When most people think about tax audits, what comes to mind for most people are investigations into their income tax reporting. However, business owners tend to be more likely to face audits for their sales taxes than their income taxes.
There are a few common—yet avoidable—errors that often trigger sales tax audits.
Filing your tax returns late
When you register for a sales tax license (or permit) with your state, you will be told how often you must file sales tax returns. This depends mostly on the amount of sales tax you are expected to owe. For brand-new businesses, this figure is typically a total guess. While many businesses file sales tax returns every month, others opt to file quarterly, yearly or according to customized arrangements. Due dates are adjustable, but for many states, it falls on the 20th of the month.
New business owners often get confused by the fact that they never get a notice of when their sales tax return is due, so they must be aware of their filing frequency and specific due dates to ensure their compliance. Failing to file on time could lead to penalties and potential audits from state tax authorities.
Making late payments
Typically, businesses have the same payment and filing deadlines, which makes matters much easier. There are electronic filing systems that make paying sales tax bills much easier. In most cases, if you file electronically, you must pay electronically as well.
If you do choose to pay electronically, it is important to consider your payment deadline, as processing that payment may take some time. Even if you paid on your due date, your payment would still be considered late if processing took a couple days.
Not documenting exemptions
Certain products or customers are exempt from sales taxes. For example, in Minnesota, there are no sales taxes on clothing. Certain resellers are also exempt from sales tax, as they are not considered end consumers.
Regardless of the reason for the exemption, you need to document them appropriately when they occur. Collect exemption certificates the first time a new customer who is tax-exempt purchases from you so you can produce it when needed. Otherwise, if you are missing that certificate, you will be liable for paying the missing tax.
Determining taxation rates according to ZIP code
Many small businesses base their sales tax rates on ZIP code, but this is not always the correct protocol. Tax jurisdictions do not always match ZIP code boundaries. If you are charging the wrong sales tax rate, your customers could get you in trouble with the government—particularly if they were overcharged as a result. Rather than using ZIP codes to determine sales tax rates, use geolocation to pinpoint the location of the transaction.
These are just a few tips to help you avoid an unwanted sales tax audit. Meet with a financial advisor to learn more about this and other important tax issues for small businesses.