Quick overview

A state sales tax audit is a review by a state tax agency to verify that a business collected, reported, and remitted the correct sales taxes. Audits can be triggered by data mismatches, third-party reporting, unusual sales patterns, nexus changes after Wayfair, or random selection. In my practice as a CPA advising clients for 15+ years, the difference between an audit that ends with “no change” and one that produces large liabilities almost always comes down to documentation, timeliness, and how you communicate with the auditor.

Why responsive, structured action matters

Responding correctly preserves rights, limits penalties and interest, and often shortens the audit. States typically assess tax, penalties, and interest when they find underreporting. Many penalties can be reduced or abated if you can show reasonable cause, correct returns, or a prompt voluntary disclosure. The procedures and appeals vary by state, so early verification of the state’s rules is essential (e.g., typical look-back periods are three to four years, but some states examine longer). When in doubt, consult state guidance or a tax professional.

Sources: Internal Revenue Service (for federal income and general tax guidance) and state revenue departments; South Dakota v. Wayfair, 585 U.S. ___ (2018) expanded remote sales nexus rules.

Step-by-step response plan

Below is a practical, prioritized plan you can use immediately after receiving an audit notice.

1) Read the notice carefully

  • Note the scope, the tax period(s) under review, and the deadline for producing records. The notice will typically state whether this is a desk audit (records mailed or uploaded) or a field audit (auditor visits your place of business).

2) Preserve and collect records

  • Immediately preserve electronically stored information (sales databases, POS data, cloud backups, email, and spreadsheets). Do not delete or alter records. Collect sales journals, invoices, credit memos, exemption certificates, purchase invoices, bank statements, and past sales tax returns for the period under audit.

3) Designate a point person or representative

  • Appoint a single internal contact and, if appropriate, a qualified representative (CPA, tax attorney, or sales-tax specialist). In my experience, auditors respond better and audits close faster when the taxpayer designates one informed contact.

4) Triage the request

  • Prioritize documents the auditor specifically asks for. Provide clear, organized responses rather than a disorganized dump of PDFs. Label files by date and sequence, and include a simple index that maps the files to the auditor’s request.

5) Reconcile and identify exposure

  • Reconcile gross receipts to tax returns and bank deposits. Identify transactions that raise questions (exempt sales, resale certificates, discounts, returns, shipping charges). Estimate possible exposure, including tax, interest, and potential penalties.

6) Audit defense strategy

  • If exposure appears minimal and records support your positions, prepare a factual response and clarify points in writing. If exposure is material, contact legal/tax counsel to consider negotiation strategies: voluntary disclosures, installment agreements, penalty abatement requests, or appeals.

7) Maintain communication and meet deadlines

  • Respond within stated time limits. If you need more time, request it promptly, in writing, and provide a realistic timeline.

8) Agree, contest, or appeal

  • If you agree with findings, confirm the calculation and arrange payment or payment plan. If you disagree, follow the state’s administrative appeal process — usually a protest with supporting documentation, and then an independent hearing or review.

Common audit triggers and how to address them

  • Third-party mismatch: If vendors or marketplaces report sales inconsistent with your returns, reconcile those 1099-type reports and obtain documentation from vendors or platforms. For marketplace sellers, understand marketplace facilitator rules and confirm who collected and remitted tax. See our guide on Marketplace Facilitator Rules: Who Collects and Remits Sales Tax?.

  • Nexus changes and remote sales: After Wayfair, remote sales can create nexus. If you expanded online sales or crossed thresholds, confirm registrations and collect past returns; consider voluntary disclosure agreements for states where you should have registered. Our primer on State Sales Tax Nexus for Remote Sellers: Practical Steps to Register and Comply explains common thresholds and next steps.

  • Inconsistent reporting or sudden fluctuations: Provide explanations and supporting documents for spikes (promotions, one-time sales) or drops (sales channel changes, returns).

  • Industry-specific scrutiny: Retail, hospitality, and digital product sellers often face more audits. Build a compliance checklist (see Building an Internal Control Checklist to Avoid Sales Tax Exposure) to reduce recurring issues.

Documentation checklist (practical)

  • Sales tax returns and schedules for the audit period
  • General ledger, sales journal, and POS summaries
  • Customer invoices and credit memos
  • Purchase invoices and vendor statements
  • Exemption/resale certificates and a register of tax-exempt sales
  • Shipping logs and third-party fulfillment records
  • Bank statements and deposit detail
  • Marketplace facilitator reports and 1099-type documents
  • Contracts or agreement copies for large sales or services

Provide a clear index (e.g., “Tab 1: Sales Journal Jan–Mar 2022”) — this small step materially speeds review.

Dealing with penalties and interest

States commonly assess penalties for negligence, failure to file, or late payment. Penalties vary by state and circumstance. Common responses that can reduce penalties:

  • Prompt voluntary compliance (correct returns and payment)
  • Documentation showing reasonable cause (e.g., natural disaster, documented system error)
  • Requesting abatement or waiver where state rules allow
  • Negotiating an installment payment plan to avoid additional collection action

Always ask for the penalty calculation in writing and document your request for abatement.

Appeals and administrative remedies

Every state provides an internal protest or appeal process. Appeals typically require a written protest and supporting evidence within a short statutory window. If administrative appeals fail, taxpayers may access state tax courts. Engage counsel early if you plan to contest material liabilities.

Voluntary Disclosure Agreements (VDAs)

If an audit reveals unregistered nexus and unpaid taxes in a state, a VDA can be a path to reduce exposure. VDAs often limit look-back periods and waive penalties, but terms vary by state. Consult a practitioner experienced in multistate sales tax VDAs before filing.

What to say (and not say) to an auditor

Say: factual answers, refer to documents, offer to provide additional records, and request clarifications in writing. Don’t: volunteer speculative reasons for missing tax, make admissions without counsel present, or destroy records.

Cost/benefit of hiring outside help

Professional fees can seem high, but experienced CPAs or sales tax attorneys often reduce total exposure and save owner time. In my experience, early engagement of a specialist typically reduces audit time and lowers negotiated settlements.

Practical examples from practice

  • Example 1: A retailer with incomplete resale certificates produced a reseller register and obtained signed certificates from key customers; penalties were abated and tax exposure reduced by 60%.
  • Example 2: An online seller discovered multi-state nexus after crossing threshold in two states. A coordinated voluntary disclosure and amended returns limited the look-back to three years and avoided penalties in one jurisdiction.

Preventive steps to avoid future audits

  • Reconcile sales tax liabilities monthly
  • Maintain an organized exemption certificate archive
  • Use sales tax automation tools and regular internal controls
  • Train staff who handle sales, returns, and exemptions

Closing checklist (before audit ends)

  • Confirm auditor’s final findings in writing
  • Review calculations and make written objections if needed
  • Secure agreed payment terms or prepare protest/appeal
  • Update internal processes to close the gap that triggered the audit

Professional disclaimer

This article is educational and informational only and does not constitute legal or tax advice. State rules differ and change; consult a qualified CPA, tax attorney, or your state revenue department for guidance specific to your situation.

Authoritative resources and next steps

  • Internal Revenue Service: https://www.irs.gov
  • For information about state sales and use tax rules, visit your state revenue department website; consider researching the South Dakota v. Wayfair decision (2018) for nexus implications.

Further reading on FinHelp:

If you received an audit notice today, start by preserving records, appointing a point person, and scheduling a contemporaneous call with a sales-tax specialist to assess exposure and next steps.