8 Ways to Lower Your Company's Tax Audit Risk
Managing sales tax collection, remittance, and filing may be one of the most thankless jobs in business. It’s comprised of countless tedious tasks—from determining correct rates and rules to managing exemption certificates—each of which needs to be meticulously managed. To get sales tax right entails enormous resources, especially if compliance is done manually. Yet getting it wrong can be even more costly.
What’s to be done? Read on to learn 8 ways to increase sales tax compliance and reduce your audit risk.
Understand the true costs of manual sales tax compliance
Small to mid-sized businesses generally spend between $63,000 and $68,000 a year on sales tax compliance, according to a 2014 survey by the Aberdeen Group. Despite that, a Wakefield survey found the average cost of an audit to be $300,000 in 2017.
Those figures have likely increased because states couldn’t require out-of-state businesses to collect and remit sales tax in 2014 or 2017. Today they can, and that’s made sales tax compliance exponentially more complex — and expensive — for businesses that sell across state lines.
Be prepared: Tackle sales tax compliance proactively
Most of us put off doing unpleasant tasks, even when we know there can be dire consequences. But putting off sales tax never ends well. Most states rely on sales tax revenue to fund essential services like education and transportation, so state tax authorities have a vested interest in capturing all the revenue they can. Thus, the audit.
Sales tax software puts businesses in the best possible position to deal with an audit. It provides a consistent, documented, and predictable process — exactly what state examiners want to see.
Forego the file cabinet: Store relevant documents in the cloud
Documenting sales and use tax collection and remittance is critical, according to a former deputy auditor of the Ohio Department of Taxation. “Without a process, it’s more difficult for a company to justify its calculations and payments.”
It’s hard to find a file cabinet with no misfiled papers, and just one misfiled document can lead to costly penalties. Storing documents in the cloud puts them at your fingertips. It pinpoints expiring or missing forms, facilitates reporting and analytics, and reduces both emotional and physical clutter (Marie Kondo would approve!).
Register with all the right jurisdictions
Most businesses get audited at some point or another, and not just by their home state; in fact, as many as one-third of all audits may be aimed at businesses headquartered in other states.
If you have business transactions in states where you’re not registered, the state can demand to see more of your records than if you were registered. In Ohio, for example, auditors generally examine four years’ worth of documented transactions for registered Ohio businesses; for unregistered businesses, they want to see seven years of transaction records.
You may never be audited. On the other hand, an auditor could call you tomorrow; and if you’re not registered where you should be, the audit is more likely be drawn out and costly.
Consistently remit the right amount of sales tax
Tax authorities don’t just want you to remit the proper amount of tax due. They expect businesses to be able to document how the tax was calculated.
How do you determine if a product you sell is taxable, and what rate applies? How often do you check to see if the rates or rules have changed? State tax computers tend to red flag reporting that appears to lack a consistent and verifiable process.
Understand the importance of exemption certificates and use tax
Every exempt sale needs to be validated in states where you have nexus, and exemption or resale certificates need to be stored in such a way that they can be easily managed and updated. They also need to be readily found in the event of an audit; improperly documented exempt sales are a common source of audit pain.
Likewise, consumer use tax tends to be easy pickings for auditors because it’s often neglected or mismanaged. In fact, it consistently tops lists of costliest compliance mistakes.
Automating exemption certificate management and use tax reporting can greatly reduce, if not eliminate, audit exposure for non-taxed transactions.
Know your nexus
The sales tax landscape is very different than it used to be. On June 21, 2018, the Supreme Court of the United States ruled that physical presence in a state isn’t the sole requisite for sales tax collection (South Dakota v. Wayfair, Inc.). States now have the authority to tax remote sales based on the seller’s economic activity in the state, or economic nexus.
All but three of the 45 states (plus Washington, D.C.) that have a general sales tax have adopted economic nexus since Wayfair. Each law is unique, as this state-by-state guide to economic nexus reveals. In other words, it’s harder than ever to determine where you have nexus, and you’re more likely to have nexus in more than one state.
Keep your finger on the pulse of sales tax
Sales tax laws have always been subject to change. Since the Supreme Court decision in Wayfair, they’re changing more frequently, and in more dramatic ways. If you do business in multiple states, you need to constantly measure your sales into those states to determine if you have nexus. Once nexus is established, you need to track different taxability rules, sales tax rate changes, filing deadlines, and more. If sales tax compliance was a time-suck before Wayfair, it’s exponentially more so now.
Relying on manual accounting solutions to deal with sales tax is no longer viable for growing businesses. The risks of falling out of compliance in multiple states are too great. Indeed, the Supreme Court itself noted in Wayfair that sales tax software can make it easier for businesses, especially small businesses, to deal with the burdens of sales tax compliance. From a cost-benefit perspective, automating sales and use tax compliance simply makes sense.
For more information about recent sales tax changes, check out Avalara’s 2019 sales tax changes mid-year update.