Eight Tips to Make Your Next Sales Tax Audit a Slam Dunk
In the spirit of March Madness, I am sharing my tips to help make your next sales tax audit a slam dunk.
I’m only 5’3” tall with no expertise in basketball, but I do have 25 years of coaching experience in sales tax for manufacturers.
Recently a number of clients have called me because they are getting audited by various states (California, for example, is keeping everyone busy with their sales tax audits!). I’ve observed that assessments are often simply the result of missing or invalid documentation, not incorrect interpretation of sales tax regulations.
So here’s my Elite Eight tips to help you come out a winner for your next sales tax audit.
Tip #1: Missing AP Invoices
I’m convinced a great big black hole somewhere in the universe contains every missing invoice an auditor has every requested. Unfortunately, most auditors penalize you for missing invoices with tax assessments.
When creating a statistical sample of purchases under audit, make sure you have a plan to deal with the inevitable missing invoices. Perhaps agree with the auditor to select a few invoices in reserve to replace the missing ones. Otherwise, you’ll be asking the auditor for a time out to make frantic calls to your suppliers tracking down old invoice copies.
Tip #2: Depreciation Schedules of Fixed Assets
Auditors often look to depreciation schedules to audit fixed assets. If you can’t tie every number to a specific purchase, the auditor likely is going to assess you tax on what is listed on the depreciation schedule.
My record-keeping tip: Set up a Fixed Asset File with copies of all invoices, journal entries, project requests and approvals. Keep all documentation that will support a tax exemption if one was taken. Collating this information together in one central file will go a long way to making the audit process run more smoothly. The auditors will have all the information they need to tie the purchases to the depreciation schedules.
Tip #3: Clear Paper Trails of Use Tax
Make sure that you can easily reconcile and recreate your use tax payables. I’ve seen far too often journal entries and manual adjustments made to correct use tax accruals prior to filing the return. In hindsight, several years later, no one can make heads or tails of the adjustments, and the returns are difficult and sometimes impossible to reconcile.
Tip #4: Exemption Certificates
For each exempt transaction made by your company, a valid exemption certificate from your customer must be on file. It sounds easy, but in reality, this is one area where companies need coaching to develop a good process. In preparation for an audit, many companies attempt to obtain exemption certificates from customers. Inevitably they run into problems. Perhaps the company is out of business or they discover the purchases should have been taxed.
My record-keeping tip: Before the audit letter arrives put some procedures in place to make sure your exemption certificates are well managed. Who is collecting them? Who is validating them? Who is handling the renewals? Where are they stored?
Also, conduct quantitative analysis to determine your company’s exposure due to missing exemption certificates. If this is one area where your company needs help, watch our webinar: Exemption Certificates: Getting Proactive with a Purpose.
Tip #5: Document Everything, Especially Audits
I have one client that created a master spreadsheet of all the audits that her company has undergone. This information includes the state, the audit period, the initial assessment, the final assessment, any overpayments applied to offset the assessment, the basis for the assessment (sales/exemption certificate issues; purchases/fixed assets; purchases/expenses) and any negotiated issues that were resolved in the audit. Now that’s a slam dunk! Not only does the spreadsheet provide a great replay of the company’s audit history, but it also showcases her audit proficiency and highlights her management of the company’s sales and use tax procedures.
Tip #6: Create A Plan for Improvement
If an audit or overpayment review indicates areas that need improving, create a playbook to address the problems. Does your staff need training on sales tax? Are exemption certificates missing? Do team members have a good understanding of when use tax is due? Do controls need to be tightened on exemption certificate management? A sales and use tax management playbook gives you a game plan that makes everyone accountable. Periodically spot check to see if processes are being followed and improvements are made.
Tip #8: Build a Team
On the surface, sales tax may not seem complicated, but imagine if every time a basketball team played in a different state they had to follow a new set of rules? Sales tax teams need to stay on top of different nuances between states and industry-specific exemptions, as well as a variety of legal entities and ERP systems. Line up a team of resources to ask for help, get opinions and brainstorm solutions.
A good team, good coaching, well-trained players and regular practice are the keys to having a championship sales tax season.