Avalara provides a number of helpful products to try and navigate complex sales tax transactions and interactions between businesses and government through automated sales tax software. Avalara’s software covers national and international activities. However, there are a number of issues you need to consider if you go under audit by a state’s department of revenue.
While you might have used Avalara’s products to accurately report and file your sales tax returns, the Department of Revenue’s (DOR) auditor likely will be approaching your audit with a presumption that underreporting exists and he/she is going to find it. This means you are being considered “guilty until you prove yourself innocent.” That is not a welcome feeling.
However, being aware of the situation and what to expect can provide a level of comfort going into the otherwise uncomfortable process of a sales tax audit. To be the most prepared/comfortable going into the sales tax audit, you will need to know the level of two things: your exposure and your documentation.
Exposure applies to what levels of tax are you subject to and the extent of any possible mistreatment or mischaracterization in handling those transactions. Typically, the notice of audit will identify the type of tax at issue. Statistically, sales tax audits are the most common as they impact most taxpayers to the highest dollar amount. Exposure is going to apply to sales and purchases. Purchases generally can be broken down into general purchases and fixed assets (in Florida and some smaller jurisdictions, there Can also be commercial rent issues/exposure). To evaluate your exposure, you need to examine the types of sales/purchases you have and make sure you have properly recorded and reported those transactions. I will assume that any tax that might be due has been paid. There is no need to go into the collections side as that would be best served in a separate article.
When you have identified the types of purchase and sales transactions your business has, then you need to verify they have been treated properly. Most states have a myriad of intricacies that carve out exceptions to general rules of taxability. Generally, statutes will create “small” categories of transactions that otherwise would be taxable but for the specific exemption. But, this also occurs for exemptions as well. Many states also carve away exemptions from certain transactions to make them taxable in contrast to the otherwise general nontaxable treatment for the sales/purchase transaction.
Hopefully you have identified that your exposure is zero. That is not the end of the concern though. It is important to know the basis of your treatment – especially when the transaction is not taxed. Most DORs will hold the audited entity responsible for tax due on the transaction. This means you, the business, are held accountable for either sales or use tax that might be due. In other words, the DOR will audit you for tax that should have been paid or collected so that you cannot claim another entity’s responsibility as a defense to the payment of uncollected or unremitted tax. To avoid this unfairness, documentation is key. You have to document the transactions – and especially the basis or support for why you did not collector remit tax. These “administrative” requirements have lead to large amounts of tax being due for businesses that rightfully did not collect tax – but just couldn’t fully document the reason for doing so.
It is especially important to identify any documentary deficiencies as early as possible. Time is your friend here as you can work to get the documentation replaced or work on “alternate” sources to support the proper tax treatment. DOR audits routinely take the position that you owe tax if you cannot prove the exemption or prove you properly collected/remitted tax. Most instances involve not collecting tax on a sale or paying tax on a purchase based on a statutory exemption. This is particularly costly if you operate in a competitive low margin industry as subsequently covering a 6 – 7 % discrepancy can turn a profitable project into a loss.
The exposure and documentation issues have only gotten more important in our post-Wayfair world. The recent Wayfair case redefined sales tax nexus and is impacting more and more businesses as more states are enacting legislation similar to that in the Wayfair case.
Nexus is the basis or connection between a business and a state that creates the obligation to register, collect and remit tax to a state. This necessarily involves a reporting function in filing tax returns. Filing tax returns then opens the door to a subsequent audit to confirm the accuracy of those returns. Since physical presence is not longer the practical test to evaluate nexus, it is important to make sure you are aware of your exposure – even before the statute becomes effective. Statutes adopting an economic presence as a basis for nexus typically provide a period of time before they become effective. However, states that have not done this are starting to move more quickly to join those that have as those states don’t want to be the “last one to the table.” This means the lead time is shrinking.
While audits likely will take time before they start getting issued to look at periods involving economic nexus statutes, you have to think that aggressive states will still audit larger entities that report early. These aggressive DORs might be willing to gamble that entities that have to report might have exposure under the state’s preexisting statutes. As those aggressive DOR’s generally “teach” their auditors to have aggressive attitudes toward taxability, it is valuable to be on the defensive early to limit any possible exposure to the largest degree possible.
So, if you get a sales tax audit notice and realize that your accounting software might not have you fully prepared for the examination, then reach out to get help. You are not alone and don’t have to gamble that you will get the one “fair” auditor who isn’t just there to viciously and rigidly enforce administrative record keeping requirements while turning a blink eye to the economic reality of your operations. As noted above, you can even proactively get help to check your compliance and reporting accuracy before an audit or before a state’s effective date for economic presence for nexus. To clarify, the economic nexus issue will be enacted by your customer as you will selling “into that state” which means you have to worry about compliance based on your customers and not necessarily just your business or employee locations. If this is the case, then feel free to reach out to us to help evaluate your exposure and risk. Our free initial consultation means you speak with us without any initial cost or obligation to hire us. We are here to help and look forward to speaking with you to assist in any way possible.
About the author: Mr. Parker is an associate in the Law Offices of Moffa, Sutton, & Donnini, P.A., based in the firm's Tampa office. Mr. Parker's practice concentrates on sales and use tax and includes state tax audits and controversies proceeding from audit through administrative litigation involving sales and use tax and all other state taxes including reemployment tax, communication service tax, cigarette & tobacco tax, motor fuel tax, and Native American taxation. Mr. Parker received his accounting degree, law degree, and L.L.M. in Taxation from the University of Florida. You can leave more about Matthew on his firm bio.
At the Law Office of Moffa, Sutton, & Donnini, PA, our primary practice area is Florida taxes, with a very heavy emphasis in Florida sales and use tax. We have defended Florida businesses against the Florida Department of Revenue since 1991 and have over 100 years of cumulative sales tax experience within our firm. Our partners are both CPAs/Accountants and Attorneys, so we understand both the accounting side of the situation as well as the legal side. We represent taxpayers and business owners from the entire state of Florida. Call our offices today for a FREE INITIAL CONSULTATION to confidentially discuss how we can help put this nightmare behind you.
ADDITIONAL RESOURCES
Preparing your Online Business for an Out-of-State Sales Tax Audit, published July 2, 2019, by Jeanette Moffa, Esq.
Out-of-State Sales Tax Audit Defense, published June 18, 2019, by Jeanette Moffa, Esq.
Florida Sales Tax Informal Written Protest, published November 17, 2018, by James Sutton, CPA, Esq.
Protest a FL Sales and Use Tax Audit, published August 8, 2019, by Matthew Parker, Esq.