One of the last things you want to hear is that your company has been selected to undergo a sales tax audit. Being audited can be scary. But instead of feeling defenseless, there are steps you can take to manage the audit and take control of the process. I’ve assisted many companies with their sales tax audits over the years, and I’ve accumulated a lot of knowledge about the best practices in managing a sales tax audit.
The first step of any sales tax audit is being notified by the state that you have been selected for audit. Once this happens, you can start preparing for the audit immediately. Instead of throwing your hands up, this is your first opportunity to take control of the situation. For the period under audit, the first thing you’ll need to do is gather the relevant records. This blog post will outline what you need to do to successfully gather and prepare your records for a sales tax audit.
In preparation for the audit, the first thing to do is make sure that all the requested records as well as other anticipated records are available for the audit period. If the records are stored in a warehouse or off-site, you’ll need to determine how long it will take to retrieve any off-site records. The records may not be instantly accessible, so you’ll want to start this process early.
So what types of records will the auditor look for in a sales tax audit? The auditor will probably include a list in the notification letter. There are the ones that are normally requested:
Once you’ve compiled the records, you’ll need to evaluate the condition and completeness of the records. If you are finding holes in the records, you’ll need to track that information down. Because of the time this may take, you’ll again want to start this process as soon as possible upon being notified of the audit. Keep in mind that for expense and sales, a sample is usually the approach so you might not need all the records. But, knowing you have the records helps you prepare for the sample selection.
After gathering and reviewing the records, you may identify issues. These should be addressed prior to the auditor’s arrival and may need to be discussed with the auditor during the determination of audit procedures. The following are potential record issues:
The reason you want to be aware of these issues is because they may affect any sampling procedures performed by the auditor. The auditor will need to trace a transaction and, if taxable, trace the tax paid or collected on the transaction. If there are issues with records such as destructed records, you’ll want to come up with alternative options to discusswith the auditor. With electronic records, this audit trail may disappear so the auditor will need to review the taxpayer’s procedures on paying or collecting the appropriate taxes on these types of transactions.
Electronic records, where no paper exists, can put the taxpayer under additional scrutiny by the auditor. The taxpayer must have good internal controls when faced with an examination of electronic data. Certain functions should be scrutinized by the taxpayer so that the electronic data will be accepted by the taxing authorities such as: access authorization, security codes, system access and data access logs, regular review of logs, preservation and security of data integrity of archival records, etc.
In preservation of electronic records, transparency is critical for the taxpayer. Preparation of a manual on systems operations and data retrieval will provide internal controls validation under audit. Knowing what type of information can be retrieved through query reports will help boost an auditor’s confidence in the electronic trace.
Once the records have been located, a brief review is advisable to identify any major exposure areas. An effort should also be made to obtain any missing or incomplete resale, exemption or direct pay certificates to support all tax-free sales.
It may also be a good time to consult outside advisors to discuss recent developments in the tax laws or to perform a review of significant exposure areas or potential overpayments or credits. You should also review tax returns and reconcile them before the audit takes place to ensure there was no tax collected and not remitted.
For more helpful information about audit defense, download the Sales Tax Institute’s FREE whitepaper: Best Practices for Managing a Sales Tax Audit. This free whitepaper contains valuable information that can help you proactively prepare for an audit, from before the audit to post-audit strategies.
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