Ask anyone who has ever been in the business 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.
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. As you would probably guess, there are a lot of inadvertent mistakes in that process that 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.
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 (elbow bump if reading in 2020). 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 floorplan 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.
Alternatively, the CDTFA can 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, 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.
AUDIT INTRODUCTION TO CA SALES & USE TAX AUDITS
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:
AUDITS CONSISTENTLY REPORTING/FILING LATE
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.
REPORTING SUBSTANTIAL EXEMPT SALES
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.
A HISTORY OF PAST AUDITS
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.
CARELESS USE OF REPORT OF SALES
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.
YOUR BUSINESS UNDERWENT A MAJOR CHANGE
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.
SUBSTANTIAL NON-COMPLIANCE FOUND WITHIN YOUR INDUSTRY
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 her, 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
HOW THE AUDIT IS CONDUCTED AND WHAT TO EXPECT
If the CDTFA suspects your business may be in non-compliance, you may receive an audit engagement letter. The first step of any sales tax audit is the “audit engagement letter.” In the letter, the auditor will briefly set out the terms of the audit and a preliminary list of documents to prepare for the first meeting. A thorough review of records is universal, but questionnaires, interviews, and even covert observation are all common techniques. There will be a request to contact the auditor, who will likely request an interview.
The interview typically consist of a wide array of questions from the auditor while he or she types away a report of their observations and identifies potential areas of liability. After the interview, a dealer can expect more burdensome document requests.
The requested documents typically span several years of financial statements, inventory records, and deal jackets. The auditor will also make document requests to third parties in order to cross reference information given by the dealer. Many times these third party records are unreliable and often result in an over assessment of liability.
Auditors will often use a sample to make their assessment, this means that one improper tax assessment can cost you many times over. This is because the auditor will treat the sample if as representative of the total taxable sales. A tax professional can take a closer look at the auditor’s findings and help identify any discrepancies.
Lastly, the auditor will make their determination. If there is a liability found, the CDTFA can add penalties, levies, and even prosecution in instances of felony tax evasion. However, before the determination is finalized you will have an opportunity to rebut the auditor’s results. If the auditor is convinced by your argument and evidence, he or she may adjust the amount owed. If the auditor disagrees, you can still engage in the appeals process. If a settlement cannot be reached after the appeal, the last available option is to sue.
The first step the auditor may take is to reach out and set up an interview. This is a critical stage in the audit, and the auditor will ask specific questions that may pertain to both sales and use. The auditor will likely ask about sources of inventory, resale to wholesalers, consignment sales, cash expenses, and whether the dealer is engaged in any in-house financing.
The auditor may also ask whether the dealer or any family members own their vehicles or are allowed to drive vehicles off the lot.
The auditor is looking for leads here. CDTFA auditors are trained to already look for certain flaws based on the type of actions the dealer is engaged in. For example, when an auditor learns that a dealer is engaged in buy-here pay-here financing, the auditor will already be on the lookout for underreported sales when examining those accounts.
EXAMINATION OF RECORDS
Once the auditor makes their way to the office, the first item they will likely look to secure for examination are the ROS books assigned to the dealer from the DMV. The auditor will have already called the DMV and got the ROS book numbers that correspond with the audit period. The auditor will also request to look at the dealer jackets and inventory books. Although many dealers may not maintain double entry accounting systems, you should expect for the auditor to request your general ledger if one is available.
Auditors will usually examine a sample period out of the tax years under audit. The size of the period will depend on the experience and judgement of the Auditor. The following principles should be considered in selecting a test period:
- The size should be large enough to ensure reasonable accuracy
- The auditing time required should not be excessive in relation to the problem
In general, when auditing a business with good internal control, and a good accounting system, the test period may be a relatively small portion of the total audit period. However, in an audit of a business with little or no internal control, the test period most likely will cover a larger proportion of the audit period.
The Auditor will compare the dealers reported sales from their sales tax returns to the dealers Reports of Sale to verify that there was not any underreporting of sales. The auditor will also look at voided reports of sale to ensure that there are no taxable sales that the dealer has treated as unwinds. Beware, for added measure the auditor will next compare these reports to information gathered from a DMV Sales Database that provides the auditor with a list of all transactions that the dealer completed registration for.
After crosschecking the reports, the auditor may come up with a list of vehicles that they will claim the dealer owes sales tax on. Because the results are from a sample, any liability found may be multiplied across the remainder of the periods.
The results will be compared and analyzed for reasonableness in consideration of the dealer’s business as a whole. If the results seem unreasonable, the auditor will discuss the situation with the dealer. The auditor and the taxpayer will need to come to some kind of agreement as to whether the results are representative of the business for the time period in question. The auditor will, whenever possible, discuss the use of test periods with the taxpayer, include the taxpayer in the development or selection of a sampling plan, and try to reach an agreement. In fact, very often the auditor will discuss and consult with business taxpayer its procedures and techniques, to obtain necessary information for the audit.
If, during the course of a sample, a document cannot be located, normal auditing procedure requires the auditor to obtain the reason for the missing or incomplete documents. When the investigation fails to reveal any specific reason, the auditor may first determine whether there is any acceptable alternative evidence. Auditor and dealer will work together to obtain missing documents or auditor can ask for additional documents that may indirectly provide information sought by auditor.
The auditor will develop a sampling plan to outline methods of testing, time frame and so on. Prior to determining the type of testing to be used in a given audit situation, the auditor
must make a thorough examination of the business operation for the period under audit.
This examination includes a review of source documents, changes in business activity, and changes in accounting procedures and key personnel. The plan is usually completed with assistance and input from the taxpayer.
The information and methods documented in this plan are not binding on either the taxpayer or the CDTFA staff. The sampling plan can and will be continually evaluated (and changed, if necessary) based upon information obtained during the audit process. However, if any deviation from this sampling plan is required, the deviations are fully explained and discussed with the taxpayer.
CDTFA staff must first try to obtain from the taxpayer any data or documents which should have been retained in accordance with Revenue and Taxation Code section 7053. However, if all other available avenues of information have been exhausted and approval of the district administrator has been obtained, CDTFA staff may request the information directly from the taxpayer’s financial institution either by obtaining the taxpayer’s authorization or by issuing a subpoena duces tecum. Procedures for requesting records directly from a financial institution must comply with the California Right to Financial Privacy Act.
FOLLOW UP MEETING WITH CDTFA REPRESENTATIVE:
Once again you will be expected to make a presentation of the evidence in your favor. At this point, is your case remains unresolved, a "Notice of Determination" will be issued.
APPEALS PROCESS AND SETTLEMENT OPTION
After a Notice of Determination is issued, you will have 30 days to file a “Petition for Redetermination.” You can use the CDTFA's form, or file your own petition, which must:
- Be in writing.
- Identify the amount(s) you wish to contest
- State the specific grounds or reasons that the tax is not owed.
- Be signed by the taxpayer or an authorized representative.
In this petition you may also request an Oral Hearing in front of the Board of Equalization and an Appeals Conference. At every stage you will be asked to present your evidence and make your case. At this point you have the option of making a Settlement Proposal.
If you cannot reach an agreement through the appeals process or through a Settlement Proposal, the next stage is going to court. There is a Full Payment Rule which requires you to pay the proposed tax in full (though you are not required to pay the interest at this time), and then apply to the court for review. If the court finds in your favor, you are eligible for a refund.
While this is the typical process that auditor’s follow in a used car sales and uses tax audit, there is no specific structure to a California Sales Tax audit. The auditors are authorized to use a wide range of tactics to find the information they need. The auditor will be searching for two basic things. These things are: taxable sales that were not taxed, and taxable sales that were not properly taxed.
TAXABLE PURCHASES THAT WERE NOT PROPERLY TAXED
This is the use tax part of the audit. If you purchased something for personal consumption instead of resale, use tax is due.
A dealer should be familiar with the use issue presented by questions regarding whether the dealer or their family members own their own cars or whether they drive cars off the lot. Although a dealer may already be both aware and compliant that family members are not to use dealer license plates for personal use, the dealer may not be aware of certain circumstances in which they may be liable for use tax for personal use of a vehicle they drive. These penalties also apply to cars that a dealer might lend to an employee or even loaner cars given to customers while their vehicles are being serviced. It is important to go into the initial interview well prepared and ready.
At some point, the auditor may come to the dealership and take a tour of the lot. The auditor will be looking for anything out of the ordinary. They will be making an evaluation on whether the sales tax collected is reasonable based on the size and activity of the dealership.
The auditor may also peek into windows and examine car interiors. The auditor may examine the interiors of the vehicles to determine whether any of the cars in inventory are being driven for personal use. If a car should come under suspicion, the auditor may request to take an odometer reading and compare the mileage to that at the time of purchase. The auditor will also be looking to find any other sources of revenue that the dealer may have; such as a body or repair shop, or other items held at the dealer for sale.
TAXABLE SALES THAT WERE NOT PROPERLY TAXED
This is the sales tax part of the audit. The auditor is looking for instances where you did not charge tax, or where you charged the wrong tax rate.
SPECIAL TAX DISTRICTS: APPLYING THE CORRECT RATE
Most people are familiar with the fact that the sales tax charged in one California city can differ from the rate charged for the same item in another California city. The reason behind the varying rates is because California has what are called “special tax jurisdictions,” also referred to as special tax districts. Special Tax Districts cause a great deal of confusion among many used car dealers, and even some tax professionals.
The State of California allows each city or “jurisdiction” to set their own sales tax rate to a limited extent. Each jurisdiction may choose to implement their own tax which they may charge on top of the State’s base rate of 7.25%. Because each district may choose a different amount to add to the State’s minimum, special tax districts are created which charge varying amounts of sales tax.
Outside of the car dealer industry, the seller usually charges their customer the rate according to the district they do business in. However, there is a dealer-specific exception which requires the dealer to charge the rate applicable to the district where the vehicle will be registered.
This means that the dealer is required to charge a different rate from one customer to the next. While most sellers would not be required to charge a different sales tax rate unless physically moving their business to a new district, the dealer may need to calibrate the sales tax rate repeatedly for each transaction.
For many car buyers, their purchase will often be the largest financial transaction they will make in years. Therefore, a dealer can expect that their buyers may have come to them from a district with a different sales tax rate which must be applied.
More often than not, car dealer newcomers are susceptible to this mistake out of unfamiliarity with dealer-specific rules. However, it is no surprise that even veteran dealers get tripped up by this tricky exception. Failure to apply the appropriate special district rate can result in collecting the wrong amount of sales tax. Auditors routinely look here first for sales tax mistakes.
The auditor will first take a look at the dealer’s previous transactions; apply the proper sales tax rate (based on the registration address) to the sales price; and then compare the appropriate sales tax amount to the actual amount collected by the dealer. If the auditor finds that a dealer has undercharged, the dealer may likely be held responsible for the difference in sales tax which should have been collected.
Of course, charging the wrong district rate may also mean that the dealer has overcharged in some instances. In the case that a dealer has overcharged, they must return the excess tax collected to the customer or turn over the excess amount to the CDTFA.
In either case, the bad news is the dealer may find himself with an unexpected tax bill. The resulting liability from this avoidable error often ends in financial burden, particularly for dealers in need of a steady cash flow to cover their floor plan curtailments.
You can plug-in the customer’s address here to find the appropriate tax rate to charge by address. Be sure to have a conversation with your F&I to ensure that your dealer is in compliance with this regulation. If you think there is a chance your dealer may have miscalculated sales tax in the past, please reach out to a tax professional and discuss how you can take the appropriate steps to resolve the issue.
The amount a dealer charges the customer for registration of the vehicle is non-taxable so long as it does not exceed the actual amount paid to the DMV. Hopefully you are already in the practice of refunding the difference between fees actually paid to the DMV and the amount you estimated and charged the customer at the time of purchase.
There is a risk that the DMV will also take issue with any over assessment of registration fees which have not been refunded. Again, anything collected in excess of what is paid to the DMV no longer qualifies as a tax-exempt fee. Which means that the dealer will be liable for sales tax on these amounts.
Countless dealers give their customers a refund without getting a signed cash receipt or photocopy of the refund check to file away in the deal jacket. Failing to document the refund may signal the need to dig deeper into your records, under the belief that there will be more violations for the auditor to uncover.
By contrast, a well-documented record of refunded DMV fees indicates to the auditor that the business owner is responsible and familiar with the rules and regulations of the industry.
Establishing credibility with the auditor is important. In some cases the auditor might call off the audit entirely if a preliminary finding indicates that the dealer is in compliance.
WARRANTIES: OPTIONAL vs. MANDATORY
Warranties provide a great opportunity for both the dealer and the customer. The dealer can make a little extra profit, and the customer can drive off with peace of mind. As an additional benefit, these customer’s purchase of a warranty is a non-taxable sale. This means you will not have to worry about collecting more tax when selling this product. Please note however, warranties only qualify as tax exempt if they are optional to the buyer.
By contrast, a mandatory warranty occurs when the seller requires a buyer to purchase a warranty as a condition to the general transaction. This disqualifies the sale of warranty from the sales tax exemption allowed when left optional. Persuading purchase is ok, but beware of the sales tax liability created when the customer’s choice is hindered. If the customer does not want to buy the warranty, the dealer should not be call off the sale.
This might pose an issue for dealers who tack most of their gross onto the back end. Due to an oversaturation of dealerships in the market, dealers undercut competitor prices as they often find themselves vying for the same customer. Before the last wave of lease returns came due, a shortage of inventory caused auction prices to spike; this severely limited the ability of most dealers to engage in these price wars. These dealers use mandatory warranties to gain a competitive edge.
This is done by marking the vehicle at or near cost to bring the customer in. The dealer then makes up the profit on the back end by mandating the purchase of warranty.
The customer may leave or reluctantly oblige; figuring that if they are going to pay the same overall price elsewhere anyway, they may as well get the added benefit of a warranty. What once was a crafty strategy to gain competitive edge is now the worst kept secret in the industry. The CDTFA is also aware of this strategy.
Pricing below the fair market price by shifting dollar amounts from the sale of the vehicle to the sale of the warranty has sales tax implications. This is because the vehicle sale is taxable, whereas the warranty is sales tax exempt. When dealers also undercut the vehicle price, they short the amount of sales tax otherwise owed to the state. Auditors are specifically instructed to examine deal jackets for transactions that have a low sales prices and an added warranty charge. Because auditors usually come from accounting backgrounds, they are keen to notice these transactions.
If almost every deal has an extended warranty, you might raise an auditor’s suspicion without realizing you have done anything wrong. Although dealer intentions are often benign, a pattern of moving dollar amounts from a taxable column to a non-taxable one can be interpreted as sales tax avoidance.
Another area the auditor will be on the look-out for sales tax avoidance is deals with trades. Depending on how a deal is structured, a trade-in value assigned in a deal may grab the attention of an auditor. This is particularly an area of concern if the auditor suspects that the trade price and the sale price were both lowered to minimize the amount of tax paid. The Auditor will base their assessment on the fair market values of the vehicles.
Of course, there are times where a dealer will have the opportunity to steal the trade; and there are times where a dealer will give an over allowance on the trade to make the deal work. An over allowance is treated like a discount, these generally do not present an area of concern for the auditor.
In contrast, an under allowance––assignment of a trade value that is below its fair market value––can lead to sales tax liability. This is the case even for isolated instances if the auditor determines the under allowance was made for the purpose of sales tax evasion.
Here is what the auditor is looking for:
- Recorded trade-in allowances that are consistently below market value and that are not attributed to less than fair condition of the trade-in.
- Gross profit margins that are consistently lower on transactions involving trade-ins than on those without trade-ins and which are not attributed to business practices followed by the industry, such as trades on loss-leader automobiles, or trades during promotional sales.
- A widespread pattern of under allowances occurring consistently throughout the audit period.
Although the auditor will primarily look for a pattern of behavior, if the auditor determines that a dealer deliberately under allowed the trade-in value in an isolated incident in order to avoid sales tax, the under allowance will be taxed as an additional gross receipt. Additionally, an intent to evade penalty may also be assessed.
Out-of-state buyers may qualify for a tax-exempt transaction. However, you may not allow the out of state customer to drive the vehicle off the lot. It does not matter that the dealer is fully confident that the buyer actually intends to drive the vehicle right out of state. If the vehicle touches the road, it is considered to have been used in California and the seller can now find themselves with a tax liability.
To qualify for the exemption, the vehicle must be transported across state line. The dealer is responsible for documenting this by keeping a bill of laden. Should you find yourself in an audit, you will be glad to have kept it.
UNWINDS & ROLLBACKS
Although in each of the following cases the dealer winds up in possession of the car, the following transactions vary for sales tax purposes. The main distinction to be cautious of is between an unwind and a rollback.
An Unwind references an incomplete vehicle transaction where a Report of Sale has been completed, but the customer did not take delivery of the vehicle. Processing an unwind is relatively easy. The dealer will simply void the Used Report of Sale and complete a Statement of Facts that confirms the vehicle never left the dealer’s possession and was not operated. The dealer must retain all copies of a voided report of sale and the REG 256, with the book copy, at the dealer’s primary business location so it is available in the event of an audit.
In the event that the return takes place after the customer has received delivery and operated that vehicle, this transaction must be treated as a rollback. Under the DMV’s Vehicle Industry Registration Procedures handbook, a sale is triggered for registration purposes once the vehicle is operated by the customer. The report of sale cannot be voided when this occurs; all fees are due from the date of sale and must be submitted promptly to DMV.
A rollback usually happens financing could not be secured by the dealer, and so the dealer exercises a valid contractual right to rescind the transaction before some enumerated deadline in the contract. When this occurs, down payment and other money paid by the customer should be returned and the dealer takes back possession of the vehicle. Although there may be other reasons why a vehicle is returned, this is the most common circumstances for a return after operation.
As stated above, once the vehicle is operated a dealer is required to submit registration fees. Although the dealer may think the deal is null and void, a sale has essentially been recognized and recorded in the DMV database. The process for handling a rollback is much more complicated than an unwind. In addition to the basic transfer requirements in Chapter 11 of the DMV Procedures Manual, the following are required:
- A Statement to Record Ownership (REG 101) form in the name of the second buyer that includes the name of the legal owner (lienholder), if appropriate
- A Lien Satisfied/Titleholder Release (REG 166) form from the lienholder for the first sale, if applicable. A REG 166 is notrequired when:
- Financing was notapproved for the first sale or the dealer entered the information in error. Accept a Statement of Facts (REG 256) form or a Statement of Error/Erasure (REG 101) form from the dealer regarding the lienholder information.
- The lienholder remains the same for the second buyer. The lienholder must be shown on the REG 101 for the second buyer.
- A REG 256 containing the following information:
- Name of the person who returned the vehicle to the dealer and the date returned.
- Reason the vehicle was returned (for example, credit unavailable).
- If the vehicle was voluntarily returned by the prospective purchaser.
- If the vehicle was sold under conditional contract, chattel mortgage, etc.
- If the trade-in, if any, was returned to the prospective purchaser.
- If the down payment was returned and whether it was a cash down payment or cash in addition to the trade-in
- A Vehicle/Vessel Transfer and Reassignment Form (REG 262) from the first buyer to the dealer.
- Two Report of Sale–Used Vehicle (REG 51) forms: one for the first buyer andanother for the second buyer.
- A smog certification, if appropriate.
- Two transfer fees and any other fees due.
Because the CDTFA auditor will crosscheck the dealers reported sales with the DMV database, these rollback sales may become problematic if the dealer is unable to prove that the sale did not go through and all payment was refunded to the customer.
Another way a car might make its way back to the dealer is if it is repossessed. Regardless of time elapsed, a repossession does not negate sales tax. Even if the repossession occurs before the end of the reporting period, sales tax is owed on the entire taxable amount. Auditors are trained to assume that dealers are repossessing the vehicles and inappropriately treating them as unwinds to avoid paying tax without having returned any of the funds. This is a temptation for many dealers, and you should avoid this at all cost.
However, there is a process to claim credit for sales tax paid on bad debt. A dealer must first claim this bad debt as a loss when filing their federal returns. Once the dealer has made this claim on their federal returns, they may apply to be credited for a prorated portion of the sales tax which corresponds to the bad debt.
For example: if 50% of the agreed taxable amount is charged off as a loss, you can reclaim 50% of the sales tax paid once you have filed your federal return.
Although this is particularly useful for dealers who carry deals in-house, almost all dealers can take advantage of claiming credit on bad debt. Think about all the pick-payments your dealer has allowed in the past year. These deferred down payments may go unpaid notwithstanding your best collection efforts.
If you find yourself in an audit, be sure not to leave any money on the table. Sales tax credits like the one above can be identified and used to help offset areas of liability. Reach out to an industry knowledgeable tax professional today if you believe that you have unclaimed sales tax credit owed to you.
Unlike franchise stores, used car dealers are not required to maintain certain types of records. This ends up being a major pitfall for most independents. Poor record keeping practices can land you in hot water once a tax audit rolls around.
While the majority of used car dealers do a decent job maintaining their deal jackets, this is just the baseline. Here are the contents of a well-kept deal jacket.
The following list of items should be kept in your deal jacket if they aren’t being filed there already:
- Auction Invoice or other Proof of Purchase
- Vehicle Reconditioning Receipts
- Smog Certificate (if applicable)
- Retail Contract Agreement Signed by Customer
- Bill of Sale (Reg 262)
- Report of Sale (ROS) Copy
- Optional Products & Services Disclosure Form
- Contract Cancellation Option Form
- Buyer’s Guide
- Signed NMVTIS (optional: AutoCheck/Carfax)
- Copy of Registration
- Copy of Vehicle Title
- Customer’s Credit Application and Disclosure (if applicable)
- Corresponding Spanish Contracts (if applicable)
- Copy of Check or Signed Receipt for Registration/License Fees Refunded to the Customer
- Copy of Gap and/or Warranty (If applicable)
A dealer must be careful to appropriately document any less than usual developments that take place after the sale of a vehicle. In a perfect world, every sale would stick. We all know that sometimes life happens; customers change their mind, financing falls through, or financial circumstances change.
HOW TO PREPARE FOR THE AUDIT
In an ideal world, every business would be preparing for an audit at all times. Pristine record keeping, good systemization, and redundancies make coping with the demands of any audit so much easier, but reality rarely measures up to those standards of perfection.
If an audit takes you by surprise, you will need some time to prepare your books and records for inspection. Speak to your attorney, bookkeeper and/or CPA about the documents required. You may wish to arrange for a reverse audit, where your tax attorney or other tax professional looks at the records for the time period of the audit. Not only can they advise you of potential problem areas, they may even be able to find instances of overpaid tax. These credits could help to offset any assessment made by the CDTFA.
While it is possible that the CDTFA will approach you with an adversarial attitude, it is to your advantage to meet the auditor with calm professionalism. There is a lot you can do to boost your credibility and to help the audit proceed quickly, smoothly, and as painlessly as possible.
MAKE A GOOD FIRST IMPRESSION - BE COURTEOUS AND HELPFUL.
Responding to all requests for meetings in a timely manner is a good start. Be aware that you can usually negotiate the timing of meetings so that they suit you and your business, as long as the request is reasonable and polite.
PROVIDE EASY ACCESS TO YOUR FACILITY.
Obstructing site visits makes you look guilty and is likely to antagonize the auditor. If the auditor will be working on site for some time, provide them with a comfortable desk or office for their use.
PROVIDE ACCESS TO ALL RECORDS AND INFORMATION THEY REQUEST.
Have the requested information ready in time for the meeting. Neat, careful, and convenient preparation of the requested documents will go a long way towards demonstrating transparency and willingness to work with the auditor.
COMMUNICATE WITH YOUR AUDITOR WHEN REQUESTS ARE UNCLEAR.
Sometimes the requests for information are generic and may not apply to your particular business. In this case, feel free to talk to the auditor and ask about alternatives. If the auditor is planning to look at your records using a sample time period and you know that it was not a representative period for any reason, you may be able to negotiate. This is more likely to be successful if you have been reasonable and open throughout the process.
IF POSSIBLE, PROVIDE ACCESS TO A KNOWLEDGEABLE STAFF MEMBER.
If the auditor has questions, having a designated point person who understands the daily workings of your business can expedite the process. On the other hand, make sure that the auditor is not conducting informal conversations with staff members with incomplete knowledge, as this could lead them astray in their investigations.
Treating the auditor with professional respect is not the same thing as treating them like a friend of your business. Be ready to comply with their requests, but you are not required to volunteer additional information. You should not sign anything without careful consideration: the auditor is unlikely to explain the potential consequences of each document or agreement, so it is up to you to research and clarify anything that you don’t fully understand.
HOW A TAX ATTORNEY CAN HELP
Going through an audit can be immensely stressful and isolating. If you have any reason to believe that the CDTFA may find discrepancies in your sales/use tax, the worry about impending consequences can cost you many nights of lost sleep. Even if you think that everything is in perfect order, the sense of being a small business owner up against the behemoth of the CDTFA can leave you feeling outmatched and alone.
Hiring a qualified tax attorney is one of the best things that you can do for your business during an audit. You can expect your attorney to:
- OVERSEE THE SALES AUDIT TO MAKE SURE THAT THE AUDITOR IS CONDUCTING THE AUDIT CORRECTLY AT EVERY STAGE.
- ANALYZE AND DISSECT THE STATISTICAL METHODS USED BY THE BOE IN YOUR CASE TO ENSURE THAT THAT YOU ARE BEING TREATED FAIRLY.
- PREPARE AND PERFORM ANY PRESENTATIONS WHICH MUST BE MADE TO THE DISTRICT PRINCIPAL AUDITOR AFTER THE FIELD WORK IS FINISHED.
- FILE ALL NECESSARY DOCUMENTS SO THAT IF IT COMES TO AN APPEAL PROCESS YOUR RIGHTS WILL BE FULLY PROTECTED.
- GUIDE YOU THROUGH ANY APPEALS PROCESS TO MAKE SURE THAT EVERY APPROPRIATE AVENUE FOR APPEAL IS EXPLORED IN ORDER TO MINIMIZE YOUR LIABILITY.
- FILE ALL REQUESTS FOR ORAL HEARINGS, PETITIONS FOR REHEARING, OR REQUESTS FOR RELIEF FROM PENALTIES.
- REPRESENT YOU AT THE OFFICE OF TAX APPEALS
- DRAFT, FILE, AND NEGOTIATE ANY SETTLEMENTS, REQUEST FOR RECONSIDERATION, OR CLAIMS FOR REFUNDS.