Understanding What Triggers a Sales Tax Audit
For many businesses, sales tax compliance isn’t top of mind… until an audit notice shows up. Unlike income tax, which often gets more attention, sales tax obligations can fall through the cracks, especially for companies operating across state lines or selling online. But state tax authorities are watching, and even minor missteps can lead to a closer look.
Sales tax audits can be triggered by various factors. Sometimes they happen randomly, such as being chosen through routine screening by state tax authorities. However, more often, audits result from specific red flags. Issues like filing inconsistencies, missing returns, significant fluctuations in reported revenue, or discrepancies between your tax filings and reports from vendors or customers can attract attention. Operating in multiple states without properly collecting or remitting tax can also increase scrutiny, especially as state laws around nexus continue to change.
Even honest mistakes can lead to a review. Knowing what might cause an audit helps you take a proactive approach to compliance and puts you in a better position if that notice ever arrives.
What Happens During a Sales Tax Audit
While each state may approach audits a bit differently, most follow a fairly standard sequence. Here’s how it typically unfolds:
1. Notification and Initial Contact
You’ll receive a formal notice (usually by mail) outlining the audit’s scope, time period, and the records being requested. An auditor will then reach out to schedule an initial meeting or request preliminary documentation.
2. Preliminary Review
The auditor will review your sales tax filings alongside key financial records to identify any inconsistencies or gaps. This may include checking for missing returns or comparing reported sales with internal records.
3. Fieldwork or Remote Audit
Depending on the situation, the auditor may conduct their review at your place of business or remotely. They’ll examine invoices, exemption certificates, purchase records, and sales data in detail.
4. Findings and Discussion
Once the review is complete, the auditor will present their findings. If issues are identified, you’ll have an opportunity to respond or provide additional context.
5. Final Assessment and Resolution
You’ll receive a formal report summarizing any taxes owed, plus interest or penalties if applicable. You may also be given a chance to appeal or resolve the findings through payment or negotiation.
Ultimately, the more prepared you are, the more control you’ll have over how the audit unfolds, and the fewer surprises you’re likely to face along the way.
Key Documents and Records You’ll Need
During a sales tax audit, auditors will expect access to a wide range of records to verify compliance. Having these documents organized and accessible can significantly reduce the time and complexity of the audit. Here’s what you’ll typically need to provide:
Sales Records
- Sales invoices
- Sales journals or point-of-sale (POS) reports
- Online sales platform reports (e.g., Shopify, Amazon)
Purchase Records
- Purchase invoices and receipts
- Accounts payable records
- Use tax records for out-of-state purchases
Tax Returns and Filings
- Sales tax returns for the audit period
- Supporting schedules and worksheets
- Proof of payments made to the state
Exemption Certificates
- Properly completed resale or exemption certificates for tax-exempt sales
- Renewed certificates as required by state law (e.g., Illinois resale certificates must be updated every three years)
- Certificate logs with dates and customer names
Bank and Financial Records
- Bank statements
- General ledger and trial balance
- Income statements and balance sheets
Business Registration and Permits
- Sales tax registration certificates
- Business licenses
Having this documentation ready (organized by year and clearly labeled) makes the audit process smoother and helps establish credibility with the auditor.
Common Mistakes That Lead to Penalties
Sales tax audits don’t always uncover intentional wrongdoing. In many cases, penalties result from avoidable errors or oversights. Here are three of the most common mistakes that can lead to issues during an audit:
Incomplete or Invalid Exemption Certificates
Failing to collect or properly document exemption certificates is one of the most frequent red flags. If a customer claims a purchase is exempt but you can’t produce a valid, completed certificate during the audit, you could be held liable for the tax. Keeping these records up to date and reviewing them regularly is key.
Misreporting Sales or Use Tax
Underreporting taxable sales, or neglecting to self-assess use tax on out-of-state purchases, can quickly lead to penalties. Auditors compare reported figures with internal records and third-party data, so even small discrepancies can raise concerns. Accurate, consistent reporting is essential.
Poor Recordkeeping
Disorganized or missing records make it difficult to support your filings. If the auditor can’t verify your reported sales, exemptions, or purchases, they may estimate liability based on incomplete information, often resulting in a higher tax bill. Strong recordkeeping is both a defense and a signal of credibility.
Steps to Take When Preparing for an Audit
Getting audited isn’t something most business owners plan for, but how you respond makes all the difference. Once you’ve been contacted, the priority shifts from daily operations to preparation. A measured, organized approach helps protect your business and makes the process far more manageable.
1. Review the Audit Scope
Read the notice carefully to understand the audit period, the records being requested, and any specific concerns. Knowing what’s being examined helps you prepare more intentionally.
2. Gather and Organize Your Documents
Pull together the records outlined in the notice, such as sales reports, exemption certificates, tax returns, and/or financials. Make sure they’re complete, clearly labeled, and easy to access.
3. Designate a Point of Contact
Assign a team member, or better yet, your accountant or advisor, to manage communication with the auditor. Having one person handle requests helps prevent confusion or duplication.
4. Reconcile Key Figures
Before the audit begins, reconcile your sales tax filings with internal records to catch any discrepancies early. This gives you a chance to clarify or correct issues before they become findings.
5. Consult Your Advisor
A CPA or sales tax specialist can help you prepare effectively, review your records for potential issues, and advise on how to respond to the auditor’s questions.
How a Trusted Advisor Can Help You Navigate the Audit
Facing a sales tax audit can be stressful, especially if you’re unsure what’s being asked or how to respond. That’s where the support of a trusted advisor makes a measurable difference. A CPA with audit experience doesn’t just help you gather paperwork; they help you interpret what the auditor is looking for, prepare documentation thoughtfully, and respond with clarity and confidence.
At DHJJ, we work closely with clients before, during, and after audits to reduce uncertainty and avoid unnecessary penalties. From reviewing exemption certificates to reconciling filings with financial records, our team brings a structured, strategic approach to audit readiness. Contact us today to learn how we can help support you through an audit process, or more importantly, help you build the right practices before an audit ever takes place.
