Why State & Local Audits Are on the Rise (And What It Means for Scaling Businesses)

It’s no secret that states rely heavily on sales tax as a stable source of revenue. Sales tax hasn’t always been strictly enforced, but in recent years, we’re seeing a rise in state sales tax audits, and an increase in local tax authority enforcement.

We’re breaking down why state and local audits are up, and what you can do to make sure you’re compliant and current (without having to do a ton of manual data entry).

The Current Audit Climate for State & Local Tax Authorities

The increase in state and local tax audits stems from a few key factors:

• Pandemic-era federal funding has expired, leaving several states with budget gaps and increased economic volatility. In this environment, sales tax revenue becomes more critical than ever.

• Consumer spending patterns have changed, making revenue less predictable and making it harder for states to forecast and commit funds to key initiatives.

• Inflation has increased state operating costs, forcing them to turn their focus to a previously reliable revenue stream.

• A growing use of data analytics is helping states identify under- or non-compliance surrounding sales tax, allowing states to initiate audits with less upfront labor. In some cases, states are using tools that offer automated cross-state data sharing and third-party marketplace data from payment processors and POS systems.

States are being strategic with their audits, focusing on high-growth companies, such as SaaS, ecommerce, subscription services, and digital goods. As a result, it’s essential for companies in these sectors to be compliant, up-to-date, and aware of their tax liability at all times.

Why Growth Companies Are More Exposed

Rapidly-growing companies have a few unique traits that make them prime targets for state tax audits.

1. Rapid market expansion = rapid nexus expansion
2. Digital and multi-state sales = multiple filing obligations
3. Process and system limitations in scaling businesses

High-growth companies are essentially speedrunning their way towards nexus – the threshold that activates your tax obligation in a specific region. Events that can create nexus include rapid hiring, adding remote employees, contractors, or inventory storage, and expanding into new marketplaces.

Many companies invest heavily in operations in order to drive revenue, while failing to build a robust compliance team. When a huge sale is made in a new marketplace, compliance is forced to scramble in order to register the business in new states, update taxability codes, and track nexus in a new area. Understaffed compliance teams aren’t able to reliably track global nexus manually, and with patchwork systems, manual reporting, and no centralized tax policy, the risk of exposure increases with every dollar in revenue.

California and Texas are among several states that take an aggressive approach to sales tax non-compliance, with Texas pursuing back taxes and interest before audits are even complete, in many cases.

The Most Common Audit Triggers

Whether your compliance team is tracking, reporting, and filing manually or using an AI-driven sales tax compliance partner like Kintsugi, it’s critical to avoid audit triggers.

We don’t want you to get audited, but more importantly, we want you to be up-to-date and compliant if you get audited.

Common audit triggers include:

Nexus-related issues

• Crossing financial nexus thresholds unnoticed
• Physical nexus from employees, inventory, and dropshipping

Unfiled or incomplete returns

• Gaps in filing history exposed through data matching
• Failure to register in new states post-expansion

Product or service miscalculation

• Mis-taxing goods due to incorrect product categorization, especially for digital products
• Under-collecting due to incorrect tax codes

Customer complaints

• Refund requests, exemption certificate errors, and more
• States investigating pricing or collection discrepancies

Marketplace or vendor reporting mismatches

• States comparing marketplace-reported sales vs. seller-reported figures
• Inconsistency flags shared by third-party platforms

How Growth Businesses Can Stay Ahead of State Sales Tax Audits

Staying ahead of state sales tax audits requires more than simply tracking nexus and staying compliant. For many companies, an audit is less a matter of if and more a matter of when, which means that preparation and robust documentation are just as crucial as ongoing compliance.

A partner like Kintsugi not only monitors for nexus, minimizes exposure, and ensures that your filings are correct with human-in-the-loop AI, but it also makes it simple to prepare records in the event of a state audit, for a more streamlined experience.

Audits genuinely don’t have to be a headache, as long as you’re prepared.

• Conduct a regular nexus review. Monitor nexus thresholds on a regular basis, closely track remote employees and contractors, and stay aware of warehouses.
• Implement a tax determination system. Automated tax engines that integrate with your billing and ERP systems help you stay up-to-date on taxability codes with audit-ready transaction-level detail.
• Strengthen sales tax filing and documentation. Maintain a regular filing calendar across states, centralize your exemption certificates, and ensure that your reporting is aligned across marketplaces.

Prepare for an Audit Before It Happens

Most critically, it’s essential for growth companies to prepare for audits before they happen. Impeccable digital records, internal response protocols, and a trusted sales tax compliance partner like Kintsugi can help.

Sales tax audits will likely continue to rise, which has a disproportionate impact on digital businesses scaling across state lines, but proactive compliance can shield you from the worst of an audit and actually function as a growth enabler instead of a cost.

The best time to get started with a sales tax compliance partner was when your company was founded. The second best time is before you get audited.

Know your guidelines by state, and get your free nexus assessment today.