As a SaaS company, you are responsible for collecting and remitting sales taxes to the appropriate tax agencies. At some point, these tax authorities will want to know if you are remitting the right amount of sales taxes. They'll do this by carrying out a sales tax audit.
Tax authorities don't need a reason to select your business for a sales tax audit; you should expect it sooner or later. To be safe, SaaS companies should prioritize compliance, prepare for these audits, and work to avoid the consequences of sales tax non-compliance.
In this article, we will talk about managing a sales tax audit from start to finish. We'll show you how to prepare for a sales tax audit, how to navigate the process successfully, when to seek professional help, and what to do after the audit. Keep reading!
- A sales tax audit reveals whether a SaaS company has collected and remitted the right amount of sales taxes to the relevant tax authority.
- Some factors that can trigger a sales tax audit include historical non-compliance, operating in a high-risk industry, reporting errors from vendors, high sales volume, and so on.
- You prepare for a sales tax audit by curating exemption certificates, organizing sales reports, understanding sales tax laws for concerned states/jurisdictions, and educating your employees.
- A sales tax audit starts with the tax authority sending an audit notification to your company and ends with the issuance of a final assessment.
- Automation makes sales tax audits easier by ensuring accurate collection of sales taxes, keeping detailed sales records, and generating reports on demand.
Understanding sales tax audits
A sales tax audit is a thorough review of a company's financial records by relevant tax authorities to ascertain if the business collected and remitted the right amount of sales taxes. Government auditors review your records for errors, discrepancies, and misinformation.
During a sales tax audit, auditors will comb through your financial records. They will calculate the sales tax payable and compare it with your sales tax remittance to check if you are fully compliant.
Tax agencies mostly select businesses for sales tax audits when they believe the amount collected and remitted as sales taxes is lower than what it should be. Some of the other factors that could trigger a sales tax audit include;
- High-risk/Complex Industries - If you operate in an industry with high revenue and a reputation for non-compliance, your business will likely be selected for sales tax audits.
- Non-Compliance Records from Previous Audits - If your SaaS company has been audited before and the tax authorities find out that you didn't remit the right amount of sales taxes, you should expect more frequent audits moving forward.
- Reporting Errors from Vendors and Customers - As a SaaS company, you operate a B2B/B2C business. You may also have vendors that resell your product/service. If these organizations are sales tax non-compliant, it can trigger a sales tax audit for your business.
- Company Size - As you scale, you naturally attract tax authorities to your doorstep. Tax agencies can call for a sales tax audit after researching how many employees you have, the number of your physical offices, your average salary spent, and so on.
- Unique Business Activity - When your company opens a new office, goes on a hiring spree, makes an acquisition, files for bankruptcy, or does anything out of regular business transactions, it can attract authorities to you and trigger a sales tax audit.
- Company Sales Volume - If your company makes more revenue than other businesses in your industry, it can trigger a sales tax audit. The higher your sales volume and revenue, the higher your chances of getting selected for a sales tax audit.
As a SaaS company, preparing for sales tax audits in advance is crucial to mitigate the potential risks from this process. So, how do you prepare for a sales tax audit?
Preparing for a sales tax audit
Preparing for a Sales Tax Audit
Proactive SaaS CFOs always anticipate potential audits. It helps if you prepare in advance so you can identify where you have exposure and mitigate risks. Here are some of the things you should do to get ready for a sales tax audit.
Understand the sales tax laws of relevant states and jurisdictions
Tax agencies will audit you based on their sales tax laws and guidelines. When establishing nexus in a place (either through economic activities or physical presence), ensure you direct your tax experts and accounting team to study their sales tax laws.
Document all financial records
Your financial records are a shield when it comes to sales tax audits. When you keep detailed, accurate, and organized financial records, you can quickly access them when the auditor's notice arrives. The most important records you need to keep for sales tax audits are exemption certificates.
Ensure all exemption certificates are validated and documented
Exemption certificates are tendered by purchasers that hope to resell your product/service. The final consumer pays the sales tax, which will be double taxation if you collect sales taxes from these vendors. Exemption certificates prove you complied with tax guidelines by not collecting sales taxes.
States have different guidelines for valid exemption certificates. The certificate needs to be issued by the state where the buyer will sell your product, and the certificate needs to be considered valid by the concerned tax agencies. Your tax team should help you validate exemption certificates, and they should be kept in readiness for audits.
Educate your employees
During sales tax audits, auditors may interview your employees. Be sure they are adequately informed on what information to reveal and how to answer the auditor's questions.
Assign someone within your organization to the auditor to help control the flow of information. If the auditor is on-site (which rarely happens for SaaS businesses), ensure you inform your employees so they don't say the wrong things around the office.
Regularly check for sales tax audit notices
Tax Authorities will inform you of a sales tax audit through your official company email or direct mail. Ensure your official channels and company address are accurate and up to date. You need to check your inboxes regularly and get ready as soon as you receive an audit notification.
Navigating a sales tax audit
Navigating a Sales Tax Audit
If you've previously handled audit exercises, then navigating a sales tax audit will not be difficult. However, the scale and scope of audits can increase as you grow, increase sales, and generate revenue. Here are the different stages of a comprehensive sales tax audit process;
Stage 1: Notification of sales tax audit
The first thing to happen in an audit is the delivery of a notification message. The State Department of Revenue will send a notice to the taxpayer (your company) informing you of the scheduled sales tax audit. The audit notice will usually include an Information Document Request (IDR).
Stage 2: Assigning a company representative to the auditor
After you get the notice of audit, assign a competent senior employee to represent your organization. All the information between the tax authority and your company will be between this representative and the auditor. Pick someone familiar with the sales tax compliance process of the company.
Stage 3: Compilation of records for the selected period
Inform your tax/accounting team and other concerned employees when you receive the audit notice. You'll need to compile all the documents in the IDR and get them over to the auditor as soon as possible. Most times, the documents requested will include the following;
- Financial Statements (for the audit period)
- Sales tax reports and remittances (for the audit period)
- General ledgers
- Exemption certificates
- Sales and purchase journals
- Shipping Records
- Bank Statements
The auditor may also request more documents from you as the audit progresses. If you don't submit any of the requested records, you'll need to explain why you can't provide them to the auditor.
Stage 4: Examination of provided financial records
At this stage, the auditors will analyze your financial and sales records. They will check the gross income on your federal income tax returns and compare it with the gross sales on your sales tax returns. If you sold some of your SaaS products/services to resellers, they will also examine the validity of the exemption certificates for each vendor.
All your corroborating documents will be checked to determine if you paid the right amount of sales tax. Discrepancies in revenue/income figures, invalid exemption certificates, and missing documents can lead to substantial sales tax liability for your SaaS company.
Stage 5: Interviews
When the auditor is done reviewing your documents, they may request interviews with your business executives or other concerned employees. This will help them gather more information and establish the reasons for errors and discrepancies (if any). They may also send out interrogatories requesting specific answers to any questions.
Stage 6: Reconciliation
At this stage, you and the tax agencies will discuss the discrepancies they've found and try to reconcile the errors on both ends. The tax authority will suggest necessary adjustments to rectify underreported sales taxes. The final adjustment will often come as a settlement figure.
Stage 7: Settlement/disputes
With the evidence from your records, Tax authorities can claim that you under-remitted sales taxes and then suggest an amount for you to pay. At this point, you can negotiate with the authorities and come to an agreement that works for both of you.
If your company is satisfied with the outcome of this negotiation, then the audit is considered settled. If not, you must hire a tax attorney and prepare for administrative/legal solutions.
Stage 8: Assessment
The revenue body will issue an assessment once you both agree or the dispute process is concluded. This assessment contains the final sales tax liability figure owed and the deadline for payment. If the auditor is convinced you paid the right amount of sales taxes, the assessment will state that you have no liabilities.
How to successfully collaborate with sales tax auditors
Sales tax auditors are not your enemies. If you pull the right levers, you can successfully work with the auditors, mitigate risks, and conclude without having to pay huge liabilities (or none at all). You can ensure a successful collaboration by;
- Responding to audit notifications promptly
- Disclosing all known errors, discrepancies, and missing documents in advance
- Providing easy-to-read documents and reports
- Requesting regular updates during the audit process
- Negotiating and developing a good working relationship with the auditor
The role of automation in sales tax audits
Regarding sales tax audits, accuracy and proper documentation are vital. Collecting and remitting the right amount of sales taxes is essential to stay compliant. However, without adequate documentation, auditors can exploit loopholes in your compliance process and ask you to pay outstanding sales tax liabilities where you have none. Automation solves these problems.
A sales tax automation solution like Galvix helps you calculate, file, and remit accurate sales taxes automatically. The software also monitors over 11,000 tax jurisdictions and their sales tax laws to ensure your company stays updated with new guidelines. Here's why automation software is a lifesaver regarding sales tax audits.
- Updated Sales Tax Laws Across all Jurisdictions - Sales tax solutions are guided by sales tax laws updated regularly to keep you compliant. On Galvix, tax rates, product classification, and filing formats are constantly updated for over 11,000 jurisdictions.
- Accurate Sales Tax Collection - With a sales tax solution, you no longer need to worry about applying the correct tax rates and collecting proper sales taxes. Galvix ensures you collect sales taxes in real-time, either during checkout or invoice creation.
- Detailed Record Keeping - Automation software stores all your sales records for future reference. During a sales tax audit, you can easily pull out documents like sales journals and receipts for your auditors.
- Automatic Filing and Remittances - Late filing is one of the primary triggers of a sales tax audit. With a software solution like Galvix, you'll never miss a filing due date.
What features should an automation software have to support audits?
Before you opt for any automation software, ensure it comes with the necessary features that make it useful during sales tax audits. Some of these features include;
- Configurable Report Generation - Your sales tax solution should allow you to generate sales reports and documents on demand. When you can access detailed records for each jurisdiction or state at the click of a button, your documentation problem is solved.
- Sales Tax Reconciliation - A good automation software should have a tax reconciliation system. This feature ensures you have accurate sales tax return balances (both starting and ending) for any period.
- Tax Exposure Modelling - An automation software should also offer powerful financial modelling on the potential cost of historical non-compliance. You get insights on how much non-compliance can cost your SaaS company.
Galvix comes with all these features and more. With our sales tax automation solution in your arsenal, you have everything you need to successfully scale through sales tax audits.
When to seek professional help: The role of tax advisors and attorneys
Some companies believe that seeking professional help and involving a tax lawyer in the sales tax audit process sends a wrong message to the auditor. It looks like you've got something to hide, and the attorney is there to help you do it. This is not entirely true.
Tax agencies prefer to relate directly with tax experts in your company so they can do their work efficiently, get logical responses to questions, and conclude the audit faster. Also, your tax consultant can quickly provide auditors with the extra documents they need even before they ask.
Having a tax expert on your team also shows the auditor that you are monitoring the audit process closely. These experts will defend all your sales transactions better than you ever can and prove that you comply with sales tax laws.
Tax authorities won't slam you with bogus outstanding sales taxes unless they are sure you owe that amount. You may or may not choose to hire a sales tax attorney for the audit process. However, you should seriously consider doing so if any of the following scenarios arise;
Exceeding statute of limitations
The statute of limitations defines how far back an auditor can inspect your company's sales tax returns and other business transactions. For most states, the statute of limitations is 3 years, and auditors won't request records beyond this period.
If the tax authorities believe you have consistently under reported sales taxes by a particular percentage (say 25%), the statute date can be increased to confirm this pattern. Also, if the tax agency believes there are fraudulent activities, tax evasion, or gross negligence on your part, they can increase the statute of limitations.
When a tax agency calls for a sales tax audit and asks for sales records going back more than 3 years, that's a solid signal to get a tax attorney. It means they want to dig deep into your sales tax returns and compliance over the years, which is usually not a good sign.
Tax disputes and appeals
After a sales tax audit, the auditor will present their final assessment. If the audit process reveals you didn't collect and remit the right amount of sales taxes, you'll be required to pay the deficit out of the company's pocket. Depending on the state or local tax jurisdiction, you'll also be asked to pay penalties and interest.
If you believe you complied with all sales tax laws and paid the correct sales taxes, you have the right as a taxpayer to appeal through legal or administrative procedures. For this, you'll need a tax attorney.
Allegations of tax fraud
Allegations of tax fraud are pretty severe and rare. If the tax authorities believe a company intentionally evaded sales taxes or fraudulently underreported the amount of sales taxes collected, the defaulter may face criminal charges. This should not be you.
However, if tax authorities slam you with a tax fraud charge, you'll need professional help from tax lawyers and experts to help you beat the case. You may eventually have to pay a heavy fine to avoid going to jail if found guilty.
Post-audit steps and strategies
Post-Audit Steps and Strategies
After a sales tax audit exercise, your company should take some steps to strengthen future compliance efforts. Whether the tax authorities made adjustments or not, your post-audit strategies should focus on avoiding regular sales tax audits and keeping your business away from the prying eyes of tax authorities. Here are some effective post-audit strategies you can adopt.
Review the auditor's assessment
When you receive it, reviewing the auditor's assessment carefully is essential. The report will reveal the cause of discrepancies (if any) along with compliance recommendations for your SaaS company. If there are adjustments to your sales tax calculations and payments to be made, the auditor's report will outline them clearly.
As a proactive taxpayer, you have to either accept these adjustments and make the payments or challenge them through administrative or legal proceedings. Keep in mind that the legal option will cost your business money and may affect your company's reputation in the long term.
Tax authorities may also put you on a 'special' list for more frequent audits in the future. It is better to pay up the deficit and implement the recommended compliance strategies in subsequent remittances.
Implement recommended compliance strategies
The common issues that lead to adjustments and create sales tax liabilities during tax audits include tax rate changes, invalid exemption certificates, underpayments, insufficient records, etc. The auditor's assessment will reveal where the loophole came from, and it is your duty as a taxpayer to plug it for future compliance.
Ideally, you should revisit your sales tax compliance checklist after each audit and update it with relevant points from the exercise. This way, you can cover all your bases in the compliance process and get ready for subsequent audits.
Remit sales taxes on or before their due dates
One way to communicate to tax agencies that you are serious about compliance is by remitting sales taxes early. Filing returns after due dates can make tax authorities flag you for another audit, and innovative companies should work to avoid frequent audits as much as possible.
Find out what triggered the audit
There are many reasons why a tax agency will select your business for a sales tax audit. You may have filed your returns late, or it may be because of a vendor with a record of non-compliance.
Also, you might be operating in a high-risk industry with a reputation for sales tax non-compliance. Whatever the reason, try to find out what put you on the radar of a particular tax authority.
As a growing SaaS company, successfully passing sales tax audits is important for your overall financial management strategy. When you want to raise funds, merge with a more prominent company, or sell your business, investors will see that you are sales tax compliant and will be inclined to do business with you.
You need to prepare for sales tax audits in advance, manage the process, direct the results in your favor, and learn from the sales tax audit process. If you follow all the tips we've laid out in this resource, your next sales tax audit will be a walk in the park.
How long does a sales tax audit take?
It depends on the size of the company, activity in the sales tax jurisdiction, audit schedules, the records' complexity, and data transparency. An efficient sales tax audit should take about 1 to 6 months to conclude. However, this process can take time for years, depending on the circumstances of the audit.
How often should SaaS companies conduct Internal sales tax audits?
SaaS companies should conduct in-house sales tax audits once every year. This will help you stay on track with compliance and ensure you aren't accumulating sales tax liabilities. If you conduct an in-house audit and discover outstanding sales tax obligations, disclose it to the relevant tax authority immediately.
Who is a sales tax auditor?
A sales tax auditor is a professional appointed by a tax agency to review and examine companies' sales and financial records. Their job is to determine if the company has collected and remitted the right amount of sales taxes.