Sales and use tax audits that result in large sums of uncollected or under-accrued taxes can crush a business, especially a small business. These assessments can decimate your existing cash flow, pressure you to extend your credit, and even force you to close your business.
If your small business is currently undergoing a sales and use tax audit from your state government or you think you might soon, there could be serious consequences, which is why it’s important to start preparing now. Keep reading and learn how S.H. Block Tax Services can help you avoid, prepare for, and navigate your upcoming audit successfully.
What’s the Difference Between Sales Tax and Use Tax?
State governments frequently conduct audits on a business’ sales taxes and use taxes at the same time, but these two types of taxes aren’t the same.
- Sales tax is applied to any exchange of an item or service, whether through sale or transfer. In Maryland, the consumer is responsible for sales tax, which usually just gets added on to the price of the item at the time of sale.
- Use tax applies to the consumption of an item or service for which the seller has charged no sales tax. Use tax doesn’t apply when sales tax has already been charged. For example, you should pay Maryland’s use tax when you purchase items from an online merchant that does not collect sales tax.
Essentially, use tax ensures that the state government gets its tax proceeds from a transaction no matter how that transaction was conducted or where it took place.
There are two types of use tax.
- Consumer use tax: Tax charged to the buyer for items or services for which the seller did not charge or collect sales or vendor use tax. Consumer use tax is self-assessed and is the full responsibility of the consumer.
- Vendor/retailer use Tax: tax charged to the vendor for items or services sold outside of the vendor’s state.
Just because you don’t charge and accrue sales tax for an item or service does not mean there is no tax due on that item or service. And when the numbers from your annual returns don’t add up, the State of Maryland will likely initiate a sales and use tax audit.
Items That Might Trigger a Sales and Use Tax Audit
If you’ve ever endured a tax audit, you know it’s a time-consuming experience that can exhaust your resources and your patience. If you haven’t been audited before, know that it’s best to prepare now and avoid further frustration down the road. Preparing for an audit means identifying and controlling potential risks.
Many factors could lead the state to audit your business, but the most common include company size, company sales volume, or filing late or complicated returns. Your business might also be subject to an audit if you’ve recently declared bankruptcy or closed your doors. Also, companies who are subject to significant tax adjustments in previous audits are more likely to face an additional audit the following year so the auditors can compare their sales and use returns.
Businesses with a sharp increase in exempt sales are also more likely to get flagged for an audit since the state might suspect you of using your discretion to pad your numbers. And the inverse is also true: a steep decline in exempt sales could act as a red flag and trigger an audit. Finally, if one of your vendors failed to charge use tax and got audited, there’s a good chance you’re next on the state’s list.
The examples given above are just the beginning; there are dozens of reasons the state might conduct a sales and use tax audit on your business.
To help avoid audits, you may want to consider hiring skilled and experienced bookkeepers who can make sure you remain in compliance with sales and use tax laws throughout the year.
Preparing for a Sales and Use Tax Audit
Once the state notifies you of their intent to perform a sales and use tax audit, it’s time to get serious about preparing. Below is a list of steps you should take to prepare for a sales and use tax audit.
1. Gather relevant documents
All invoices should have supporting documents for you to review. Pay special attention to returned items or listings in which the use tax might not have been paid appropriately in full.
2. Discuss red flags with employees
While you’re ultimately responsible for the state of your business’ finances, your employees might have insight into the daily operations of your company. This can prove especially helpful when attempting to determine why certain purchases were classified as being exempt from sales tax.
3. Contact your vendors
If your suppliers have recently been audited and were assessed taxes on the same purchases, you probably don’t owe sales tax on those purchases.
4. Provide all requisite documents
The auditor will probably request very specific records, and you need to make sure you can provide those documents in a timely and accurate fashion. Failure to do so could arouse suspicion or eliminate your eligibility for certain deductions.
5. Don’t panic
Remain calm throughout the process and only deliver the information your auditor asks for. If you or your employees appear anxious, it could signal to the auditor that something is amiss, even if nothing is.
6. Remain professional
Remember, the auditor is only doing their job. There’s no reason to act rudely or lose your cool, and doing so will almost certainly work against you. Let the auditor know you’re doing everything in your power to comply with the law and that you’re willing to help correct any mistakes that may have been made.
Because sales and use tax audits are complicated and stressful, even upstanding business owners with honest intentions can get themselves into hot water with the state during an audit. That’s why you should always contact a qualified tax attorney as soon as you receive a “notice of audit and examination scheduled” letter from your state government.
Contact S.H. Block Tax Services and Start Preparing for Your Upcoming Audit
Getting ready for a sales and use tax audit can easily make you feel overwhelmed, but you don’t have to face an audit alone. S.H. Block Tax Services has been successfully helping businesses anticipate, prepare for, and navigate these audits for decades, and we’re confident we can help you as well.
Our firm has nearly 100 years of combined legal experience, and our entire staff works to help clients overcome their financial challenges so they can continue to grow their business. We’ve earned an A+ rating with the Better Business Bureau thanks to our work on behalf of clients, and we offer free consultations where we can diagnose your tax issues and begin developing an efficient plan to address them.
The content provided here is for informational purposes only and should not be construed as legal advice on any subject. Please read our full disclaimer here.