As your business grows, so do your chances of facing a sales tax audit. Multi-state transactions can rapidly increase your collection obligations, incomplete tracking of tax exemption certificates can trigger big tax bills, and ad hoc attempts at compliance can raise your risk of an assessment following a sales tax audit.
Fortunately, you can take action now to reduce your risk of getting hit with penalties and fines in the event of an audit.
1. Keep your business contacts in context.
What sort of contacts or connections does your business have with other states? The types of activities your company engages in define your obligation to collect sales taxes in remote states. These connections comprise “nexus”, the term used to describe where you are obligated to collect.
Do you travel to trade shows and events? Does your business help customers install your products? Do you get customer referrals from a web link from an affiliate in another state? If you answer “yes” to any of these questions (or many others), you may have an obligation to collect sales taxes in a state besides the state your business resides in.
If you have nexus in a state but fail to collect tax there, state auditors will assess for back taxes as well as penalties and interest. Protect your business by paying close attention to state nexus laws, and be sure to register with each new state where you have nexus.
2. Keep your exemption certificates up to date.
Auditors focus on the proper and accurate management of exemption certificates. These are the certificates presented to you by your customers who claim to be exempt from taxes. Remember, your company is required to be certain the certificates you accept are valid and appropriate for the sales you make. If sales are exempted based on an invalid exemption certificate, your company is on the hook for the taxes.
Exemption certificates may be very broad or very specialized, they may be subject to expiration dates, and they are often easy to complete and file inaccurately. One thing is true of all exemption certificates: they represent the proof your company relies on to make tax exempt sales. Naturally, they are an important piece of any sales tax solution, but especially so for companies who make many exempt sales.
Missing, inaccurate, or incomplete certificates spell trouble for businesses because they are invalid and will not support an exemption from tax. Make sure that you keep all exemption certificates accurate and current. Update certificates when they expire, or when customers change names, get acquired, or even go out of business.
3. Keep in mind the rate.
Finding sales tax rates may seem trivial, but applying the wrong rate to a large number of transactions can set you up for audit penalties. In a few states, rates are fairly consistent, but in a majority of states, rates may vary from address to address.
One major “gotcha” for businesses is the realization that sales tax rates aren’t tied to ZIP codes. In fact, there can be multiple tax rates in a single ZIP code, or multiple zip codes with the same rate. If you’re using a tax calculator to get your rates, it’s best to use one that relies on geolocation, rather than ZIP code alone.
4. Keep to the path you have established.
In the end, your sales tax compliance solution is an amalgam of many decisions. Remember though, while state by state rules may vary, you must be consistent in the way you adhere to those rules.
Establish procedures that solve your sales tax challenges accurately, consistently, and remain eminently repeatable. Consistency may be the hobgoblin of a petty mind, but it sends a message of competence and reliability when it comes to sales tax audits.
Questions? Comments? Please feel free to submit your questions or comments below - as well as suggestions for other favorite "tips" to avoid sales tax audit assessments.
Other recent “Audits and Sales Tax” posts by Shane Ratigan:
- Audits and Exempt Sales: “Good Faith” vs “Four Corners” Standards
- Avoiding Sales Tax Audit Assessments: 4 Tips