Sam Brotman, JD, LLM, MBA February 9, 2022 13 min read

The Car Dealer's Guide To CA Sales & Use Tax Audits - Part 1


Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law

Ask anyone who has ever owned a dealership and they will tell you that the car business is a tough one. With all the moving pieces that a dealership faces on a day in and day out basis though, one risk that often gets overlooked by owners is the risk that they face in a sales tax audit.

Most of the “mistakes” that we see in the context of audit preparation are benign. Things like not separating shipping charges properly, people not accounting for time and material costs, things being billed individually, or a failure to adjust sales tax rates for the proper district are little and seemingly harmless mistakes in the context of your business operations. But they will trigger an audit.

California has a long history of targeting car dealerships for sales tax audits due primarily to high abuse/error in the industry and the complexity of these types of audits (which usually result in more tax being owed to the State).

Additionally, the California Department of Tax and Fee Administration (CDTFA) has become notorious for aggressive tax positions taken toward dealership resulting in liabilities in the hundreds of thousands or even millions of dollars depending on the volume of the dealership.

If you can imagine, think about all the steps involved from taking the offer given to a customer, turning that into deal documents, inputting that information into your dealer software, and then reporting your sales both to the DMV and to the CDTFA.

There are a lot of inadvertent mistakes in that process that CDTFA tends to capitalize on. You would be surprised that we work with businesses all the time who have perfect records and are nevertheless left with a liability.

If you can imagine, think about the process your deal takes from the time that the customer walks in, to the time you must report the sale to both the DMV and to the CDTFA. After your customer has agreed to come in and talk numbers, an eager salesman hands off a four square to your desk manager.

After a round of pep talks, first and second pencil, your closer comes in and solidifies the deal with a firm handshake or elbow bump. But before breaking out the bubbly, take a look at the nuances of your deal to ensure any potential sales tax issues have not been overlooked.

A lot can happen between first and final pencil. For example: the customer might backdoor a trade; can you balance finance products with an acceptable payment; does the customer need a few weeks to bring in a pick-payment; or perhaps your customer would like to take the vehicle out of state. These are just a few areas which might cause sales tax trouble if not properly addressed in your deal structure.

As you would probably guess, there are a lot of inadvertent mistakes made in the deal process that the CDTFA tends to capitalize on. You would be surprised that we see businesses all the time who have perfect records and are nevertheless left with a liability.

The biggest problem for car dealers is being audited and being left with a liability that you cannot pay immediately. Imagine being hit with a tax lien, which can damage your credit and is a matter of public record.

Liens have prevented past clients from the ability to access their floor plan in order to purchase inventory at auction or through other wholesale sources. Nextgear Capital, AFC, and other industry lenders have clauses in their dealer agreements which allow them to freeze a dealer’s account if their credit has been impacted negatively.

The CDTFA can also levy you and remove all the money from your business operating account in order to satisfy past tax liabilities. This means having no working cash to meet floor plan payments or other dealership obligations.

A visit by a CDTFA auditor can leave a business owner vulnerable for other reasons as well; agencies are known to routinely share information with other regulators.

A brush with the CDTFA can open the floodgates to audits and investigations from agencies such as the Employment Development Department (EDD), the Franchise Tax Board (FTB), and the Internal Revenue Service (IRS).

At Brotman Law, we defend many car dealerships from the CDTFA in audits on an annual basis. Because of our familiarity with the industry and our even greater familiarity with how California sales tax audits work, we wanted to create a reference guide for dealers to learn more about the sales and use tax laws in California and the risks that they face in an audit.

It is our hope that in reading this (in four parts), you will take corrective action to avoid many of the common traps in a California sales tax audit.

However, if you have received an audit notice, we can help you defend you and your business against the threats posed by the CDTFA. Please contact our office to book a strategy session with our senior legal team and protect yourself today.


In California, the public agency charged with administering sales and use tax is known as the California Department of Tax and Fee Administration (CDTFA). You may recall that this responsibility once belonged to the Board of Equalization (BOE).

In response to criticism of the BOE, the California Legislature passed the 2017 Taxpayer Transparency and Fairness Act. The act stripped the BOE of its traditional authority; and it created the CDTFA and the Office of Tax Appeals in order to undertake the BOE’s former responsibilities.

The acronym CDTFA stands for California Department of Tax and Fee Administration. This is California’s enforcement arm. The agency is responsible for administering, enforcing, and collecting sales and use tax.

Their mission is to uncover tax reporting errors or fraud, promote compliance with California’s tax codes and regulations, and increase State revenue. The CDTFA collects approximately 70 billion a year, approximately one-third of the state’s total revenue.

In order to meet these figures, the CDTFA uses the audit as a means to identify sales and use tax it can assess and collect.

How Dealers Are Selected For Audit

When it comes to selection in audits, there is an element of complete randomness that is beyond control. That said, there are a few things that can increase a dealer’s odds of being selected. Here are a few of the most common ways to find an auditor at your door:

    A pattern of failure to report, or late filing is a definite red flag to the CDTFA and a surefire way to make your business a prime target for a sales and use tax audit. Missing payment deadlines reflects poor bookkeeping practices. It also suggests that a business is struggling to meet its payment obligations, which increases suspicion that the business has motive to under-report sales taxes owed.
    There is plenty of room for error when dealing with tax-exempt items. The CDTFA knows this all too well. This is why businesses who report a lot of tax-exempt sales look ripe for audit. THE CDTFA is not just looking for fraud here, they know that innocent oversight or misunderstandings of the tax code can lead to unintentional violations. 
    Old habits die hard. Don’t let your business die along with them. If you have been audited in the past, be sure to address any issues that were found the first time around. Particularly in cases where an audit ends in an assessment of unpaid tax, you can be sure for all practical purposes that the agency will be back again.
    While reports of sale may not be the first thing to land your business’ file on an auditor’s desk, if an auditor is on the fence about performing or waiving an audit you do not want to add any unnecessary suspicion of unreported sales. 
    While voided Reports of Sale due to printing errors are unavoidable, a large number of gaps in the ROS series issued by the dealer may suggest to an experienced auditor that there may be some unaccounted taxable transactions to be uncovered. It is best to practice extra care here rather than risk raising any eyebrows.
    Opening or closing a location, or a sudden increase or decrease in sales can be a reason for the CDTFA to take a closer look. This means that young and expanding dealerships may find themselves especially at risk.
    Many used car dealers are hard-working, ethical individuals. However, a few less than trustworthy individuals have cast a shadow of suspicion on the entire industry. Car dealers are not alone here, businesses that see a lot of cash sales also fall into this category. With all the moving parts that go into making each sale possible, your resources are likely over extended

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-Aileen Dwight, Licensed Clinical Social Worker & Psychotherapist

Last updated: July 8, 2024

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
Brotman Law



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