For businesses operating in multiple states, keeping up with State and Local Tax (SALT) compliance can feel like a never-ending puzzle. And when a notice for a SALT audit lands in your in-box, with its deep dive into your tax filings and business activities, it can all seem too much to handle. But with the right preparation and plan and partners to assist you, it’s possible to sail through the audit.
Understanding SALT Audits
In this article, we’re generally talking about a “SALT audit” as a thorough review conducted by state or local tax authorities in a given state to verify that businesses have accurately reported and remitted taxes, which can include sales tax, use tax, or income tax . Audits can also be related to payroll taxes or personal property taxes, but our focus in this article is on the sales tax audit.
Each state has its own rules, meaning that businesses operating in multiple states must navigate a web of differing requirements. An audit usually begins with a formal notice from the state, followed by the auditor’s request for records. The process can span weeks or months, depending on the scope of your operations.
This article breaks down how to prepare for a SALT audit, including the key phases to ensure compliance and avoid costly penalties.
Here’s what you can find out:
- Self-Audit (Regular Internal Audit) – Before the audit
- Organize Your Records: Ensure all tax and financial documents are accurate and complete.
- Assess Your Risk: Identify potential issues in your sales and use tax processes and proactively review and correct tax records
- Expert Assistance: Consult with a tax professional for guidance.
- Pre-Audit (Preparing for the Audit)
- Understand the Auditor’s Role: Engage respectfully and understand the audit process.
- Initial Request for Information: Prepare and submit required documents.
- Conduct Internal Preparation: Review records and consult with your tax advisor.
- Audit in Process (Navigating the Audit)
- Initial Meeting: Meet with the auditor to discuss the process and provide documents.
- Document Review: Auditor examines records for compliance.
- Sampling Techniques: Understand the auditor’s methods for sampling and the data that will be used to make the assessment.
- Post-Audit (Responding to Audit Findings)
- Review the Findings: Analyze the audit report and consider an appeal if necessary.
- Corrections and Compliance: Address discrepancies and update procedures.
- SALT Appeals: Follow state procedures for challenging audit results.
- Mitigating Penalties (Post-Audit Strategy)
- Penalty Abatement: Negotiate to reduce penalties based on good faith efforts.
- Managed Audit Programs: Consider self-audit programs to reduce penalties.
- Legal Considerations: Know your rights to appeal and seek legal recourse.
Not quite what you need? Let’s talk. Reach out to us at info@milesconsultinggroup.com.
Phase 1: The Self-Audit (Regular Internal Audit)
Much like a routine health check, conducting a self-audit on your multi-state SALT compliance can help you avoid surprises when an official audit takes place. Performing regular internal audits is the first step to ensuring that your tax records are accurate and that your business stays in good standing across multiple jurisdictions.
- Organize Your Records: Ensure that all your tax returns, exemption certificates, invoices, and general ledgers are in order. Multi-state operations require particularly diligent recordkeeping to track differences in tax rates and exemptions.
- Assess Your Risk: Perform internal reviews on key areas like sales and use tax, as these are frequent targets of audits. Review how your business manages exemptions and multi-state transactions.
- Expert Assistance: Engage with a tax professional experienced in multi-state SALT audits. A professional can guide you through identifying areas of potential exposure and recommend corrective actions.
At Miles Consulting, this is what we do. Contact us now.
How to Conduct a Self-Audit
A self-audit involves pre-emptively stepping into the auditor’s role to proactively identify and correct potential issues in your tax records. Here’s how to approach it by state:
- Review Gross Receipts:
- Untaxed Sales: Run reports to identify any sales on which tax was not collected or paid.
- Exempt Transactions: Validate that exempt sales are supported by proper documentation, such as valid resale certificates.
- Tax Treatment: Ensure that products are correctly classified as taxable or exempt, with appropriate documentation.
- Tax Reporting: Check your tax accrual accounts to confirm that collected taxes are reported and paid in a timely manner.
- Examine Purchases:
- Fixed Assets and Expenses: Run reports of fixed asset purchases and review expense accounts for potential unreported use tax.
- Inventory Items: Verify that you are not paying tax on items meant for resale, potentially uncovering refund opportunities.
- Implement Best Practices:
- After conducting your self-audit, establish written procedures to ensure accurate tax collection and reporting. Share these procedures with your team to maintain compliance.
Performing these tests requires an objective view of your sales tax processes and a good understanding of multi-state issues, including nexus, taxable variations by state, differences in exemptions, etc. So we help clients with that process and offer external consultant guidance (contact Miles Consulting for help), so that a future audit by a state will be more efficient with established procedures.
Phase 2: The Pre-Audit (Preparing for the Audit)
Once you receive notification that your business has been selected for a SALT audit, it’s time to prepare. The pre-audit phase is critical for setting the stage for a smooth and successful audit experience.
Here’s a quick overview of what happens and the steps to take:
- Understand the Auditor’s Role: Auditors are tasked with ensuring tax compliance and may seem demanding. While their requests might sometimes feel unreasonable, it’s important to engage with them respectfully. Initial contact is often made via a letter requesting books and records, though sometimes a phone call precedes this. In such cases, it’s best for employees to direct the auditor to a designated contact person and seek professional assistance from firms like Miles Consulting if needed. Trust us on this – you don’t want to go at this alone!
- Initial Request for Information: The auditor will send a “books and records” letter requesting documents such as sales and use tax returns, general ledgers, sales invoices, purchase invoices, exemption documentation, and federal tax returns. Compile these documents timely to facilitate a smooth audit process.
- Conduct Internal Preparation: Before submitting any data, review your records and consult with your tax advisor. This includes assessing previous self-audits if conducted, to understand potential exposures and corrections already made. If no such intensive review has been performed, your advisor will need a comprehensive overview of your reporting habits and areas of risk.
- Meeting with the Auditor: Once preparations are complete, contact the auditor with proper authorization. Discuss prior audits, explore the option of a Managed Audit Plan (MAP) in a state like California to potentially reduce penalties, and outline the testing approach, whether statistical sampling or block sampling.
Quick points to remember
- Audit Notification: The audit begins when you receive a formal letter from the taxing authority requesting documentation. Immediately consult with a SALT expert before responding.
- Action Plan: Work with your advisor to review the requested documentation. Auditors are looking for discrepancies, so it’s essential to identify any issues before they do. This phase often includes “circling the wagons” and being strategic about how you engage with the auditors.
- Do Not Engage Alone: Avoid direct communication with the auditor without professional representation. Auditors might ask leading questions, and it’s important that you don’t inadvertently provide inaccurate or incomplete information. We have helped many clients navigate audits where they have engaged us in the middle of an audit because it’s not going well. And we can help with that, certainly, but it’s so much better if you allow us to assist from the beginning. That said, if you’re reading this and undergoing an audit right NOW, and you need help, know that At Miles Consulting, we’re on your team – let us help you. Contact us now.
Phase 3: Audit in Process (Navigating the Audit)
Once the audit officially begins, it’s time to navigate the process. Expect to provide documentation and possibly meet with auditors in person. The objective of this phase is to provide the information requested while mitigating risks.
- Initial Meeting: After receiving the requested documents, the auditor will likely request an initial meeting. Your tax professional will play a key role in managing these meetings, ensuring that only necessary information is provided. In this post-Covid environment, some auditors do still come on site, but we’re finding that more and more audits are conducted remotely via email and Zoom. And that changes the dynamic some.
- Document Review: The auditor will examine your records, focusing on areas like sales tax, exemptions, and nexus (your obligation to collect tax in multiple states)*. Depending on the findings, additional information might be requested.
*For more on navigating nexus, read this article we wrote.
- Sampling Techniques: Many SALT audits use statistical sampling to extrapolate tax liabilities. Understand the sampling methods (e.g., block sampling or actual basis exams) used in your audit, as these can significantly affect the outcome. Again, Miles Consulting will guide you here.
Phase 4: Post-Audit (Responding to Audit Findings)
Once the audit concludes, the auditor will issue their findings, which may include underpayments, overpayments, or penalties. The post-audit phase is critical for addressing these findings and managing any potential liabilities.
- Review the Findings: Carefully review the auditor’s report with your consultant. If you disagree with the findings, consider filing an appeal or requesting a review. Many states have formal appeals processes for resolving disputes.
- Corrections and Compliance: If discrepancies are identified, work with your advisor to correct them. Implement changes to ensure future compliance, such as updating exemption certificate management or adjusting sales tax reporting procedures.
- SALT Appeals: Multi-state businesses should be familiar with appeals processes across different jurisdictions. Each state’s Department of Revenue (or equivalent) may have its own steps for challenging audit results, ranging from informal reviews to formal hearings.
Phase 5: Mitigating Penalties (Post-Audit Strategy)
If discrepancies result in penalties, there are often opportunities to reduce or eliminate them.
- Penalty Abatement: Work with your tax professional to negotiate reduced penalties, especially if the errors were unintentional. Many states allow for penalty waivers in cases of good faith efforts to comply.
- Managed Audit Programs: Some states offer managed audit programs, allowing businesses to conduct a self-audit under state supervision, often with the benefit of reduced interest or penalties. This can be a useful strategy for future audits, especially for businesses operating in multiple states.
- Legal Considerations: Always be aware of your legal rights in multi-state audits. You have the right to appeal, negotiate settlements, and, in some cases, take the matter to court if necessary.
Staying Audit-Ready
To avoid future audit issues, businesses should maintain ongoing compliance with state and local tax laws. Regular self-audits, up-to-date records, and expert advice from Miles Consulting can help you stay prepared for any future audits.
For more detailed guidance and support through every phase of a SALT audit, come to Miles Consulting. Book a consultation, drop us a line, or send us an email at info@milesconsultinggroup.com.