What Are the Risks for Tax Payers in a Sales Tax Audit?

The biggest mistake that I see taxpayers make and the biggest area of risk that they have is the dangerous assumption made by taxpayers that because they "didn't do anything wrong" in the sales tax audit, they don't have anything to fear. The reality of the situation is that the auditors are looking for mistakes in the way that the taxpayers filed their sales tax returns and in the amount that they paid. The auditors are devoting a significant amount of time and energy to going through all the taxpayer's data and verifying their taxable sales so the reality of the situation is is that even if you don't feel like you made a mistake,

the auditor may well find something. If not, the auditor may resort to indirect methods of testing. When the auditor goes to indirect methods of testing, they're using statistical samples to arrive at what the proper conclusion is. The problem with statistics is you're taking a population of transactions and you're taking a sample of that population. So let's say I have a restaurant and the restaurant had three years of sales that is included in the sales tax audit. Depending on which days I pick for my sample, it could significantly skew the results of the audit. So if I pick weekdays, for example I'm probably going to see a lower transaction amount and I'm probably going to see more cash sales on weekend where there's more larger groups and more people go out to dinner and there's larger transaction sizes. I might see fewer cash transactions, I might see larger average daily sales, so two weekdays versus two weekends if taken as a sample and applied to that population could yield statistically very different results. So even if the restaurant is diligent enough to track their daily sales, if I'm using a statistical method to arrive at those sales versus what the restaurant has I could get a huge variance. Auditors tend to go after low-hanging fruit so the auditor is not going to dive into a lot of very complicated things. They're going to go after quick wins and a lot of the quick wins happen when they go after those indirect methods of testing. The auditor is going to put the burden on the taxpayer to produce documents to refute the auditor's conclusion. You shouldn't be guilty until proven innocent in a sales tax audit, but the reality of the situation is that's sometimes how it goes is the other biggest risk for taxpayers is penalties. The penalty portion of the liability could be anywhere from ten to forty percent, but the really real kicker with sales tax audits is those penalties can stack on top of each other so it's possible that if the taxpayer wasn't diligent in their records they could get a forty percent penalty and a twenty percent penalty. So you can see 60 percent in penalties adds up really quickly in the context of an audit. A lot of taxpayers, because they don't live in sales tax audit land, don't understand the risks that are going in so it's important that you go in knowing that number one there's a huge amount of risk even if you haven't done anything wrong and number two that before the audit even begins you're taking steps to mitigate and protect yourself as much as possible. Those are the risks that you have to deal with in a sales tax.


Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law