Sales tax has evolved a lot in recent years. So has the sales tax audit.

Examiners can still show up and go over your books in person, and tax agencies will still send audit notices via snail mail. And why not? According to the Tax Policy Center, money collected from sales tax can be the leading source for many jurisdictions, constituting 25% to 35% of a state’s revenue. 

Many events can ignite a sales tax audit. Bad luck for one, or a customer of yours undergoing their own audit might produce one of your invoices, resulting in the auditor possibly contacting you for an exemption certificate or other documents. An audit of one of your suppliers could turn up one of your exemption certificates for a transaction that the auditor may think is taxable. Your industry or competition could be factors – as could a whistle blown by a disgruntled former employee.

What if you get flagged? Punishments can range from assessments, penalties and liens to use of collection agencies for past due taxes. You could be looking at considerable expense to your business.

But have sales tax audits changed over the last few years, through the pandemic and the introduction of economic nexus in 2018? Are they happening more often? Are they being conducted differently?

On the rise

In TaxConnex’s recent market survey, more than one in four (26.7%) top finance professionals reported seeing an increase in state sales tax audits in the past two years. Almost half (48.5%) of respondents expect sales tax audits to become more frequent in 2022-23, and nearly one in five (18.5%) cite being audited as one of their chief worries for this year. 

The Sales Tax Institute reports that Maine, Illinois, California, Massachusetts, Wisconsin and Washington have been the most aggressive states in sending notices and audit requests since the U.S. Supreme Court’s 2018 Wayfair decision opened the door for states to enforce economic nexus.

California audits about 1% of active accounts each year, “concentrating on those most likely to be inaccurate in their tax reporting.” In FY2019-20, the state’s sales and use tax audit program found $576 million in tax deficiencies. One of the biggest areas for non-compliance in California: out-of-state vendor purchases and assessments for purchases of tangible personal property from out-of-state vendors not collecting state use tax.

In an unpredicted twist, the pandemic is showing jurisdictions how lucrative sales tax can be. There’s no reason to believe more states won’t jump on the sales tax audit bandwagon.

Increased Questionnaires

Many states send or otherwise make available sales tax nexus questionnaires - detailed questions to determine a company’s taxable activities.

Examples of questions pertaining to economic nexus: How are sales made into the state? Did your company or affiliate actively solicit sales into the state? What are your gross receipts from sales of tangible property during the last five years? How are deliveries made into the state?

If you receive a state nexus questionnaire, don’t ignore it – but do handle with care.

“In general, the questions that are asked on a nexus questionnaire can be quite broad,” writes the Arizona accounting firm Henry+Horne. “The question may be stated in such a way that may make you think the response should be a simple ‘yes.’ However, a more accurate answer may be ‘yes, but . . .’  In other words, if you answer yes to a question without providing further explanation, it is easier for the state to conclude that your company has nexus.”

The path to audits is getting sneakier. The Journal of Accountancy recently wrote that state auditors have been known to visit an e-commerce site and place an order to see if the seller charges sales tax. If no tax is charged, a questionnaire is then mailed to the seller. To find economic nexus, the Journal report adds, auditors are now also monitoring companies’ advertising or notoriety in a state, purchase records of in-state taxpayers and, to find sellers, federal Form 1099-MISC.

One begets the other…

Could registering with one area of a state impact your chance of getting audited. Previously the answer to this would have been, probably not, but that answer is slowing evolving.

In the sales tax world, for instance, sales tax registrations generally refer to the authorization to collect sales tax in a particular jurisdiction. This type of registration occurs at the department of revenue (DOR) or a similar agency. Once a valid application has been submitted and the applicable fee or bond paid, the jurisdiction will issue a sales tax license.

In the past, when paper-based applications were the norm, a business could complete and mail the application along with their fee or bond to the DOR. Many of these applications would also ask for the Secretary of State (SOS) identification number. With the paper-based application, a business could leave this line blank and in most situations, a sales tax license would be issued without a question. Now that applications have been moved online, many of the states require an SOS identification number before the application can be submitted. It’s another hoop to jump through to maintain compliance.

Going Virtual

Then there’s the cutting-edge concept of virtual audits – quicker, paperless, and fueled by quicker exploitation of data that’s already in a tax jurisdiction’s system. No longer do you have to worry about an auditor showing up at your door, or alerting your office that there will be auditors in the office over the next week. Due to the pandemic, virtual audits have increased significantly.

“Virtualizing audits enables significant increases to efficiency. In the world of tax administration, for example, it could allow auditors to tap different data sources to select audits more accurately based on the level of risk, and to use new tools to automate the repetitive tasks of an audit,” writes the consultancy CGI. “Auditors … can draw on artificial intelligence to deliver a higher quality of audit evidence [and] use big data analytics to better identify fraud in financial or tax reporting.”

No travel and more data at their fingertips could spell trouble when wondering if your business could be next for an audit.

Is there a definite answer to whether audits are increasing or becoming more difficult, as usual, the answer is, it depends. An audit can be managed effectively in a way that causes little downtime, but your best course of action is to have sales tax in order before an audit notice arrives.

TaxConnex can help you prepare for, and assist you with any sales tax audit by ensuring you are in compliance before the audit notice arrives. Contact us to learn about the latest developments in sales tax and what they mean to you and your company.

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Robert Dumas

Written by Robert Dumas

Accountant, consultant and entrepreneur, Robert Dumas began his public accounting career on the tax staff at Arthur Young & Co., followed by a brief stint at Grant Thornton. In 1998, Robert founded Tax Partners, which became the largest sales tax compliance service bureau in the country, and later sold it to Thomson Corporation. Robert founded TaxConnex in 2006 on the principle that the sales tax industry needed more than automation to truly help clients, thus building within TaxConnex a proprietary platform and network of sales tax experts to truly take sales tax off client’s plates.