In 1930, Mississippi became the first state to adopt a general sales tax. Since then, all but four states have jumped on the bandwagon, and 46 states means 46 sets of rules, regulations, rates and exemptions.

For many years, sales tax laws in other states weren’t of much concern to small businesses. It was mostly big companies that engaged in interstate commerce. But now the world is one big shopping mall, and with a few keystrokes consumers can buy goods in any state from Maine to California.

In a 1992 decision, the U.S Supreme Court exempted out-of-state retailers from collecting sales taxes in states where they have no physical presence, like a store, office or warehouse. Although that decision involved a mail order company, the ruling has been applied to all remote sellers, including online retailers. The result? Companies have increased their geographic market, costing states billions in sales tax revenue.

The use tax

So, what are states doing? Many are trying to strengthen use-tax compliance. A use tax applies to transactions not subject to sales tax where tangible personal property, bought in one state, is used in another state. The use tax is generally the same rate as the state’s sales tax, and is to be paid by the party making the purchase. That means you may owe use tax on a computer you ordered from another state and on which you did not pay sales tax.

Use tax looks like sales tax, smells like sales tax and costs like sales tax, so states are making up for sales tax losses and enforcing the collection of use tax by conducting sales/use tax audits. All this means you need to be prepared. There has been a noticeable increase in sales/use tax audits as states try to recoup those lost sales tax revenues.

Tax laws vary greatly from state to state. Here is just one quirky example: Antacids are exempt in Connecticut, but are taxable once you cross into Massachusetts. It doesn’t take much research to see that learning all the differences in sales tax laws would require more antacids than both those states could hold.

If you’re audited

The best defense in a sales/use tax audit is thorough record keeping. Detailed documentation could save you big money in taxes and penalties, while decreasing the amount you have to spend on defending yourself in the audit.

Some records that may be reviewed include sales tax returns, worksheets, canceled checks, federal income tax returns, state tax returns, general ledger, general journal and closing entries, sales invoices, exemption documents supporting nontaxable sales, charts of accounts, fixed asset purchases/sales invoices, expense purchases, merchandise purchases, bank statements, canceled checks and deposit slips, cash receipts and depreciation schedules.

A sales/use tax audit usually begins when an auditor contacts you by letter or phone to schedule a pre-audit meeting. In this meeting, the auditor will typically present an audit authorization letter and other documents for you to sign. He or she will then explain what records are required to complete the audit and ask for additional information such as details of your accounting procedures.

Getting ready

To prepare for the scheduled audit, you will need to gather and organize the records requested by the auditor. Don’t provide too much or too little information – only what they ask for. Too much information can potentially uncover liabilities they weren’t even looking for and waste a lot of your time. Too little information might raise the auditor’s suspicions and cause the scope of the audit to be increased.

While sales tax and use-tax regulations vary slightly for retailers, laws vary wildly for construction, manufacturing, distribution and other businesses like drain cleaning that may have mixed taxable and nontaxable transactions. To help you understand where you may have sales tax exposure and get a jump on a possible audit, learn the laws of your state and the states where you have a physical presence.

Most states detail their rules on the Internet. To get started, go to a map at www.taxadmin.org/fta/link/default.html on the Federation of Tax Administrators Web site, click on your state, and start studying. You’ll soon realize those lawmakers back in Mississippi had no idea in 1930 the size of the genie they were letting out of the bottle when they created sales tax.