements in which if an item is reported as exempt in their state, then they inform the state it was shipped to that it should be taxable from the seller’s perspective in the destination state.

This is where online sellers often run into trouble with sales tax audits.

Audit Trigger: Many Sales Tax Exempt Sales
Disproportionately high exempt sale ratios are another popular way for companies to get flagged for audit.  State agencies often have an “acceptable range” of exempt sales for particular industries.  If companies report exempt sales outside of that range, then there is an increased probability of receiving an audit notice.  Many companies have legit reasons for high volumes of exempt sales.  For example, a company might:

  • ship a high volume of its sales to another state
  • sell a high volume of a particular product
  • have a high percentage of sales to a tax-exempt customer(s)

All are legitimate reasons to classify a sale as an exempt sale.   Despite correctly reporting the exempt sales, the retailer is likely in the agency’s crosshairs for an audit.  In these situations, it is incredibly important for a company to retain the documentation to prove the exemption.  This is a recurring issue for online retailers in particular.

Audit Trigger: Certain Susceptible Industries
There are several other ways in which a company can get flagged for audit.  Companies that are in an industry with a tradition of under reporting are often low hanging fruit for state revenue departments.  Other companies that have third party reporting connections are also frequently audit, such as car dealers tied with DMV and c-stores, liquor stores, and restaurants with ties to alcohol and tobacco.  States also often audit industries with high use tax exposure such as real property contractors.  Therefore, if you are in these industries, it is critical to comply with your state’s sales and use tax law.

Did YOU Receive an Audit Notice?
If you or your client’s company receives the feared audit notice, it is likely advisable to have an experienced tax professional at your side.  Knowing how to handle an auditor, what they are entitled to, and what to provide is often a result of experience dealing with state tax audits.  It is also worth pointing out that the gritty nature of a sales and use tax audit differs greatly from a federal income tax audit.  Therefore, a sales tax attorney is likely the better choice.

Do you have questions about sales tax audits? Start the conversation in the comments below.

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