The letter has arrived. The sales tax audit is over, the assessment is larger than you expected, and you have a limited window to respond. Our strategic guide to audit defense covers how to manage the audit itself; this article addresses the decision that comes after it.
Should you fight the assessment, settle it, or, in some states, pursue both at once? We have advised on this point many times, and the answer is: it depends. But of course, “it depends” is only useful if you know what it depends on. Here is the framework we use.
Key takeaways: deciding whether to fight or settle a sales tax assessment
- Five factors drive the decision: your likelihood of success, the dollar exposure, precedent risk, the multi-state ripple effect, and your ongoing relationship with the state.
- Settling is often the smarter move when the cost and uncertainty of fighting exceed the realistic savings.
- Some states let you pursue settlement and appeal in parallel, keeping both options open until one resolves.
- Whatever you decide, the outcome of this audit will influence your next one, in this state and in others.
The five-factor framework for responding to a sales tax audit assessment
As we work with clients facing an assessment, we consider these five questions each time.
- Likelihood of success. How defensible is your position, on the law and on the documentation? For instance, a strong legal argument with weak records is a weak case. Auditors and appeals officers decide on evidence, so a review of your exemption certificates, invoices, and sales tax filings comes first.
- Dollar exposure. Fighting a $40,000 assessment may not make sense once professional fees are considered, whereas a $2 million assessment usually justifies a full evaluation of your options. With combined state and local rates topping 10% in the highest-rate states, assessments scale quickly with revenue, so calculate the cost of each option before committing to one.
- Precedent risk. An assessment covers a defined period of time, but your position on how your products are taxed applies to every period that follows. If you concede a taxability question now, you may be conceding it for years of sales to come, so a small assessment can carry a much larger long-term cost.
- The multi-state domino effect. Will contesting or conceding draw attention in other states where you have similar exposure? We cover this in more detail below, but it should be part of the decision from the beginning.
- Business relationship with the state. If you will be filing in this state for the next 20 years, an aggressive fight over a marginal issue may cost more goodwill than it recovers. Your audit history stays on record and informs how the state approaches you in the future.
When settling is the smarter move
Nobody enjoys writing a check for tax they believe they don’t owe. But fighting has real costs: professional fees, management time, interest that keeps accruing on the unpaid balance, and the risk of losing outright. An appeal tends to be all or nothing on each issue; you win the point or you don’t.
Settlement trades the chance of total victory for certainty. In our experience, it is usually the smarter move when the disputed amount is modest relative to the cost of the fight, when your documentation has gaps that would weaken your case in an appeal, or when a fast, final resolution carries its own value, for example ahead of a financing round or the sale of the business.
Bottom line: the goal is to keep the most money with the least risk.
Are you unsure how long an appeal may take for your circumstances? Contact us to discuss your specific issue and situation.
Settling and appealing at the same time
In some states, including California, you can pursue a settlement while your appeal is still moving. The two processes run side by side, and the settlement option generally stays open until the appeal is finally decided.
We recently used this approach for a client facing a disputed issue of roughly $200,000 in a California sales tax audit. We believed the position was strong, but it was harder to prove than we would have liked, and an appeal would have been all or nothing. So we did both: we filed the appeal to preserve the client’s rights and opened settlement discussions at the same time.
The state came back at close to 50 cents on the dollar. The client accepted, recovering roughly $100,000 on a $200,000 issue, with no further fees and no risk of losing the appeal outright. Would the appeal have delivered more? Possibly, but it could have delivered nothing a year later and at a greater cost. Where you need to be careful is assuming you must choose one route at the outset. Whether both options are open and whether pursuing them together makes sense, depends on the state and on the specific facts of your case.
The voluntary disclosure angle: clean up exposure before the next audit finds it
An audit shows you exactly how a state views your business. If the auditor found unregistered obligations or untaxed product lines, the same issues may exist in states that haven’t contacted you yet.
That is where a voluntary disclosure agreement (VDA) comes in. A VDA lets you approach a state before it approaches you, typically in exchange for a limited lookback period and a waiver of penalties. The key is timing: once a state has contacted you about a tax type, the VDA door for that state generally closes. The short period after an audit ends gives you the opportunity to map your exposure everywhere else, while the VDA option is still available. Resolving an assessment in one state and then waiting for the next notice to arrive is typically the most expensive way to manage multi-state exposure.
The multi-state domino effect and how your audit history follows you
States talk to each other more than most CFOs and controllers realize. Registration data, audit referrals, and information-sharing arrangements mean a finding in one state can prompt questions from other states. This is especially true where the underlying issue is the same everywhere you sell, such as the taxability of your SaaS product or your economic nexus footprint.
The audit also follows you within the state. Your prior audit results inform how the next examination is scoped, and many states weigh your audit and compliance history when deciding whether to waive penalties. The position you take now will carry into the next audit cycle. Getting ahead of the domino effect means treating the assessment as information: quantify the same exposure in your other states, then decide, state by state, whether to disclose proactively, register prospectively, or hold your position.
Reasonable cause penalty abatement in practice
Even when the tax is owed, the penalties often aren’t set in stone. Most states can waive penalties where you exercised reasonable diligence: you relied on written advice, you had systems in place that failed in an understandable way, or your compliance history is otherwise clean. Texas, for example, presumes you’ve requested a penalty waiver during an audit and tells you the outcome with the audit results, whereas other states require a written request with documentation.
The practical points to follow: ask early, ask in writing, and support the request with documented evidence. Penalty relief can materially reduce the final cost of a six-figure assessment, for example, and in our experience it is one of the less contested parts of the negotiation. Whether you decide to fight or settle, a sales tax audit is ultimately a test of preparation, and the companies that fare best are the ones that made the decision with full information rather than under the pressure of a looming deadline.
Received an assessment and weighing your next move?
If a sales tax audit has left you with a number you’re not sure you should accept or contest, we’d welcome a conversation before your response deadline arrives. If your position is worth defending, we’ll help you defend it; if it isn’t, we’ll tell you that too. Contact Miles Consulting Group at info@milesconsultinggroup.com or book a consultation through our website.
Frequently asked questions
Should I fight a sales tax audit assessment?
It depends on five factors: how defensible your position is, the dollar amount at stake, the precedent the outcome sets for future periods, the risk of triggering scrutiny in other states, and your ongoing relationship with the state. If the realistic savings exceed the cost and risk of the fight, contesting makes sense. If not, settlement usually preserves more value.
What is the difference between settlement and appeal in a sales tax audit?
An appeal asks the state, and eventually an independent reviewer, to rule on whether the assessment is correct, and each issue is generally won or lost outright. A settlement is a negotiated compromise, often expressed as cents on the dollar, that trades the chance of full victory for certainty and speed. In some states you can pursue both at the same time.
What should I do after receiving a sales tax assessment?
Note your response deadline first; appeal rights expire quickly, often within 30 days. Then assess the strength of your position and your documentation, compare the cost of each response against the realistic savings, and consider whether the findings point to exposure in other states that a voluntary disclosure agreement could resolve before another audit begins.
Can penalties be removed from a sales tax assessment?
Often, yes. Most states offer penalty relief where the taxpayer exercised reasonable diligence, and some consider a waiver automatically as part of the audit. Requests should be made early, in writing, and supported by evidence such as reliance on professional advice and a clean compliance history.
Can one state’s sales tax audit trigger audits in other states?
It can. States share information through registration data and audit referrals, and an issue found in one state, such as the taxability of software or an unrecognized nexus footprint, usually exists wherever you sell. Quantifying that exposure promptly, while voluntary disclosure is still available, is the best way to get ahead of it.
