Texas Sales Tax Audits

Introduction

The primary purpose of the sales tax audit is to confirm that the taxpayer has reported the correct amount of tax. Reported amounts from the sales tax history must be analyzed when examining the taxpayer’s records.

Representation/Nexus in Texas

Nexus is the establishment of representation in the State of Texas, making a taxpayer responsible for collecting sales or use tax. The due process clause of the United States Constitution requires some definite link, some minimum connection between the state and the person, property, or transaction it seeks to tax. This link, referred to as representation, is determined to be sufficient by an analysis of the benefit derived. The analysis indicates whether the taxpayer has received some economic gain or advantage from his association with the state.

According to Section 151.107 Texas Limited Sales, Excise, and Use Tax Act and Sales and Use Tax Rule 3.286, Seller’s and Purchaser’s Responsibilities, a retailer has representation or is engaged in business in Texas if the retailer:

  • Maintains, occupies, or uses in Texas permanently, temporarily, directly or indirectly or through a subsidiary or an agent, a physical facility, including an office, place of distribution, sales or sample room, warehouse or storage place, or other place of business;
  • Has a representative, agent, salesman, canvasser, or solicitor operating in the state under the authority of the retailer for the purpose of selling, delivering, or taking orders for a taxable item. This includes salespersons, agents, canvassers, solicitors, repairmen, installers, inspectors, etc.;
  • Utilizes independent salespersons in direct sales of taxable items;
  • Operates a delivery vehicle in this state;
  • Derives receipts from a lease of tangible personal property located in this state;
  • Promotes a flea market, trade day, or other event involving the sales of taxable items;
  • Allows a franchisee or licensee to operate under its trade name if the franchisee or licensee is required to collect Texas sales or use tax;
  • Conducts business in this state through employees, agents, or independent contractors.

These types of documentation may support the claim of nexus:

  • Shipping documents
  • Vehicle logs
  • Sales invoices
  • Gasoline tickets
  • Territorial assignment sheets
  • Documentation of a place of operation by the taxpayer
  • A written statement from the taxpayer
  • Delivery directions
  • Travel notes
  • Expense vouchers
  • Itinerary sheets or logs

Once representation/nexus has been established, an out-of-state seller continues to be legally required to collect tax on sales made into Texas for a period of 12 months after the seller ceases to be engaged in business in Texas.

Reporting Categories

Reporting categories are broken out as follows on the sales tax return:

  • Total Sales
  • Taxable Sales
  • Taxable Purchases
  • Amount Subject to State Tax
  • Amount Subject to Local Tax
    • Amount Subject to City Tax
    • Amount Subject to Transit (MTA/CTD Tax)
    • Amount Subject to County/SPD Tax

Even though the category “Deductions” does not appear on the sales tax return, this amount is calculated by the computer and appears on the Audit History.

Total Sales – Taxable Sales = Deductions

Audit procedures used in each audit situation will be adapted to the individual taxpayer’s system of accounting and record-keeping. Since different reporting methods are used by taxpayers to complete sales tax returns, it is important that the auditor understand the method utilized by the taxpayer. The auditor should complete an analysis of the accounting system and devise specific audit procedures applicable to the audit. Certain procedures must be performed on each and every audit:

  • Sales tax reconciliation,
  • Gross Sales (Total Sales) reconciliation,
  • Examination of purchases, etc.

Audit Process Flowchart

If you find yourself or your company the subject of a Texas sales tax audit, please contact attorney John Ellsworth for an analysis of your position and possible defenses that might be interposed.  John can be reached at 847-580-1279.