Managing the sales tax audit process

When the audit notification arrives

It’s important to consider the delivery method of audit notifications, whether physical mail or electronic notification, as both can negatively impact the ability to meet audit deadlines. Generally, the deadlines are based on the issue date of the notification, not the taxpayer’s receipt of it.

Upon receiving an audit notification, it’s crucial to read everything, including attachments, to understand the scope of the audit and related requirements. The notice should make the process clear, including essential dates and deadlines. It should also cover the kinds of data auditors will want to see.

Once you understand all the requirements, assess your tax profile, internal team, skillset, and capacity to handle the specific audit. Locate where all data resides, the IT resources needed to acquire it, the operational resources to understand its use, and whether your tax advisors should be involved.

Crucial documentation needed for the initial audit phase

The documents you’ll want to collect vary by type of audit, but in general, here are the ones to gather:

• Tax returns and workpapers covering the audit period
• General ledgers
• Chart of accounts
• Sales journals and sales summaries
• Transaction reports
• Use tax accrual data
• Reconciliations
• Exemption certificates

Early preparation is key

Providing well-organized documents that are easy to understand can help ensure a smoother process. Be prepared to produce additional records upon request. Make sure you’re comfortable with any information shared — once the tax auditors have it, you can’t take it back. Ensure the information you provide is correct because incorrect information will create skepticism about the quality, accuracy, and completeness of your processes and potentially lead to adverse findings.

If some of the requested information seems irrelevant, ask why those documents are being requested so you can adjust to the scope, depth, and breadth of the request. This step will make it easier to accommodate their request while not providing them with unnecessary information.

The best audit is the one you perform: Conduct internal or self-audits regularly

Preparation is crucial for successfully managing a sales tax audit. Conduct self-assessments to identify potential risk areas, remediate issues, and ensure your systems can efficiently process and collect all required information. During this process, you should examine a wide range of information, even some that might not seem immediately obvious, including:

• Reporting inconsistencies, sales tax reconciliation differences, unusual sales tax calculations, sales tax payment fluctuations, sales tax calculation anomalies, special events such as disasters or business interruptions that may impact traditional tax processes, etc.
• Sales tax obligations that result from or after:
  • Mergers
  • Acquisitions
  • Newly opened facilities
  • Business process changes
  • Divestments
  • Capital expenditures
  • Operational expenditures

Data and document management strategies

The ability to produce audit data quickly saves time, strengthens your audit defense, and protects your organization’s bottom line. Audit requests can be complicated and time consuming. Using technology can mitigate the impact of a sales tax audit by employing automated processes to determine and calculate taxes and apply rates in real time. This method lets you quickly retrieve audit-ready data with just a few button presses, further enhancing your compliance capabilities.

Advanced indirect tax reporting and analytics software allows you to generate reports and fulfill sales tax audit requests quickly and consistently by enabling you to:

• Efficiently and effectively locate taxes at the line-item level that the jurisdiction has collected
• Export detailed transaction-level audit data to other file formats
• Create custom ad hoc audit defense reports

With a centralized tax data warehouse, indirect tax teams can control tax reporting, quickly find data, and have greater confidence in reporting and compliance processes.

Tax audits are never fun, but they are inevitable. So, it’s beneficial for you to consistently ensure that your organization has audit-ready systems and processes. You can achieve this by conducting bi-annual certifications to analyze your processes and verify they are SOX compliant.

Auditors are humans, too

Being friendly and professional and treating the auditor as a fellow human can benefit you during and after the auditing process. First impressions matter, so it’s important to greet the auditor properly and make time for them without seeming put out. Find a well-lit place for them to work that is conducive to getting work done.

Ideally, after a few meetings with the tax auditor, your team will have a good sense of critical issues that may arise in the audit. The tax team should also have a good feel for how strong the company’s defense is, for example, availability of documentation, validity of tax positions, errors, etc., for any audit findings.

Maintaining communication

Work with the tax auditor early on to create a joint work plan that outlines when documents are due and when they will complete their findings. That way, if the tax auditor takes longer than promised, you have documentation for their supervisor, which might help you avoid interest and penalties for those extra days.

Providing requested information

At this stage, there is typically a period of information sharing during which the tax auditor requests information to clarify questions. If they ask about missing documents or assert that tax was collected but not remitted, don’t take it as a personal insult or accusation. Don’t withhold information or create unreasonable delays, as that might make the tax auditor dig deeper and work harder to find potential discrepancies or errors.

On the flip side, don’t overshare, either. Don’t provide records or details they didn’t ask for; this complicates the process, opens the door for miscommunication, and, potentially, larger assessments.

Strategies for streamlining sales tax audits include:

• Disclosing known errors to the auditor up front
• Treating the auditor with respect
• Assigning one person from your company to manage the relationship with the auditor
• Asking the auditor for updates during the process
• Negotiating with the auditor before the final assessment

Additional tips

Ask for all information requests in writing, and don’t put people in the same room with an auditor. Both policies help reduce miscommunication that could make the auditor dig a little deeper.

Inform the floor and tax department that a tax auditor is onsite so people don’t discuss company matters in or around the tax auditor. Don’t leave files out or put tax auditors in a storage room with files.

Understanding tax auditor expectations

The tax auditor isn’t your opponent but does represent the taxing authority and its priorities. They’ll review your records over days, weeks, or months to discover oversights or fraud and to ensure compliance with tax laws. Their goal is to increase revenue for the state and apply penalties when a business owes taxes.

The job of a sales tax auditor includes:

• Uncovering transactions with zero tax charged over several months
• Examining discrepancies between primary-source data and sales tax returns
• Searching for mistakes, errors, and omissions in data
• Ensuring that the appropriate amount of tax was charged and paid on purchases
• Ensuring appropriate taxes are charged on shipping
• Reviewing sales tax exemption certificates for resales

How to respond to preliminary findings

When the tax auditor presents their findings, go through them line by line to see if you agree. If you agree, it’s time to let the business know to cut a check. If you disagree, go back to the tax auditor before they finalize their findings to discuss what can be adjusted before submission and negotiate on gray areas where there might be refunds to offset underpayments. You’ll likely have to chase down more documents to see if you have additional information that might change the findings. For example, perhaps they missed some exemption certificates. Set up an appointment with the tax auditor to present your case.

Post-audit activities

Review the findings thoroughly and develop a plan to rectify the identified issues to prevent those same issues in the future — because if you receive an assessment, you can expect another audit. This process requires organization-wide coordination and internal reviews to discuss findings.

Then, take steps to resolve any identified compliance problems — another effort that requires the entire company. Use the insights gained from this audit to help avoid or improve future audits, leveraging automation and artificial intelligence (AI) to analyze historical results and current transactions. Automation can also assist in overcoming resource limitations by identifying and fixing errors and preventing them in the future.

This exercise is akin to due diligence, where you use past data to anticipate future issues.

Navigating the appeals process

If you disagree with the audit's findings, you can discuss your rationale with the tax auditor and hopefully come to an amicable agreement that results in an adjustment to the penalties, interest, and fines.

This step is where the professional, cordial relationship you established with the tax auditor at the start comes in handy; they may be more willing to work with you. If there’s still a disagreement, you can escalate your conversation up their chain of command.

If that doesn’t work, you can file a formal appeal of the audit findings. Your organization must have the invoices or exemption certificates to prove to tax auditors that their assessment is invalid to contest a sales tax audit over documentation issues. Even if you have this documentation, consider the effort and cost necessary to defend your position.

Before contesting a sales tax audit, some general factors to consider are:

• Likelihood of success. Do you have the necessary documentation, and if so, is it sufficient to ensure victory?
• Cost-benefit analysis. Consider advisory and legal fees; internal costs such as time, money, and effort; and other ancillary expenses to contest the audit. Will the reward outweigh those costs? If so, by how much?
• Other business factors. Would losing jeopardize some other area of the business? Do government contractors bid in that jurisdiction, for example? Or are there other areas beyond tax where perfect compliance is a must-have qualification for doing business?
• Negative publicity. Might contesting the audit result in bad publicity that affects other business areas or tarnishes the company’s reputation? Does that potential cost outweigh the value of the audit liability in question?
• Future impact. Would an adverse decision now set a bad precedent and have worse repercussions in future audits or capital projects?

The best way to successfully appeal a finding is to use the state’s guidance to show why it’s incorrect. Show them letter rulings and make basic arguments based on facts, not complex legal positions. You control the facts, so use them to negotiate more favorable terms for your organization.

Data analytics and visualization technology can be helpful here. Solutions like Alteryx allow organizations to analyze millions of data records at lightning-fast speeds. This tech, for example, can help you prove that an event they flagged as a deficiency is isolated, and they inappropriately attributed it to every transaction.

When appealing the findings, use all available resources to strengthen your case. Include your government affairs, legal, and tax offices to ensure your complaints are clearly heard, understood, and given fair consideration.

If all else fails, legal proceedings are an option. But these carry financial and possibly reputational costs and will put your company in the spotlight for supposedly not paying taxes, which is never a good look to the public.

The importance of technology in audits

Automated tax technology and robust tools for tax analysis can help you gather and share data, enabling you to provide information to auditors quickly and efficiently. Using structured, standardized reports instead of manually compiled ones helps build trust and confidence in both the process and the data, ensuring the information is accurate and not manipulated.

By replacing manual processes with automated indirect tax solutions, you minimize the potential for human error and omission, leading to reduced operating costs. Tax technology can also lower the risk of an audit, saving your business time and money in the long run. When your business is audited, indirect tax software allows you to respond to audits faster and more accurately.

Before, during, and after an audit, technology can help by providing visibility into data and helping uncover errors or defects that need to be corrected. Here are some tools you’ll want to consider:

• ONESOURCE
• RIA Checkpoint
• Alteryx
• Oracle Business Intelligence Enterprise Edition (OBIEE)
• QuickSight
• Qlik
• Power BI
• Tableau

Tax software like ONESOURCE Determination allows companies to automate indirect tax calculations on transactions without the headache of managing and maintaining an in-house solution or reporting system.

Meanwhile, AI can reduce the time it takes to perform tasks while leaving tax professionals better informed about tax status. It frees them for higher-value, more intellect-intensive work, which can solve internal inefficiencies. Machine learning, generative AI, and advanced data analytics algorithms can help tax professionals deliver accurate and timely calculations, tax filings, and reports while creating clearer visibility to help ensure compliance with tax rules.

Companies should adopt real-time reporting because it provides instant access to your company’s transaction data to speed up the process.

Building a proactive audit defense strategy

Congratulations! You’ve survived your audit. Now it’s time to prepare for the next one. Here are steps to take in your preparation:

1. Create a tax audit manual to facilitate sales tax audit management. This reference guide should include all data sources, including current internal stakeholders and their contact information, relevant tax codes, historical results, a roadmap of best practices, tips and tricks, and the process for working with the state.
2. Perform periodic reverse audits on a predefined schedule — such as quarterly — to detect anomalies, errors, and areas of concern to be resolved before external audits.
3. Deploy technology to help audit teams prepare for an audit. Proactive analysis is challenging without the right technology in place. Fortunately, there is a wide range of tools and technologies you can implement at any time.
4. Automate your compliance functions to eliminate much of the laborious work of sales and use tax management and help protect against adverse audit filings. Automated solutions also improve efficiency by assessing, calculating, and accruing sales and use tax when invoices are processed initially.

In conclusion

A sales tax audit is inevitable. But with the right approach, you have nothing to fear from the process. This approach involves promptly responding to notifications, using technology to streamline data collection, providing only requested information, and putting everything in writing throughout the process.

If you disagree with the findings, carefully consider whether the cost — in money and reputation — is worth appealing or even initiating legal proceedings. Use the insights gained from the audit to address any compliance issues and prepare for the next inevitable audit. Stay informed about tax legislation and audit practices to stay ahead of tax trends.

Having a technology infrastructure in place can help you automate many parts of data entry to ensure you’ve paid the correct amount in sales tax and, therefore, avoid penalties from an audit. The right technologies and tools can make an audit just a nuisance instead of a costly, painful event.

Remember the importance of proactively preparing for a sales tax audit by implementing best practices to reduce errors. It may seem like common sense, but prioritizing prevention is critical to effectively readying your company for potential audits. Always make it a top priority to ensure your sales tax operations and compliance functions are audit ready.

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