CDTFA Audits (Sales & Use Tax)

Southern California Sales & Use Tax Audit Attorneys

Protecting Business Owners in Southern California

Very few taxation problems are as worrisome as being informed your company will be subjected to a Sales & Use tax audit. Retailers face many challenges in doing business in Southern California. Surviving tough economic times can lead to a range of financial difficulties. One of the most serious risks is being informed that the California Department of Tax and Fee Administration (CDTFA) has scheduled a Sales & Use tax audit.  In this situation, you need legal help that understands the system, the SBE, and how to manage these issues to avoid the worst consequences. Dallo Law  Group is widely known as being one of the most effective Sales and Tax Audit law firms in Southern California to reduce risk, financial losses, or worse.

Here is what can happen to a business subjected to a Sales & Use tax audit:

  •  Substantial Back Tax Assessments: Auditors may dispute your documentation for exempt sales or use “indirect” audit methods for an estimation of revenue, often resulting in a “Notice of Determination” for tens or even hundreds of thousands of dollars in unpaid taxes.
  •  High Interest and Penalties: Penalties may include a 10% penalty for negligence or failure to pay, along with additional penalties depending on the circumstances. Interest accrues on unpaid tax at rates set by California law and can significantly increase the total amount owed over time., significantly inflating the balance of taxes owed over the usual three-year audit period.
  •  Personal Liability for Business Owners: Under California law, unremitted sales tax is called a “trust fund tax.” If the business cannot pay, the CDTFA can personally assess “responsible persons,” such as owners or officers, and can hold these individuals personally liable for the debt even if the business is a corporation or LLC.
  •  Expansion of Audit Scope: If an auditor discovers errors in one sample period, such as a single quarter, they may expand the audit to cover the standard three-year statute of limitations, or up to eight years if no tax returns were filed. 
  • Suspension of Seller’s Permit: In cases of non-compliance or failure to pay the assessment, the state can suspend your seller’s permit, effectively forcing your business to cease all operations.
  • Aggressive Collection Actions: Once an assessment from the agency is final, they are authorized to seize bank accounts, garnish wages, and place tax liens on your business and personal property to attempt to satisfy the debt.
  • Criminal Investigation Referral: If the auditor finds evidence of intentional evasion, such as falsified records or “skimming” cash sales, the case can be referred to the CDTFA’s Investigations Bureau for criminal prosecution, which may result in criminal prosecution under California law, depending on the facts and circumstances.
  • Operational Disruption: Managing an audit requires an average of 35 to 40 hours of dedicated staff time. The distraction of gathering years of records and hosting an auditor on-site can significantly impair daily business operations and growth.

The CDTFA and Your Business in Southern California

The California Department of Tax and Fee Administration (CDTFA) is the agency responsible for administering and enforcing California sales and use tax laws. If you operate a retail establishment that engages in taxable sales, you are required to collect sales tax from customers in trust for the State of California and remit those taxes to the CDTFA. 

A Sales and Use tax audit by the California Department of Tax and Fee Administration (CDTFA) is a rigorous examination that can place an immense administrative and financial strain on any business. Unlike many federal reviews, California’s auditors often utilize aggressive “markup” tests and shelf-tests to estimate sales, which can lead to assessments that far exceed a company’s actual records. Understanding the potential outcomes is critical for protecting your business’s continuity and your personal assets.

Failure to Maintain Records

While all tax audits can be extremely burdensome and nerve-racking for a business owner, sales tax audits pose additional concerns for a business person. The failure to maintain adequate books and records can prove disastrous and costly for the taxpayer, as the SBE may determine that you owe an exorbitant amount of sales taxes, and you may find it difficult to prove the contrary. Furthermore, the CDTFA has the authority to suspend or revoke a seller’s permit for failure to comply with sales and use tax laws, which may prevent a business from continuing operations. Finally, the State Board of Equalization (SBE) can seek to obtain payment of sales tax liability from the responsible individuals of the business and can levy their personal assets if payment can’t be obtained from the business.

What Triggers a California Sales Tax Audit?

CDTFA has a few reasons to suspect that the business is understating its sales tax. This may occur when there are significant discrepancies between sales reported to the CDTFA and other financial records, such as income tax filings or bank statements. Another reason is that you are paying sales tax but are not registered with the CDTFA. The CDTFA also pays close attention to a significant increase or decrease in sales. Lastly, the CDTFA might want to look at your books to see if there was a major change in your business, like new owners or you sold off the business. The goal is to make sure there is compliance with the laws and to collect all the taxes that are due.

Common Triggers

Some common triggers the CDTFA looks at to determine if they will conduct an audit are:

  •         Unusual Discrepancies in Tax Returns: If there are sudden drops or spikes in reported sales and/or frequent amendments to the tax returns, this could give cause for the CDTFA to warrant a closer look into your books. In addition, if you consistently file or report late, this is a major red flag for the CDTFA.
  •         Random Selection: The CDTFA may select businesses for audit based on risk factors, compliance reviews, or other internal criteria, to ensure there is overall compliance across various industries.
  •         Informant Tips and Whistleblower Reports: The CDTFA receives anonymous tips regarding potential tax evasion. The CDTFA will conduct a validity assessment of the claim before acting. The CDTFA takes these tips seriously.
  •         Complex Business Structures: Complex business structures (including multiple business entities or subsidiaries) could also trigger an audit, because intercompany transactions require a more thorough examination. Furthermore, if one of your vendors gets audited, you might be on the list as well. This is called an “audit by association.”
  •         Failing to Register Your Company: This is a critical aspect of tax compliance, as tax authorities rely on accurate and up-to-date records to assess and collect taxes.
  •         High Volume Cash Transactions: High cash volume businesses are at a higher risk of an audit because the possibility of unreported cash transactions is higher.

Other Industry-Specific Triggers

Certain industries could trigger an audit. Certain industries may face increased audit scrutiny due to the complexity of transactions or higher volumes of taxable sales. These industries usually involve cash transactions. One example is E-commerce and online retail businesses. CDTFA worries that sales could be underreported because sales are across state lines. In addition, auditing E-commerce helps ensure compliance by third-party platforms. Another industry is hospitality and food services. These audits help the CDTFA enforce compliance with special food tax rates, and tips/gratuities are reported correctly.

The CDTFA also closely monitors construction and contracting businesses. The goal of the audit is to confirm that workers are correctly classified and that materials are correctly labeled as taxable or non-taxable. The last industry is manufacturing and wholesale. These industries have many moving parts. The CDTFA audits these industries to monitor certificates and track exempt sales.

Data Analysis and Technology

Another reason your company can get audited is due to technology forensics. The CDTFA has automated data matching software. The software will cross-reference sales data with other sources and identify inconsistencies and anomalies. Another tool the CDTFA uses is predictive analysis, which is why audits are increasing and can be much harder to contest without professional help.  The CDTFA looks at historical data and identifies high-risk businesses. These tools allow CDTFA to efficiently allocate audit resources.

Reducing the Risk of a California Sales Tax Audit

You can reduce the risk of a California Sales Tax Audit by filing and reporting your sales tax on time. Also, you should keep an accurate and organized record. You can protect yourself by storing and backing up all digital records. If you need help, you can always contact the professional tax advisors here at Dallo Law Group.

To reduce the risk of an audit, you should be transparent with your communication. You should respond promptly to state inquiries and demonstrate a willingness to cooperate.

What Is the Sales & Use Tax Audit Process in Southern California?

In regulation-heavy California, the right amount of revenue management is critical. The public agency with the authority for the state’s sales, use, and excise tax administration and collection is the California Department of Tax and Fee Administration. Vital California programs, such as the state’s public parks, playgrounds, roads, and schools, rely on funds generated and collected by the CDTFA through sales and use taxes, property taxes, and other special taxes.

Because so many of the state’s essential programs rely heavily on these tax funds, enforcing the laws that help maintain tax revenue is crucial; the CDTFA’s primary goal is to enforce the tax code. This task is accomplished by carrying out audits to ensure that retailers are properly and accurately collecting, recording, reporting, and paying sales and use tax. A CDTFA sales tax audit means serious business, and the agency is ruthless in its actions to identify any wrongdoings, omissions, errors, or fraud in the area of retailers’ sales and use tax.

Once your business is contacted (usually by U.S. Mail), you will be asked to respond to an audit engagement letter where the terms of the process will be explained. You will also be requested to attend a call or meeting. During that time, you will be given a list of the documents and records that you need to provide for examination.

Next, you will be provided with a timeframe to gather the materials requested for the investigation. If you need more time, you may need to sign a waiver: the California sales tax audit statute of limitations. This document extends legal requirements if the auditor finds additional tax liabilities owed. Additionally, you may be asked to sign a Waiver of Credit Interest, which can clear the CDTFA of any interest owed if the auditor finds a refund or credit is owed to you. It is always a good idea to have such documents reviewed by a tax attorney before you sign any document.

Preparing for a CDTFA Audit

Your preparation for the CDTFA audit is paramount to having the process go as well as possible. Carefully follow directions and thoughtfully consider supplying the documents requested of you. Some typical records include:

  •  General Ledger
  • Sales And Use Tax Returns And Worksheets
  • State And Federal Income Tax Returns
  • Sales Invoices
  • Purchase Invoices
  • Cash Register Receipts
  • Property Tax Statements
  • Documentation Supporting Any Exempt Sales

What to Expect During a California Sales & Use Tax Audit?

During the CDTFA sales tax audit, you can expect the process to involve a standard set of actions. Namely, the auditor will look for discrepancies between your records and your tax return. There are different ways the auditor may draw comparisons and come to reasonable conclusions with the evidence provided, combined with industry standards. Furthermore, investigations typically begin with the intention of uncovering simple mistakes and may lead to blatant and willful evasions or even fraud, depending on the circumstances

Form CDTFA–503 – ABC Letter Procedure

What happens when CDTFA, during an audit, believes a certain item is taxable, and you do not agree? The answer lies in Form CDTFA–503 — ABC Letter procedure. The CDTFA developed this procedure to help you prove the item is not taxable. Some reasons that you do not need to pay include the vendor already paid the tax, the item is not subject to taxation, or the item is reported somewhere else.

When applicable, the auditor will sit down and explain the “ABC Letter procedure.” The auditor will inform you that the procedure alone does not relieve you of your duty to pay tax, but other evidence might be considered. After the meeting, you will have four weeks to reach out to the vendors and gather documentation to be sent to the CDTFA. The vendor will have ten days to reply to your request. You should plan on having all the documents from the vendor sent directly to the CDTFA. In California, you will be allowed to customize your “ABC” cover letter, so long as the format adheres to the CDFTA rules.

After a CDTFA Audit

Upon review and completion of the California sales tax audit, an exit meeting will be scheduled. During that period, you will be given a Report of Field Audit. This document will outline the investigation and findings. At this point, you may choose to accept the conclusions, or you may raise an issue with any points.

If you disagree with any details, you are welcome to provide more records or evidence to counter and request a further review. The final report will then be drafted by the auditor and documented in A Notice of Determination, which will state the taxes you owe. On the other hand, if the findings uncover a refund you are due, any approved refund will be issued according to CDTFA processing timelines, provided there are no outstanding tax liabilities, unless you have an outstanding tax debt. You may also file an appeal, which must occur within 30 days.

Contact us today for a consultation!

California Sales Tax Audit FAQs

What triggers a California tax audit?

A sales tax audit occurs when the California Department of Tax and Fee Administration (CDTFA) suspects that a business has underreported or failed to report its sales. This often arises when there are discrepancies between the sales tax returns filed with the state and the figures reported to the IRS. In addition to targeting potential underreporting, the CDTFA also conducts random audits, and the agency has noted that it reviews nearly one percent of active accounts each year. 

How far back can California audit

In California, the general statute of limitations is three years for taxpayers who have filed tax returns. That means the CDTFA has three years within which they can audit those returns. However, if you fail to file tax returns, the statute of limitations is ongoing.

What should I expect from a sales tax audit?

After notification of your upcoming audit, you will need to supply records. The auditor intends to be able to trace transactions and, if taxable, trace the tax paid or collected on the transaction. Proper recording, matching, and paying taxes is also important. If there are any issues with records, you may be asked for alternative options, which will be discussed with the auditor.

How long does a sales tax audit take?

Typically, a CDTFA sales tax audit may last from one to six months. The duration depends on several variables, including the level of activity in a particular jurisdiction, deliberation on audit schedules, assessment, and potential appeal. In some extreme cases, the audit may even extend to years if the retailer is very large and has an extensive scope of activities.

Can I still be audited even if I am no longer in business?

Yes, you can! The IRS or FTB can still conduct audits. Generally, the federal statute of limitations runs for three years, and the California statute of limitations for sales and use tax audits is generally three years for filed returns and up to eight years if no return was filed.. During those years, if discrepancies are found, you can be liable for any tax owed.

California Sales Tax Audit Help

CDTFA sales tax audits can be extremely complex and technical. To adequately represent you in a sales tax audit, you need the technical and tax experience of a certified public accountant to properly determine the amount of sales tax you are responsible for, as well as the creativity, analytical abilities, and negotiation skills of a tax lawyer with a Master of Law in Taxation. Dallo Law Group has qualified tax professionals who can help you resolve your sales tax dispute.

Call us at 619-912-0616 for assistance if your business is facing a Sales & Use tax audit in Southern California.