What Texas Sales Tax Auditors Are Really Looking For

Facing a Texas sales tax audit is a high-risk scenario that requires informed decision-making and a strategic defense. Making informed decisions and building a defense strategy starts with understanding what auditors are looking for. So, what are Texas sales tax auditors really looking for during the audit process?

Technically, the purpose of a Texas sales tax audit is to ensure accuracy. This means that auditors should be looking for evidence of not only underpayments but also overpayments. Practically speaking, however, the Texas Comptroller’s Office uses sales tax audits to enforce compliance. It prioritizes auditing businesses that have underpaid their sales tax liability in the past, and, in many cases, it conducts audits in response to referrals from other governmental authorities and concerns raised by members of the public.

Documents Subject to Review During a Texas Sales Tax Audit

Auditors working for the Texas Comptroller’s Office can request various forms of documentation during sales tax audits. When assessing businesses’ sales tax compliance, auditors give equal weight to both (i) documentation that reveals noncompliance and (ii) insufficient documentation to accurately assess compliance (which will generally lead to a presumption of liability).

Documents that are subject to review during a Texas sales tax audit include (but are not limited to):

• Bank statements
• Charts of accounts
• Documentation of returns
• Exemption certificates
• Financial statements
• Ledgers and journals
• Profit and loss statements
• Sales invoices
• Resale certificates
• Working papers and data used to prepare reports

Again, these are just examples. Under Texas law, auditors have broad authority to request and review the documentation they need to accurately assess businesses’ sales tax liability. If a business is unable (or unwilling) to provide documentation for review, this can have the same consequences as producing documentation that exposes noncompliance. Given this, businesses facing Texas sales tax audits need to make informed decisions about record retention and production, which makes it important to engage experienced tax counsel as early in the process as possible.

Potential Red Flags for Sales Tax Noncompliance

When reviewing businesses’ records during sales tax audits, auditors look for potential red flags of noncompliance. Some examples of these potential red flags include:

Inadequate Sales Tax Calculation and Collection Protocols

Businesses required to collect and remit sales tax must implement robust calculation and collection protocols to ensure compliance with state requirements. While this can present challenges, especially for businesses that sell online to customers in multiple states, it is a reality of doing business in today’s economy. If a business lacks documented protocols for managing sales tax compliance, this will inevitably raise questions about its ability to comply with Texas law.

Inadequate Recordkeeping

Businesses that are required to collect and remit sales tax must also keep records documenting their compliance. As a result, inadequate recordkeeping can raise questions as well. Additionally, as noted above, if a business does not have records on hand to confirm Texas sales tax compliance, this will lead to a presumption of noncompliance that can be difficult to overcome.

Inadequate Internal Controls

Along with establishing protocols for proactively managing compliance and maintaining all required records, the Texas Comptroller’s Office expects businesses to implement additional internal controls to ensure ongoing compliance. If a business does not have internal auditing procedures in place, for example, or is not conducting documented internal audits on a regular basis, this can be another red flag for sales tax auditors.

Inadequate Staff Training

Having compliance protocols and internal controls is one thing. Implementing them is another. This makes it essential for businesses to conduct adequate staff training as well. Crucially, even if a business outsources sales tax compliance, this does not insulate the business from liability for underpayments. As a result, businesses need staff members who are accountable for managing sales tax compliance internally (and raising concerns when necessary).

Evidence of Intentional Fraud or Willful Disregard

Any evidence of intentional fraud will also serve as a major red flag during the audit process. Altered sales records, false refund documentation, and other evidence can lead to serious fraud allegations. Likewise, if a business’s internal records suggest a willful disregard of sales tax compliance, this can lead to serious consequences. As with all other state (and federal) tax obligations, willful ignorance is not an excuse for noncompliance.

Evidence of Underpayment (or Nonpayment) of Required Sales Tax

Of course, what Texas sales tax auditors are ultimately looking for is evidence of underpayment (or nonpayment) of required sales tax. While sales tax audits can result in tax refunds in appropriate cases, in the vast majority of circumstances, the focus is on establishing additional tax liability. Some examples of records that could serve as evidence of underpayment (or nonpayment) of Texas sales tax include:

• Invalid resale or exemption certificates
• Sales invoices that reflect non-collection of sales tax
• Financial statements and other documents that reflect an inaccurate calculation of sales tax payments to the Texas Comptroller’s Office
• Evidence of accounting mistakes (including “gross errors,” which are not subject to Texas’s four-year statute of limitations)
• Evidence of intentional fraud or willful disregard for the need to manage sales tax compliance

With all of this in mind, when facing Texas sales tax audits, businesses must promptly gather and review all relevant documentation. Based on this review, they must make informed, strategic decisions about their defense. Due to the risks involved, businesses should take these steps with the advice and oversight of experienced tax counsel.

Request a Call with a Texas Sales Tax Audit Attorney at Brown P.C.

If your business is facing a sales tax audit in Texas, we encourage you to contact us promptly for more information. To request a call with an experienced Texas sales tax audit attorney at Brown P.C., please call 888-870-0025 or contact us confidentially online today.