A sales tax audit is a sobering ordeal, but it is one that many (if not most) California businesses will face eventually. If you are selected for an audit by the California Board of Equalization (BOE), you will have to prepare a wide range of documents and records for your auditor to review, but how far back will the BOE want to look, and what are your rights? Today we will take a look at the California sales tax audit process, the statute of limitations, and what they might mean for your business.
Introduction: what is a statute of limitations?
In general, statutes of limitations are laws which determine how much time can pass between an event and any legal filings related to that event. After that time period has passed, legal actions like claims and collection actions either can no longer be filed, or are likely to be dismissed if they are filed. In criminal matters, after the statute of limitations has passed the courts no longer have jurisdiction. Different legislative bodies set different statutes of limitation which will vary by event, crime or location.
In terms of California sales tax audits, the statute of limitations refers to how many years the BOE has to assess any unpaid taxes, fines, and penalties you may owe.
California sales tax audits
California sales tax is charged statewide at a standard rate of 7.5% but local jurisdictions in have added additional district taxes in many areas, which can range from 0.10% to 2%. The money raised by sales taxes is the main source of funding for state parks, roads, law enforcement and other public services.
California’s Board of Equalization (BOE) is the body responsible for administering and collecting many of the state’s taxes, including sales and use tax. The BOE regularly conducts audits of California businesses to ensure that they are complying with state tax law. The goal of an auditor is to find misreported or unpaid taxes which have been neglected either in error or through tax evasion.
Exactly how an audit is conducted varies depending on the type of business being audited, but at a minimum they include an examination of records such as sales and use tax returns and worksheets, state and federal income tax returns, ledgers, invoices, statements, till receipts and more. In some cases, auditors may use other types of tests such as markup analysis, statistical sampling, credit card percentage tests, and even undercover operations such as “pour tests” in bars and restaurants.
A sales tax audit can happen for any reason: sometimes it is just your turn to be audited. However, there are many circumstances which may make it more likely that you will be selected. If your business is largely cash based, if you work in an industry known for high rates of non-compliance, if one of your vendors has been audited or if you have had tax problems in the past, you make be at greater risk of a sales tax audit. If you have recently gone out of business, you can still be audited, and the BOE will attempt to hold you and anyone else directly involved personally responsible for found liabilities.
The sales tax audit statute of limitations
There is a time period within which the BOE must audit your business: this is the statute of limitations. Once that time period has passed, they cannot assess or collect taxes or penalties for those years.
In California, the general statute of limitations is three years for taxpayers who have filed tax returns. That means the BOE has three years within which they can audit those returns. However, if you fail to file tax returns, the statute of limitations is eight years.
There are some exceptions which could extend these statutes of limitations:
- If you have an amount due and payable for tax reporting periods before January 1, 2003, and
- You did not participate in the 2005 tax amnesty program
- Fraud or intent to evade tax is discovered
- From January 1, 2009, if the BOE has audited a company that has gone out of business, they can issue a deficiency determination (that is, a bill for unpaid tax and penalties) to a responsible person within the earlier of the following two periods:
- “Three years after the last day of the calendar month following the quarterly period in which we obtain actual knowledge of the entity’s termination, dissolution, or abandonment. (Knowledge through its audit activities, compliance activities, or written communication by the business.)"
- “Eight years after the last day of the calendar month following the quarterly period in which the entity was terminated, dissolved, or abandoned. If the business files a notice of termination, dissolution, or abandonment of the entity with a state or local agency other than the BOE, that filing will not constitute actual knowledge by the BOE of the filing.”
Appealing the findings of a sales tax audit
Appealing to the BOE
The process for appealing a BOE sales tax audit begins at the exit conference after the auditor has finished their investigation. If you disagree with the auditor’s report, you will generally be given a time period within which to collect evidence and make your case. The BOE appeals process is lengthy, so you will have several opportunities to prove that you do not owe the assessed liability. If your appeal is denied at every level, you can eventually appeal to the courts, although California law requires that you must pay the assessed tax (minus interest) before you can file. If the court finds in your favor, then you can request a refund.
Preventing future audits - how a tax professional can help
While nothing can guarantee that you’ll never undergo an audit, preparing now will make any future audit as painless as possible. Reviewing your sales tax record keeping on a regular basis and making sure that you have good systems and internal checks and balances in place is your best defense. Having a tax professional perform a “reverse audit” or your records from time to time is a great way to ensure that your bookkeeping is impeccable and ready for review by the BOE or the IRS at any time.
If you are selected for an audit, you should consider speaking with a qualified tax attorney early on. Your attorney will be able to determine whether the BOE is operating within the statute of limitations, they will help you prepare and review your records for the auditor, they will work with the BOE to ensure that the audit is conducted properly and fairly, and they will negotiate on your behalf to ensure that you get the best possible outcome in any appeals process or settlement. A sales tax audit is a stressful process for any business, but having an experienced tax lawyer on your side can smooth the way and give you true peace of mind.