Proven digital strategies for sales and use tax audits.

• Author: Bell-Jacobs, Moshe

If you have never had the privilege of working through a sales and use tax audit, particularly local audits, now is your chance to stop reading. However, for those who have experienced a revolving door of state and local auditors examining whether your company collected, accrued, and remitted the correct amount of sales and use tax, you likely have witnessed the evolution of the role of data in the audit process. By the end of this column, you may want to trade in the tried-and-true methods for the opportunity to manage big data when it comes to audit defense with indirect taxes.

The evolving role of big data

The early 2000s saw enterprise resource planning (ERP) solutions develop and expand into a full back-office support function. Tax departments were able to download monthly transactional data fairly easily and leverage simple desktop tools to pivot and manually analyze the data.

Fast-forward to 2023: ERP options are moving into cloud solutions to handle big data. "Big data" is not just a fun term--it is an industry-acknowledged way to describe data that has greater volume, variety, and velocity.

The transactional nature of sales and purchases directly results in a tremendous amount of data each month. Digital Commerce 360 estimates that the COVID-19 pandemic pushed e-commerce sales to new heights, adding over $219 billion to e-commerce's bottom line over the past two years. While the taxability of these transactions depends on several factors, the data is still recorded, mostly in real time, and analyzed for sales and use tax applicability.

Key triggers of increased audit pressure

In addition to big data, recent key triggers have resulted in greater complexity of tax administration and demands on state auditors--and, therefore, increasingly difficult audits.

Marketplace facilitator laws have been evolving since 2017, with states enacting these requirements in a rolling fashion. Every state with a statewide sales tax has adopted marketplace facilitator laws, shifting the burden of reporting and with it the need to manage data for sales tax compliance and audit defense. At the same time, these states have adopted economic nexus thresholds for sellers, which can result in disputes between purchasers and these newly tax-collecting sellers.

Another key factor increasing audit pressure is state and local revenue needs. Tax collection accounts for more than 50% of revenue in several states, with income tax revenue making up the majority in only a handful of states. Most local jurisdictions rely on indirect taxes, primarily sales tax and property tax, for their tax revenue streams. Further, some states--especially California--are forecasting revenue shortfalls due to a recent decrease in state income tax receipts. Revenue concerns could be one reason why companies are now experiencing even more pressure to close outstanding audits and are seeing more new audit notices.

Common strategies in audits

One common strategy in managing audits is to take advantage of sampling methodologies. Every jurisdiction and auditor has a different approach, and taxpayers need to know their options when responding to an audit notice. The most common sampling methodologies arc the following:

Statistical sampling:

* Simple definition: Statistical sampling is the selection of transactions that represent the population during an audit period. Many jurisdictions employ statistical sampling software during an audit.

* Considerations: Starting with an agreed-to chart of accounts to limit the population of transactions, especially within expenses, is a necessary first step. Additionally, confirming...