How to prepare for a sales and use tax audit

Photo: Waldemarus / iStock / Getty Images Plus / Getty Images

At some point, your company probably will be selected for a sales and use tax audit, and you need to be prepared.

For pest management professionals (PMPs) operating in states where services are not subject to sales tax, you may think you have dodged a bullet. Not true!

While the services you sell may not require you to collect and remit sales tax, many of the products you purchase for your office, your inventory and your operation are subject to use tax. And use tax falls within the guise of this type of state audit.

Why were you chosen?

There are many reasons why a company is selected for an audit. It could be that the state has deemed our industry high risk. It could be that your trucks were spotted in a nearby state in which you have not registered for taxes. It could be that one of your suppliers was audited, and your company was flagged. Or it could be random.

No matter the reason, make sure that once you get the “Request for Audit,” you understand the audit process, hire a certified public accountant (CPA) with industry experience, and be prepared for a little old-fashioned aggravation.

What information will the auditor be looking for?

A sales journal will be required where the auditor will make their selection, looking for sales invoices evidencing what was sold and whether sales tax was charged when required. If not, are there resale or tax-exempt certificates on file? If no tax was charged when required, it must be paid now. In addition, this will add to the error rate, discussed below.

Next, a purchase journal will be required that includes all vendor purchases made by your firm in order to select vendor invoices to test if sales tax was properly charged to you or if you accrued and properly paid use tax on purchases you made during the ordinary course of business. This one becomes difficult, especially for those who make most of their purchases on credit cards, because the original invoices evidencing sales tax paid aren’t usually available and will need to be secured or added to the error rate, discussed below.

Invoices and fixed-asset purchases during the audit period will be examined to ensure sales or use tax was remitted. When these items are purchased out of state, you can run into trouble because the seller doesn’t charge the tax — and you, as the buyer, often don’t accrue and pay the use tax.

Finally, you will be asked for financial statements, bank statements and tax returns, including income and sales and use tax. These items will help confirm that everything is being reported and that all sales and use taxes are accurately remitted.

What happens if the auditor finds issues?

As the auditor looks at the material you provide, some items may be tax-deficient. The auditor will look for tax, penalties and interest on those amounts. But that’s not all.

Remember the error rate mentioned above? Well, if in the sample the auditor establishes — for example, a 5 percent error rate, meaning 5 percent of the invoices examined should have had sales or use tax accrued and paid — then that 5 percent will be applied to the entire period open by statute (usually three years). This can become extremely costly, and all options, including conducting a full-blown audit for the entire period open under statute, may be wise. Speak with a qualified CPA or tax attorney to determine the proper course of action.

Dealing with a sales and use tax audit can be stressful. However, being prepared and understanding the process can help you navigate it smoothly and minimize potential issues.