Few things strike fear into a business owner’s heart like the word “audit.” If you stay in business long enough, chances are high that you will experience some type of audit, so it helps to be proactive and prepared — in this case, for a sales tax audit.
What is an audit?
A sales tax audit is the process of examining tax documentation from a business to determine whether that business has collected and paid the correct amount of sales tax owed to the state or city. An audit could occur if a tax agency suspects a business of underreporting its sales or if tax documents received by the state do not match what was reported to the Internal Revenue Service or another agency. An audit may also be performed as a routine check, not necessarily with suspicion of wrongdoing.
Why are audits often feared?
Most retailers are aware an audit will be time-consuming. Even if the business has the appropriate records, it can take time to compile, present and wait for the auditor’s review of the documents. If a business has not been keeping thorough and accurate records, this process can lengthen exponentially.
An audit is also invasive. Auditors will likely need to look at every facet of your business, regardless of if it is a good time for you or your company.
Zena Shah, chief financial officer of Galaxy Home Recreation in Tulsa, Oklahoma, remembers the first audit coming right after the death of her father-in-law as she and her husband were taking over the business. As the family was trying to grieve, they also had to contend with the audit, making the experience “painful” and “scarring,” Shah says.
While Shah was willing to share her experience, some retailers wouldn’t give their name or even location out of the concern of it raising the attention of their state’s revenue agencies. One retailer was, however, willing to share a few negative aspects of an audit, most notably referring to a recent auditing experience as an expensive “nightmare.”
Another retailer expressed frustration, saying audits can be simply a revenue grab for a state agency. Though most retailers try to collect and report sales tax correctly to avoid an audit or come through one unscathed, some describe the process of understanding tax requirements as confusing, uncomfortable and even unnerving.
Challenges in Correctly Collecting and Reporting Sales Tax
Retailers cannot control if they will be audited, but they can control if they are correctly collecting sales tax. However, this is not without its challenges.
First, a retailer needs to interpret tax laws and requirements and know the correct tax information for their specific situation.
“I think sometimes people go off of what other customers might be doing or their friends in business may be doing, and a lot of times until they’re audited, they don’t even know that they’re doing it wrong,” says Rachael Pritz, vice president at RB Retail and Service Solutions of Monroeville, Pennsylvania, a company that provides software and support to pool and spa businesses.
To avoid unintentional mistakes, Pritz recommends business owners review tax laws yearly and regularly check in with their accountants. Sales tax requirements can get even more complex for a company that has locations in or delivers to different jurisdictions. These distinctions and requirements can often be confusing to retailers or, at the very least, time-consuming to understand.
It is also important to know what is taxable and to be informed of tax exemptions.
“Sometimes labor is taxable, and in some states, labor is not taxable,” Pritz says. “Sometimes they need to pay tax based on whether they’re doing service at the customer’s home, and it’s a different tax if the customer’s coming in, and they’re paying sales tax for cash and carry items.”
Customers can also have sales tax exemptions, with some states allowing prescriptions for hot tubs, so retailers need to be mindful of what documentation is required to process these exemptions.
Being Prepared
Despite the challenges in collecting and reporting sales tax, there are several things a retailer can do to reduce the sting of a potential audit.
First, do your research in advance. Pritz recommends determining what taxes you need to be collecting and ensuring you’re registered with the state, or states if you’re operating in multiple places, taxing agencies.
Shah advises not just talking to state revenue officials or accountants but also having a personal copy of documents outlining the laws to defend the tax decisions you make.
“When you’re going through an audit, if there’s something that they take exception with, you have a document that they have published that you can then reference as to why you made the decision that you did,” Shah says.
If you’re still unsure after reviewing the documents, don’t be afraid to reach out directly, Shah adds.
“We read through the sales tax guides that they’ve provided, but we actually picked up the phone and called them … We have them confirm that sort of information for us, so we know we’re doing things the right way,” Shah says.
Beyond keeping copies of tax laws and requirements, it’s important to store records of your business transactions.
Keeping good acounting records and having all your invoices or receipts is going to be key because you have to have proper documentation. If you can’t prove it, you didn’t do it.”
Adam VanWagner, Master Spas
“Keeping good accounting records and having all your invoices or receipts is going to be key because you have to have proper documentation,” says Adam VanWagner, CFO of Master Spas in Fort Wayne, Indiana. “If you can’t prove it, you didn’t do it.”
A professional accountant can help with keeping records, and they can also provide advice and answers to your tax questions, VanWagner says.
A tax pro can also be beneficial when preparing for a season of off-site events. VanWagner recommends asking questions like, “These are the shows we have coming up, what’s that look like? Where do I need to remit tax? How much? Do I need to keep track of all the delivery locations and calculate the tax based on that?”
Spending money and time with a professional at the beginning of the year could protect a retailer in the long run.
Sales tax software can also be a helpful tool. A software program can help a business keep track of the correct sales tax percentages it should be collecting based on type and location of sale, and it can also provide helpful records and support in case of an audit or just for a business’s typical accounting needs.
Shah recommends “making sure you have a good software that you can rely on that ideally is a one-system software, so you’re not having to rely on human error.”
If a software program is not an option, it is important to keep backups. Storing physical files in a fireproof container is essential, Pritz says.
Another helpful practice is training your salespeople to be knowledgeable in both sales tax requirements and exemption options.
You can do all your research, set all the policies you want, but if a salesperson is not going to collect the right document or process the transaction correctly, then it’s all for naught.
Zena Shah, Galaxy Home Recreation
“You can do all your research, set all the policies you want, but if a salesperson is not going to collect the right document or process the transaction correctly, then it’s all for naught,” Shah says.
Finally, one of the most important tactics is to learn from experience. Shah and her team at Galaxy Home Recreation took what they learned from a previous audit and made changes that are benefitting them now as they go through another.
Two big changes that have made this second experience much easier are moving from paper records to an electronic system and instituting sales tax training for their employees, Shah says.
“Because of [the first audit], we became pretty strict about our sales tax policy, and so luckily, this audit has been a breeze. We have everything ready to file, and it took no time.”
VanWagner echoes the sentiment of being proactive and prepared, reminding retailers it’s not too late to start keeping good records and determining what is required for your business.
“The best advice I can give is: If you’re not keeping great documentation, and you’re not trying to reconcile this on your own on a normal basis, I would start now,” he says. “Be proactive going forward even if maybe you weren’t so proactive in the past.”