How to approach a sales tax audit

As state governments continue to deal with budget shortfalls, revenue agencies continue stepping up their efforts in raising revenue through sales tax audits. States have increased the size of their audit staff and are employing new technologies in their discovery efforts. Auto dealerships are not immune to selection and should know what to expect and how to prepare for an audit.

The first step in preparing for an audit is determining where and when the audit will be conducted. Audit notifications may indicate the date on which the auditor would like to begin examining purchase and sales records. If your records are in an off-site location or your day-to-day responsibilities do not allow for the extra time necessary to compile and organize your records, it is acceptable to propose a future date to the auditor. Do not allow a “surprise” audit. Also, if the audit is to be on-site, be sure to secure a location for the auditor to work away from business operations.

The second step in your preparations should be a self-review of records and procedures. A self-review should include the following:

  • Be sure your records include exemption certificates for any tax-exempt sales like sales of vehicle inventory to other dealerships. Begin requesting any missing certificates as soon as possible.
  • Review your sales records to determine if tax is properly collected on sales that are not exempt. Items used in auto repair that are purchased exempt should be detailed and taxed on the customer’s invoice. Are you collecting sales tax on items like towing and car washes if they are taxable in your state?
  • Assess your procedures for accounting for use tax on purchases. For example, are you self-assessing use tax on repair parts used internally? Do you make taxable purchases online from out of state vendors that do not charge your state’s tax? Your review should include purchases of tangible property as well as services like lawn care and intangibles like software.
  • Review sales tax returns filed during the audit period. Supporting documents should be available. Also, compare total sales on the sales tax returns to your federal income tax return. If they do not match, be prepared to explain why.
  • Identify any areas where you have overpaid sales or use tax. If you have paid tax on nontaxable transactions, your state may allow you to request a refund in conjunction with the audit. This reduces any assessed tax and also interest and penalties on that amount. Common areas to look for refunds are in parts that you paid tax on but resold to a customer or tax paid on purchases from a contractor that qualify as nontaxable real property improvements. You should let the auditor know upfront that you have identified these purchases and intend to claim a refund.

Lastly, be ready to play defense. Do not assume all questioned sales and purchases are taxable. Familiarize yourself with your states regulations in the dealership area and if you feel a questioned item should not be assessed, challenge it. Also, understand any sampling techniques employed by the auditor and be sure samples used are representative of your operations. If you have not experienced a sales tax audit before, are unfamiliar with your state’s regulations, or you have identified significant problem areas in your self-review, you may want to consider engaging a tax advisor to assist in your defense.

For more information on this topic, or to learn how Baker Tilly dealership specialists can help, contact our team.