Sales Tax Audit Triggers in California

With California increasing their emphasis on generating revenue, sales tax audits have become more common. Although sales tax audits can be random, the California Department of Tax and Fee Administration (CDTFA) will usually conduct an audit when there is suspicion that the business has understated sales. It is important to understand the red flags that can put your business at risk of being audited. The burden of collecting and paying the correct amount of sales tax as well as filing sales tax returns with the state of California falls on the business owner. Audits are subsequently conducted by the CDTFA to ensure the correct amount of sales tax has been paid.

A sales tax is a tax imposed by the state of California on the sale of goods. The state sales tax rate is 7.25% and each municipality has the option to assess an additional local sales tax. All businesses with a physical presence in California must collect and remit the correct amount of sales tax. Even online businesses with sales to California residents may be required to remit sales tax payments to California.

Receiving an audit letter can be worrisome but hiring a sales tax expert will help relieve the stress. CDTFA will often ignore taxpayer records and use a test to estimate taxable sales, resulting in a tax assessment that can greatly exceed the actual taxable sales. Here at Dallo Law Group, we will support you during the audit process and will protect you from an excessive tax assessment based on CDTFA estimates, including expensive penalties.

Why Audit Sales Tax:

The goal of a sales tax audit is to discover fraud or mistakes. However small the mistake is, the CDTFA wants to promote compliance with state sales tax laws. The increased emphasis on sales tax collections ultimately leads to an increase in revenue for the state. The CDTFA might also impose penalties to further increase the state’s revenue, increasing the importance of hiring a tax expert to get ahead of the audit.

Factors to Identify Audit Targets in California:

Businesses that earn in excess of five million dollars are more likely to be audited. However, small businesses still need to maintain compliance with California state tax laws. Taking large deductions that significantly reduce taxable income may raise red flags triggering an audit. If your business is heavily cash-based auditors are more inclined to investigate the potential of unreported income. It is important to properly report all income and deductions when filing your sales tax returns to help reduce the likelihood of being audited.

Common Sales Tax Audit Triggers:

Failing to Report Sales and Use Tax to CDTFA: Failure to file the CDTFA 401 return can lead to an audit being opened. Failing to file can extend the statute of limitations on a potential audit.

Large purchases or sales: Having unusually large transactions that are not consistent from prior years can prompt an audit.

Filing Your Sales Taxes Late Often: Having a history of late filing can cause the CDTFA to be suspicious of your business’s accounting practices.

Past Audits: Previous audits often lead to further audits in the future to ensure prior reporting issues have been fixed.

Audit by Association: Being in an industry notorious for underreporting income and sales tax can lead to your business being investigated. Operating a cash heavy business can lead to an increased chance of being audited.

Overstating deductions: Having unusually large deductions leading to a decrease in taxable income can cause suspicion. It is important to not overstate deductions and to maintain proper records.

What to Expect During a Sales Tax Audit

The audit process begins with the CDTFA sending the taxpayer an audit engagement letter. This alerts the taxpayer that they are being audited and will require a response, usually within 30 days. This is usually followed by an onsite visit investigating and examining the business’s accounting records to ensure that the correct amount of sales tax was paid. After the examination, the auditor will discuss the findings and potential adjustments. It is important to hire a tax attorney immediately upon receipt of the initial audit notice to prevent invasive investigative techniques and to assist with organizing the audit records. Early intervention by a skilled tax attorney is the best step to resolve a sales tax audit.

Time period for a sales tax audit

The statute of limitations on sales tax audits is three years from the date that a taxpayer files. Although failure to file can increase the statute of limitations from three years to eight years. If the auditor believes that the taxpayer has committed fraud, then the statute of limitations may be extended even further.

It is essential to stay compliant with sales tax laws. When faced with an audit, a taxpayer can be distracted from operating their business and be put under unnecessary stress. Reaching out to a tax attorney in California who has extensive tax experience can help prepare a defense to solve the issue. Contact Dallo Law Group today for more information.

Written By: Jacob Silver