Sales Tax Audit Checklist: Get Organized & Reduce Your Risk

This comprehensive checklist will guide you through the essential steps for gathering the necessary documents, understanding common pitfalls to avoid, and ultimately facing your sales tax audit with greater confidence.

Understanding Sales Tax Audits

Before we dive into the preparation checklist itself, it will be helpful to demystify the sales tax audit process. Understanding why these audits occur, how they’re conducted, and what the auditor is looking for can alleviate some of the anxiety surrounding this experience.

“Why Me?” — How Businesses Are Selected for Audits

Sales tax audits can have various causes. In some cases, businesses are chosen randomly, while in others, certain red flags within a company’s returns might trigger a closer look. These might include inconsistencies in reporting, significant fluctuations in sales volume, or failure to file or pay taxes on time.

Different Types of Sales Tax Audits

Depending on where you operate and the nature of the investigation, you might face audits with different structures.

In-person audits will be conducted at your business location and typically involve a more thorough review of your records. By contrast, correspondence audits are carried out via mail and often focus on specific items or issues identified in your return.

How Long Does a Sales Tax Audit Take?

The duration of a sales tax audit can vary widely based on factors like the complexity of your business, the scope of the audit, and the efficiency of both your record-keeping and your cooperation with the auditor. Some might be resolved within weeks; others could span several months.

What Is the Purpose of a Sales Tax Audit?

The primary objective of a sales tax audit is to confirm that you’ve accurately reported and remitted all sales taxes collected from customers. The auditor will examine your company’s financial records to verify your reported sales, taxable transactions, exemption claims, and timely tax payments.

Sales Tax Audit Preparation: A Checklist of Key Documents

Thorough preparation can make your audit experience much smoother. The following checklist outlines the essential documents and records you’ll likely need:

General Business Records

• Articles of incorporation or business licenses
• Federal and state tax returns from the past three to five years, including the period being audited
• Seller’s permits and sales tax registration
• Accounting software data (QuickBooks, Xero, etc.)

Sales Records

• Sales invoices/receipts (organized by month or quarter)
• Sales journals/ledgers
• Cash register tapes or point-of-sale (POS) reports
• Credit card/bank statements that match your reported sales activity
• E-commerce platform data, if applicable (Shopify, Etsy, Amazon, etc.)

Exemption Documentation

• Resale certificates (if selling goods to other businesses for resale)
• Sales tax exemption certificates issued to customers exempt from sales tax
• Any other supporting documents for non-taxable sales transactions

Other Relevant Records

• Inventory records showing purchases, cost of goods sold, etc.
• Payroll records (if labor costs directly affect taxable services)
• Sales tax returns filed during the audit period
• Any correspondence you’ve had with the tax authority regarding sales tax

Industry-Specific Documents: What Auditors Will Want to See

While the core documents listed in the general checklist are important for almost every business, certain industries have additional record-keeping requirements for sales tax compliance. These stem from the unique ways these businesses operate and the nuances of how sales tax applies to their goods or services.

With that in mind, here are some additional, industry-specific documents that may be scrutinized during a sales tax audit. Make sure to pay extra attention to the records most relevant to your business type.

Construction

Business owners in the construction industry often face complex sales tax regulations due to the blend of taxable services and potentially tax-exempt materials used in projects. Meticulous documentation is critical for supporting deductions for materials bought for resale or specific client projects, as well as ensuring that you’re correctly charging on labor versus goods.

Here are some of the documents you’ll likely be asked to furnish:

Contracts with Detailed Scopes of Work

General contracts aren’t enough. Auditors will want to see specific breakdowns of the services you’ve provided and materials you’ve used. If sales tax only applies to labor on certain project types, your contract should clearly reflect that.

Material Purchase Records with Exemption Certificates

You’ll need to keep purchase invoices, receipts, and — crucially — valid resale or exemption certificates obtained from vendors if you’re buying tax-free for resale or specific projects.

Subcontractor Agreements

Clearly outline sales tax responsibilities for subcontractors in your agreements. Are they collecting and remitting tax on their work, or are you responsible for including it in your filings?

Building Permits

Proof of authorization can sometimes serve as supporting documentation that links sales transactions to specific projects.

Change Orders

These are frequently overlooked but nonetheless important to track, as modifications to the original contract’s scope can impact what’s considered taxable or non-taxable.

Restaurants

Few industries have as many sales tax provisions as food service. Determining whether a sale is dine-in or takeout, distinguishing between taxable prepared food and non-taxable ingredients, and navigating special events and catering orders require meticulous record-keeping to demonstrate tax compliance.

Here’s what the auditor will generally be looking for:

Menus with Price Breakdowns

You’ll need to provide current menus and, more importantly, records that show the individual prices of taxable versus non-taxable items in combo meals or options. This information directly affects how sales tax is calculated.

Health Department Permits

Permits like these help establish the primary nature of your business (a bakery is different from a sit-down restaurant, for instance), which will impact what’s taxable in your state.

Employee Training Materials

If you have internal guides or documents for staff that explain which menu items are taxable and how to ring them up correctly, offering them up can demonstrate a proactive approach to compliance.

Catering Contracts and Banquet Event Orders (BEOs)

These transactions are often governed by different tax rules than regular dine-in or takeout sales, so maintaining separate records for them is crucial.

Point-of-Sale (POS) System Reports

Be prepared to provide detailed reports from your POS system that go beyond sales summaries. The auditor will want to see how the system calculates sales tax on various items and transactions.

Delivery App Agreements

If you use platforms like Grubhub or Uber Eats, have copies of your contracts readily available. These agreements typically outline whether the business or the platform is responsible for collecting and remitting sales tax on orders.

Retail

The retail industry is subject to unique sales tax challenges thanks to promotional sales, gift cards, layaways, and increasingly complex rules regarding online marketplaces.

If you run a retail business, you may need to supply the following documentation in order to showcase compliance:

Gift Certificate Logs

Maintain detailed logs of all gift certificates sold and redeemed. Remember, sales tax is usually collected upon redemption, not the initial sale, so accurate tracking is imperative.

Layaway Sale Records

Layaway transactions also come with specific tax implications, similar to gift cards. Your records should clearly show when payment was received in full and when the goods were transferred to the customer.

Consignment Agreements

If you sell goods on consignment for other businesses or individuals, you must have written agreements clearly outlining who’s responsible for collecting and remitting sales tax.

Inventory Management System Reports

For retailers with extensive inventories and varying tax rates for different product types, having robust inventory management system reports can streamline the audit. These reports should detail sales data, applied tax rates, and exemptions.

Online Marketplace Terms of Service

If you sell goods through platforms like Amazon, Etsy, or Shopify, it will help to familiarize yourself with their terms of service and tax policies. These agreements often outline tax responsibilities and reporting requirements, which could affect your record-keeping needs.

Common Sales Tax Audit Pitfalls to Avoid

Understanding the common mistakes businesses make during sales tax audits can help you prevent issues from escalating and potentially minimize your ultimate liability. Here are some key points to keep in mind.

Poor Record-Keeping: Your Arch Nemesis

Disorganized or incomplete records are a major red flag for auditors and can prolong the process significantly. As such, you should implement a system for consistent, accurate, and easily accessible record-keeping from day one.

The Exemption Conundrum: Know the Rules

Misunderstanding or misapplying exemption rules is another frequent audit mistake. Make sure you have a firm grasp of exemption requirements and obtain valid exemption certificates from customers where applicable.

Calculating Tax: It’s Not Always Elementary

Even small calculation errors can lead to discrepancies and penalties. Use accounting software to guarantee accurate sales tax calculations, and consider seeking professional help for more complex transactions or whenever you’re unsure about rates.

The Procrastinator’s Nightmare: Filing and Paying on Time

Late filing and payment are sure to attract unwanted attention from tax authorities. To avoid this, set reminders, establish efficient processes, and make timely filing and payment of your sales tax obligations a priority.

Nexus: The Interconnectedness of Sales Tax Law

As businesses expand their reach, particularly online, understanding sales tax nexus becomes increasingly important. If you sell to customers across state lines, you’ll need to brush up on nexus laws to ensure compliance in every state where you have a presence.

Don’t Face a Sales Tax Audit Alone

Responding to a sales tax audit can be complicated and extremely stressful. If you’re facing an audit or are concerned about your sales tax compliance, consulting a qualified tax professional is a wise decision.

Book a free consultation with Ramy Shabana, experienced IRS sales audit attorney and founder of Tax Relief Counsel, to make sure you’re in the clear. Ramy and his team can assist with document organization, communication with auditors, and representation during the audit process to ensure that your rights and interests are protected.

We’re here to help you get your ducks in a row and emerge from your audit with confidence.