What Happens When an Ecommerce Brand Gets Audited for Sales Tax?

Getting audited for sales tax can be overwhelming for ecommerce brands, especially with varying state regulations. This article will be your guide to understanding the audit process, from initial notices to resolution. Learn what triggers a sales tax audit, how to prepare, and what to expect at each stage.

What is a Sales Tax Audit?

A sales tax audit is a formal examination conducted by tax authorities, such as the IRS or state tax agencies, to determine whether a taxpayer has accurately reported, collected, and remitted the correct amount of sales tax in accordance with the specific definitions set by the governing tax laws. The audit process ensures compliance with state and local tax laws by reviewing tax returns, transaction records, and supporting documentation such as exemption certificates, invoices, and financial statements.

Depending on the nature of the audit, businesses may undergo an office, correspondence, or field audit, each requiring a different level of assessment and oversight. Auditors analyze the financial reports to verify your tax liability, assess revenue, and check whether deductions or exemptions were applied correctly.

The business may be subject to additional financial audits, increased tax liabilities, or penalties if errors are found. The statute of limitations for audits depends on the jurisdiction, but it typically ranges from three to six years, meaning past tax returns could still be subject to examination.

Businesses also have taxpayer rights that allow them to dispute findings through an appeal process if they disagree with the audit results.

What Triggers a Sales Tax Audit?

A sales tax audit can be initiated when the IRS or state tax authorities identify discrepancies in a business’s financial statements, tax returns, or documentation, signaling potential non-compliance. Businesses that fail to maintain proper tax compliance, misreport revenue, or incorrectly apply tax liabilities may be flagged for further examination.

Whether a company undergoes a correspondence audit, office audit, or field audit, auditors will thoroughly review financial reports, tax filings, and transactional records to determine whether errors exist. The statute of limitations varies by state, but auditors may look back several years to assess whether a business has correctly reported its sales tax obligations.

Below are some of the most common reasons businesses face an audit:

• Underreported Sales: Differences between reported revenue and actual earnings can lead to an examination of past tax returns and financial audits.
• Nexus in Multiple States: Businesses with sales tax nexus in multiple jurisdictions that fail to register or remit the correct amount of sales tax can trigger an audit due to missing tax payments.
• Use of Resale Certificates: Improper use or failure to provide valid documentation for resale certificates can result in a taxation audit and additional assessment of unpaid taxes.
• High Sales Volume: A sudden increase in revenue without a corresponding rise in reported tax liability may prompt auditors to conduct an evaluation of business records.

Since tax agencies use advanced data-sharing methods and cross-checking tools, businesses must ensure their compliance to avoid unnecessary oversight and penalties. Maintaining accurate financial records, conducting periodic compliance reviews, ensuring records are regularly audited, and understanding taxpayer rights to appeal incorrect findings are a must for businesses, especially those at risk of a tax audit.

What Happens When You Get Audited?

When a business receives an audit notification, it signals the beginning of a formal examination by the IRS to determine compliance with sales tax regulations. The audit process typically starts with an initial request for documentation, including financial statements, tax returns, invoices, exemption certificates, and translation of sales reports, all of which are critical for the assessment of revenue and tax liabilities.

Businesses may be subject to an office audit, field audit, or correspondence audit, depending on the complexity of the review and the level of oversight required. Auditors carefully analyze reported figures against actual transactions, checking for discrepancies that could indicate underpayment or overstatement of tax liabilities.

If inconsistencies are found, additional financial audits may be conducted, and penalties may be assessed. The statute of limitations for a sales tax audit varies by state but typically allows agencies to review past tax returns for up to six years.

Businesses have taxpayer rights throughout the audit, including the right to appeal any findings they dispute. The final audit report outlines any underpayments or compliance issues and the required corrective actions.

The Impact of Sales Tax Non-Compliance on Business Valuation

Failing to maintain compliance with sales tax laws can have serious financial consequences that can directly affect a company’s business valuation and long-term sustainability. When a business is audited, discrepancies in financial statements, tax returns, and documentation can lead to increased tax liabilities, penalties, and interest charges, significantly reducing a company’s net worth.

Investors and potential buyers thoroughly examine financial reports during due diligence, and any history of a tax audit, whether an office audit, field audit, or correspondence audit, raises red flags that can negatively impact a company’s perceived stability.

Non-compliance can also lead to legal actions, forcing businesses to undergo lengthy examinations, engage in costly appeals, and possibly face additional financial audits for previous years within the statute of limitations period.

A company with unresolved tax liabilities may struggle to secure financing, attract buyers, or maintain credibility in the marketplace due to concerns over inaccurate financial reporting and weak internal controls. Additionally, non-compliance with the IRS or state tax regulations can result in reputational damage, further affecting revenue and customer trust.

To maintain a strong business valuation, companies must prioritize compliance, conduct regular oversight of their taxation audits, and ensure proper review of all tax-related financial data.

Why Does Non-Compliance Reduce Valuation?

Non-compliance with sales tax regulations significantly reduces a business’s valuation because it creates uncertainty, financial instability, and potential legal risks that deter investors and buyers. When a company is audited, any inconsistencies in financial statements, tax returns, or documentation can lead to increased tax liabilities, additional penalties, and costly legal proceedings, all of which lower the overall market worth of a company.

A history of tax audits, whether it’s a correspondence audit, office audit, or field audit, signals to potential buyers and investors that the business may have poor internal controls and inadequate compliance measures. This can result in buyers reducing their offers, delaying acquisitions, or withdrawing interest altogether due to concerns over hidden tax liabilities and unresolved audit assessments.

Additionally, businesses with unresolved examinations and outstanding taxation audits may struggle to secure loans or financing, as lenders consider tax-related debts a sign of financial mismanagement. The reputational damage associated with non-compliance can also reduce customer confidence, decrease revenue, and create long-term financial setbacks.

Companies must maintain transparency, conduct regular compliance reviews, and ensure that all financial reports are accurate to avoid valuation decline due to audit failures.

How to Protect Your Business From Getting Audited

Facing a sales tax audit can be stressful, but businesses can take proactive steps to reduce the risk of being selected for an examination. Proper compliance with sales tax regulations, maintaining well-organized financial records, and ensuring accurate tax returns can help minimize exposure to an audit notification.

Tax authorities, including the IRS, rely on advanced data analytics and cross-referencing tools to identify discrepancies in revenue, tax liabilities, and transactional reporting. The best way to avoid unnecessary oversight and scrutiny is to stay ahead of tax obligations, maintain transparency, and implement strong internal controls.

Below are some key steps businesses can take to protect themselves from an audit:

• Regular Compliance Reviews: Conduct routine review and assessment of tax records, ensuring reported revenue, deductions, and tax liabilities align with actual financial activity.
• Stay Updated on Tax Laws: Track changes in taxation audit requirements to ensure ongoing compliance, particularly if the business operates in multiple states.
• Maintain Proper Documentation: Securely store all financial statements, exemption certificates, and supporting documentation to provide quick access in case of an audit.
• Work with Professionals: Consulting tax professionals can strengthen internal controls, improve financial reporting, and reduce the likelihood of a tax audit.

By following these steps, businesses can significantly lower the chances of being audited and reduce their non-compliance risks. Additionally, understanding their taxpayer rights and how to appeal incorrect audit findings can help businesses avoid unnecessary financial burdens.

Kintsugi Reduces the Risk of Non-Compliance

Kintsugi provides powerful compliance solutions designed to help ecommerce businesses reduce the risk of audit exposure, avoid costly tax liabilities, and maintain accurate financial statements. With automated sales tax calculations, businesses can ensure the correct tax rate is applied to every transaction, reducing errors that could trigger a correspondence, field, or office audit by the IRS.

Kintsugi’s software continuously monitors tax law updates, ensuring that companies stay compliant within the statute of limitations period to minimize risks associated with late filings or incorrect reporting. By providing real-time assessment and review of audited financial reports, businesses can improve their transparency, enhance internal controls, and prevent underreported revenue that could lead to an audit.

Additionally, Kintsugi generates detailed financial audit records that simplify the oversight process, making it easier to respond to an audit notification and prove tax compliance with supporting documentation. If an audit does occur, businesses leveraging Kintsugi have the advantage of accurate, well-organized data that streamlines the examination process, reducing the likelihood of penalties or disputes.

By using Kintsugi, businesses can proactively safeguard against taxation audit risks, ensuring compliance with both state and federal tax regulations. So, book a demo or sign up now.