Chapter 8

What to Do If You Are an Out of State Business and Audited by California

Any type of notification from the California Department of Tax and Fee Administration (CDTFA) can be unnerving. What do they want from me? The first two things I tell my clients are: 1) do not panic and 2) do not respond right away.

It is human nature to want to respond immediately to any type of government notice, but in this case, it is not in your best interest. Now, that does not mean you should ignore the correspondence, just take some time to find out what the CDTFA wants and then devise an appropriate response.

I also recommend that if you are contacted by the CDTFA that you consult with an experienced tax attorney right away, True, the correspondence might be notification of a sales tax audits, or it could be something completely unrelated. It could even be a mistake.

Believe it or not, the CDTFA is not just focused on the money you owe. They want for you to be in compliance with sales tax regulations and they have options available to get you there.

If you do receive a notice of a sales tax audit, call me. I have defended my clients in sales tax audits for many years and know how to take control of the situation for the best outcome for you. You can be assured that will pursue every avenue — all the way through appeals — to achieve the best results for you.

Why You Should Not Contact Your CPA

If you are contacted by a state revenue agency, do not panic and do not respond immediately. While you want to appear cooperative, you also want to control the flow of information that is being given to the agency in question. Often, taxpayers approach CPAs when they find themselves in this situation. 

Hiring a CPA may not always be the most advantageous course of action to take. While CPAs are professionals in the tax realm and are excellent at mitigating tax issues, their expertise often does not extend to advocating for clients grappling with multistate tax issues. Unless they focus their work on multistate sales and use tax issues, 

CPAs mostly deal with individual and corporate income tax preparation. Thus, they may not have extensive training or experience in the multitax arena to efficiently resolve the issue for which the state is contacting the client.  

For example, a well-meaning yet misguided CPA may rush to get the client in compliance by giving the state all the documents it requested. Taking such action would be a mistake because that could open the client up to more liability than necessary. 

By giving the state every sales and use tax document in existence, you could  unintentionally be giving the state information that goes beyond the required reporting period. For example, in California, you may resolve a past due tax liability issue by signing up for the managed audit program. 

A managed audit program limits the time period that the state can investigate to two years.  After completing a sales tax audit and turning your work into an auditor, the auditor will limit their review to data from the two year period.  See the CDTFA’s Managed Audit Program guide for an in-depth discussion of the audit process. 

On the other hand, someone who is not knowledgeable about the managed audit program or other applicable options provided by the state may end up registering for an audit period that is longer than necessary and paying more liability as a result. 

Although the state will be thrilled, this decision will provide no benefit to you. You will substantially increase your liability and potentially put your business at financial risk. For this reason, it is crucial to move forward fully informed of the options available to you and with the right professional by your side.

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Do Not Respond Right Away

Again, if you are contacted, do not respond immediately. Get help from a professional who has experience handling the issue you are facing. If you insist on responding in some shape or form, you may call the number on the notice you received. =

When you do, you may acknowledge that you received the notice and explain that you are working on a response. No matter what route you take to solve the issues, ignoring the notice is not an option. 

When a state sends you a notice, you are already on their radar so you must take action. While you must not ignore the notice, you also must be sure not to be overly eager in your response. Before you spring into action, you must gain a clear understanding of the problem and become informed about the options you have to deal with it.   

If you are contacted for an audit, then the solution may not be straightforward.  However, not every correspondence that the state sends is for an audit.

The states have very limited information on the people who are outside of their borders. If California is gathering information on a company in New York, for example, California would not have access to any state filings because the New York company has not been filing in the state. 

Instead, the state of California would have to rely on either third-party information or information it has gathered through its own means such as through internet searches. This is important to keep in mind when deciding how much information to divulge voluntarily. 

Do Not Jump to Conclusions

The very first thing to understand when you receive a notice is what information the state has on file for you that would suggest you must get into compliance. Their decision to contact you might have been informed by a notice.

There could even be a misunderstanding. Or perhaps the state has information that you were selling goods through another supplier that they think might have nexus in California, while your company itself does not have nexus. 

The state may even be contacting you for liability only limited to a particular year. For example, they might think you have nexus creating activities for 2018 but if you tell them that you have nexus creating activities going back to 2011, then you will have unnecessarily opened yourself up a can of worms. 

For this reason, before you begin working with the state towards a solution, it is an absolute necessity that you understand what the state knows about you and what your actual contacts are within its jurisdiction. Again, the mantra is to understand your risk and options. 

While you may begin to panic the moment you get a letter, your anxiety may end up being entirely misplaced. It may be that the state just wants you to register. Perhaps you do owe some liability but the state does not want to seek retroactive penalty. 

However, in the event that the state is seeking to impose retroactive penalties, you can look into signing up for the Managed Audit Program or that particular state’s equivalent. 

For all these reasons, you cannot rush to judgment or to compliance. Without understanding why you are being contacted, what the state knows about you and your potential options, you can be inadvertently making your situation worse or perhaps creating a problem that was initially non-existent.  

Stay Out of Collections

When you get contacted by a State Revenue Agency and as you go through the process of figuring out what your liability is, it is important to consider the ramifications of having your tax bill go into collections.

At the end of the examination process, regardless of whether you complete a managed audit, go through a voluntary disclosure program, or fail to respond, you will be sent a bill. Unless you pay that bill in full, collections will get involved. 

While there are various repercussions that can result from a bill going to collections depending on the facts, there are some that are universally applicable. First, there is absolutely no forgiveness once the bill goes to collections. Once collections determine you have a delinquent liability, they will exhaust all efforts to collect against the company. 

Either after all efforts have been exhausted or while they seek recourse against the company, collections may even go after officers, directors, bookkeepers/controllers, CFOs, or shareholders, all in their individual capacities. 

Collection agencies are persistent and will go through every legal means possible to get either the company, its leaders or even its shareholders to pay the debt. If you are an individual who has significant control of the business, your personal assets could be at risk. 

In the case of court-ordered debt collections, the state has the authority to garnish your wages so allowing the debt to go to collections should be avoided at all costs.  

It is Not Just About the Money

Before crafting a response, it is necessary to consider how the company will responsively deal with this liability, how it will protect its owner and its officers, and what measures the state can use to enforce collection activity over its borders. 

A state’s power to enforce its tax laws outside of its borders will be highly limited by its resources.  While the state of California’s resources are expansive in comparison to those of other jurisdictions, they are not unlimited. 

Again, there may be a disparity between what California is legally authorized to do and what it eventually will do, especially with respect to pursuing out-of-state companies. Given this reality, decisions regarding how to handle past due tax debt should be informed by an understanding of what the state’s powers are and how they may be used against you or your company.

Furthermore, imagining what the worst case scenario would be can serve as a powerful tool to help you assess and mitigate your risk.

Generally, the states are not looking to conduct audits but rather, they are aiming to get people in compliance. Often, if a taxpayer voluntarily gets into compliance based on a request, they do not have to go through an audit or submit themselves to the Managed Audit Program. 

In addition, when a taxpayer voluntarily gets into compliance in response to a request by the state, there is no further investigation of their books or records. The key takeaway is that while getting into compliance, it is important for companies to avoid opening themselves up to further liability, interest and penalties.

Notifications seeking taxpayers to get into compliance are very distinctive from audit notifications. If you are being audited, you will know about it ahead of time.

You will receive a notice with a message to the effect of "You are under examination. We would like to look at your books and records.” 

Again, audits and requests for compliance are completely distinctive so make sure to understand whether what the state is requesting is one or the other. Determine if the state simply believes that you have engaged in nexus-creating activities or if it is auditing you because it knows that you have engaged in nexus-creating activities.

Be Proactive 

If you have not received further contact after the state’s initial notification, remember, you must be proactive in resolving the situation. The problem will not go away on its own so you must be responsive. If you have not been contacted, you still have control over this process. Namely, you have the upper hand because you can reach out to states voluntarily and you have control over the timing for getting in compliance.

You can still maintain control even if you have not been caught, but understand that someone will eventually catch up to you based on your activities. Depending on your level of contacts and your presence outside the state either online or otherwise there may be different ways to manage your risk. 

However, given how increasingly aggressive the states have become in pursuing out-of-state entities that have nexus within the state, you will likely have to pay up eventually.  If you have not been in compliance in the past, now is the perfect opportunity to do so before states get more sophisticated and increase their enforcement efforts. Get into compliance or at least manage any current or impending tax liabilities as soon as possible.

Administrative Appeals

If a taxpayer chooses to submit a Petition for Redetermination, they will either hear from the Business Tax and Fee Division (BTFD) regarding a request for more evidence or the Division’s conclusions regarding the petition. (Appeals Procedures: Sales and Use Taxes and Special Taxes and Fees.) 

From there, the taxpayer must request an appeals conference if they have not done so already. Such a request must be submitted within 30 days of the Division's decision, otherwise the appeals process will end and the Division will issue a Notice of Redetermination. 

Appeal conferences are usually held by default at the CDTFA location where your audit was prepared but you may select a different location. If you expedite your appeal, your conference may be held via phone, video or in Sacramento or a Southern California office of the Appeals Bureau’s choosing.  

At the conference, you and a representative of the BTFD will present your cases before an Appeals Bureau Judge.  The CDTFA recommends that taxpayers submit all the evidence necessary to support their cases before the conference and it is possible that the CDTFA may request more information during and after the conference. 

It is to the taxpayer’s benefit to develop the record with as much information about their case as possible not simply for the purpose of strengthening their arguments at these informal hearings but also for the purpose of saving time and money if the case is formally appealed in the future. (Institute for Professionals in Taxation, Sales and Use Taxation Ed. 2, 376.)

After the conference, the Appeals Bureau may grant or deny the appeal, either in full or in part. See Appeals Procedures: Sales and Use Taxes and Special Taxes and Fees. The Bureau may even decide that a reaudit is necessary. After a reaudit, the Appeals Bureau will issue a letter to the taxpayer and BTFD outlining the findings of the reaudit and the parties’ appeal options.

If You Disagree With the Decision

If the taxpayer disagrees with the decision made in the reaudit, they have the option of either submitting a written request for consideration to the Appeal Board or bringing their appeal to the Office of Tax Appeals (OTA).

Regardless of which of the options the taxpayer chooses, the request must be submitted within 30 days from the date of the Appeals Bureau’s letter. Otherwise, a Notice of Redetermination will be issued and the taxpayer will no longer be able to appeal. 

Once the case reaches the OTA, it will be heard by a three-judge panel either in Sacramento, Fresno or Los Angeles. (See Office of Tax Appeals website.) If the taxpayer opts for an oral hearing, witnesses may be presented and the taxpayer may appear with an attorney, other individual, or pro se. See OTA FAQs page

The taxpayer may also receive a decision from the panel without a hearing, if they so choose. The decision to have an oral hearing is an individual one that would best be made with the consultation of a tax professional. This will be the last step in the appeals process before the case comes out of the administrative realm and into the judicial system. 

After the OTA issues its determination, the taxpayer may request a rehearing  within 30 days.  New evidence may be presented if  they opt for an oral hearing. If the taxpayer still does not agree with the OTA’s finding, the next step would be to file for a refund in Superior Court. 

Your Next Step If You Are Audited

Dealing with the CDTFA is nobody’s idea of a good time. However, if you are contacted by them, do not panic. Find out what they want, then call me. Whatever it is the CDTFA is asking, I have dealt with it before — trust me.

The CDFTA’s long game is to get you into sales tax compliance. They do not especially enjoy conducting audits because they are time-consuming and expensive. That is why if you are not at the audit stage, you should see if you are eligible for the CDTFA’s compliance or managed audit programs.

If you are audited, while unpleasant, it is not the end of the world. My first suggestion is to call me and we can devise an audit defense strategy, even if it ends up in appeals. We have a successful track record defending our clients in sales tax audits and can do the same for you.

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