Introduction: California Sales Tax Attorney Secrets for Audit Defense
If you are a small business owner in California selling tangible personal property, you should be collecting and reporting sales tax. You also have to file sales tax returns with the state of California.
In our experience, most small businesses try to do things correctly when it comes to their sales- and use-tax compliance. The last thing that nearly every company wants is to run afoul with the California Department of Tax and Fee Administration.
However, sales tax is an area of the law that is confusing to many people, including tax attorneys that do not focus on state taxation. Even for people who try to stay compliant with the sales tax laws, your business can still be a target for the California Department of Tax and Fee Administration (CDTFA) and be hit with a California sales tax audit.
That is why our law firm has dedicated the time and the resources to creating our complete guide to California sales tax audits. We put together the best resource on the internet for taxpayers faced with the prospect of a CDTFA audit.
The state government publishes little guidance to help those facing an audit and there is a lot of misinformation out there. We have also noticed that when speaking to businesses and business owners that many people do not really understand the audit process. So, we decided to tackle this issue head on and to reveal many of the tips, tactics, and strategies that we use in our law firm for dealing with sales tax problems.
Although our ultimate guide is fairly daunting and some of the material is rather technical, it is not our intention that you sit down and read this cover to cover. Rather, we have broken everything down into smaller, easy to digest chapters that cover different aspects of the sales tax audit process and to give you a better understanding of what the law is and how to deal with your tax auditor.
As always, our tax law firm is about trying to help people and we are always here if you have questions or need further assistance. One of the reasons that we publish these resources is to help not only our clients, but anyone who is in need of a helping hand.
It does not matter if you have the means to retain a California sales tax audit lawyer to help your you. Our firm wants you to be on an equal playing field with the auditor. As such, we have written down and shared some of our best sales tax audit defense tactics and sales tax audit strategies to help you through this process.
Thank you in advance for reading “The Complete California Sales Tax Audit Guide.” It was a labor of love and our law firm welcomes all questions, comments, concerns, and feedback that you may have about this free resource.
California Sales Tax Audits – What You Need to Know
A sales tax audit is exactly what it sounds like; the California Department of Tax and Fee Administration (CDTFA) comes in and checks to make sure that sales tax was paid properly. The goal of an audit 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. However, at a minimum, it includes 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.
What does the sales tax audit process look like? Sales tax audits are pretty rough. They involve large amounts of data, complicated statistical methods and in certain cases, they involve sampling.
This means that the state can go through a business's records over three years and audit every single transaction, but the problem with a lot of businesses, particularly a lot of retail businesses, is cash transactions.
The auditor and the representative are working through this very large amount of data and trying to make conclusions on it to make sure the appropriate amount of tax was paid in statement.
For some businesses, you can have tens of thousands, if not, hundreds of thousands, even millions of transactions over a three-year period. We see businesses all the time, particularly those with low margins and high frequency, that just have an absolutely insane amount of transactions.
In some cases, tax 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. Here are some examples of things that could put you at greater risk for a sales tax audit.
- Your business is largely cash-based,
- You work in an industry known for high rates of non-compliance
- One of your vendors has been audited
- You have had tax problems in the past
If you have recently gone out of business, you can still be audited, and the CDTFA will attempt to hold you and anyone else directly involved personally responsible for found liabilities.
Most California businesses will deal with a sales tax audit at some point, and understanding why and when sales tax audits happen and what to expect is the best way to be prepared when your number comes up.
Our firm, Brotman Law, has seen firsthand how painstaking and drawn-out the sales tax audit process is, because there are so many variables, tests and even opinions involved. We are a small business and we specialize in working with small businesses in all tax matters, including sales tax audits.
We encourage you to keep reading. We will walk you through the California Department of Tax and Fee Administration (CDFTA) sales tax audit process. You will not only learn how to prepare and how to present your documents. We will also outline the risks, problems, strategies, whether you should settle or appeal, and how you could benefit from legal representation.
The following is an overview and summary of each of the different chapters in “A Tax Attorney’s Complete California Sales Tax Audit Guide”:
What Is California Sales Tax?
In this chapter, we define both sales and use taxes and we discuss the mechanics for how sales taxes work in California. We discuss how the sales tax permitting process works and the responsibilities for businesses that are issued a California seller’s permit by the CDTFA, which is the body responsible for the administration and enforcement of sales and use tax laws in California.
Then, we look at the concept of “tangible personal property” and what type of sales are subject to California sales tax. Finally, we discuss the government functions, roles, and responsibilities of the CDTFA.
What Causes a Sales Tax Audit and Common Sales Tax Audit Triggers in California
This chapter examines the process for how businesses are selected for a CDTFA audit and the general goals of the CDTFA in promoting tax compliance among sellers of tangible personal property in California. We look at how businesses are targeted for sales tax audits and the common things that we have discovered in our tax law practice that trigger a California sales tax audit.
Then, we turn to how far back a sales tax audit can go and examine a few different things related to California’s statute of limitations for sales tax audits. Finally, we take a deep dive into the role of the sales tax auditor, what they are looking for in a sales tax audit, and how they find sales tax mistakes during the course of their examination.
Risks For Your Small Business in a California Sales Tax Audit
This next section is all about making sure that you understand and are prepared for the risks that a California sales tax audit poses to both your business and the owner personally. As we cover, the main problem with sales tax audits as opposed to a federal income tax audit (for example) is the amount of data you and the tax auditor have to deal with.
We talk briefly about statistical sampling (covered in detail in later chapters) and about civil and criminal penalties for sales tax fraud and serious errors on your business’s sales tax returns. Finally, we spend a little time discussing what a dual determination is in the context of an audit and how the tax auditor’s decision to extend liability to business ownership can have pretty severe consequences.
The California Department of Tax and Fee Administration Audit Process
Over the next several chapters, we will walk you through a California sales tax audit from start to finish and reveal insider information about how our firm handles audits. As we explain, audits are won or lost well before the initial meeting with the auditor. Sales tax audits are almost an exercise in planning over anything else. We will discuss what to you when you receive the initial audit notice and the document request attached.
Afterward, we talk about the initial contact with the auditor and the importance of having input into and pushing back on the tax auditor’s plan for the audit. We provide you with our tax attorney’s recommended strategies for dealing with the CDTFA auditor and responding to the records request.
How to Prepare for Your California Sales Tax Audit
This chapter is about one thing: preparation, preparation, preparation. We will share some of the biggest mistakes that we have seen small businesses make during the audit process and how to prepare for the challenges that lie ahead in your first meeting with the sales tax auditor. We look at common problems in the sales tax audit preparation process, how to deal with challenges associated with poor recordkeeping, gathering the documentation for your audit, and the importance of the integrity of data in the course of a sales tax audit.
Finally, we discuss the importance of eliminating confusion around what the sales and use tax law is and how to take advantage of the auditor’s knowledge gaps.
The Sales Tax Audit Meeting
All the hard work and diligence that you have put into the sales tax audit preparation process so far lead up to the presentation component that happens in the first audit meeting with the auditor. Our firm strongly advocates that you take the opportunity to have in-person contact with the auditor and to take the time to walk through the materials that you have organized for their benefit.
The alternative to this is something called a CDTFA managed audit. We discuss what the managed audit process looks like and the benefits of going through this type of audit vs. the traditional sales tax audit. Finally, we discuss timing issues associated with a CDTFA audit and how long that process will take.
What Happens After a California Sales Tax Audit?
We have now gone through what happens during a California sales tax audit, but what happens after the audit process has been complete? This chapter discusses the finalization of the tax auditor’s report as well as the exit conference with the auditor and their CDTFA supervisor.
The next part of this chapter discusses the different administrative appeal options of any proposed tax liability in brief as well as prospective judicial resolution of a sales tax audit (not recommended for reasons explained).
Sales Tax Audit Appeals Through CDTFA
This chapter is all about the California sales tax appeals process for audits and CDTFA administrative tax resolutions. We walk through both the receipt of the “Notice of Determination” and the response, which is called a “Petition for Redetermination.”
The appeals process in California is a fairly informal proceeding, but it is marked by tight deadlines and you need to make sure that you are properly prepared going into the CDTFA appeals conference. If not, there could be several adverse consequences of what happens when the audit goes wrong.
California Sales Tax Attorney: Hiring One for Your Tax Audit
Usually our firm are big proponents of clients educating and trying to resolve tax issues on their own accord, but we do not recommend going it alone (or with a CPA). Hiring a California sales tax attorney and having the support of someone who is specifically knowledgeable about sales and use tax law in California often make the difference in a tax audit.
You will see some of the strategies that we recommend and utilize in our California sales tax audit defense practice. By providing this overview, we hope that you can get a sense of how you can take a process that seems like you are at a disadvantage and give you an advantage over the auditor.
Brotman Law’s California Sales Tax Audit Defense Practice
This chapter contains a quick overview of what it is like to work with our firm. We are one of the very few California tax law firms that focuses on our California sales tax audit defense practice. We leverage our knowledge and working relationships with the local CDTFA district offices to our advantage in a sales tax audit and for the benefit of our clients.
Finally, we discuss the legal costs associated with retaining counsel in a sales tax audit. Usually, the cost/benefit associated with retaining counsel in a sales tax audit often makes this an easy choice. California tax law can be very complex. Clients are often frustrated and stressed out by the audit process, but a sales tax attorney can help come in and get your California sales tax audit organized from start to finish.
Use Tax and California Use Tax Audits
This is all about California use tax and California use tax audits. Use tax is often considered a companion tax to sales tax because use tax will often apply to situation where sales tax does not apply or where an exemption exists. We cover a few more the more technical issues associated with use tax in California and look at the impact of certain situations, such as resale certificates, on your sales tax audit. Sales tax issues and use tax issues often go hand and hand together.
Taxpayer Rights in California Sales Tax Audits
This section discusses your rights as a taxpayer in California and the application of those rights to certain situational settings that you may encounter in your dealings with the California Department of Tax and Fee Administration. We go through each situation in detail and let you know what you are entitled to as a taxpayer in California.
An Overview of Sales Tax Audit Sampling and Testing Used by California
Different Types of Statistical Testing in California Sales Tax Audits
The California Tax Attorney’s Explanation to Short Tests and Sampling
CDTFA Audits: Prior Audit Percentages of Error (PAPE) Program and Cut-Off Techniques
These chapters contain the most difficult and technical concepts that we have discussed in our Tax Attorney’s guide to California Sales Tax Audits, but they are the core of some of the most important information in this guide. Because sales tax often relies on statistical sampling, disputes in sales tax often come down to statistical matters even over the interpretation of the law.
Although it is generally preferable to keep the tax auditor focused on your source documents and data and away from the indirect methods of testing, unfortunately, it can be unavoidable. We detail several of the methods that California tax auditors use when compiling data and discuss how to challenge each method along with what to look out for when being audited to minimize your exposure.
What Types of Penalties Can I Face in a California Sales Tax Audit?
Negligence Penalties in California Sales Tax Audits
Penalties for Tax Evasion and Tax Fraud in California Sales Tax Audits
This next section deals with penalties that are commonly associated with sales tax audits and how to mitigate and deal with those penalties in the context of the audit. Often, we tell our clients to be equally mindful of the penalty portion of their potential liabilities in an audit and we do whatever we can during the audit in order to mitigate those sales tax penalties.
We go through each type of penalty from the most minor penalties to the civil penalties associated with tax fraud and tax evasion in California. Although our discussion is fairly lengthy, we have put together a very comprehensive resource when it comes to talking about tax penalties in California.
California Sales Tax Exemptions
Our ultimate guide concludes with a discussion of the sales tax exemptions in California. Although last, this chapter certainly is not the least important by any stretch of the imagination. Understanding sales tax exemptions is one of the key technical issues that you need to know in a California sales tax audit. Businesses lose out on millions of dollars in potential exemptions every year and the audit is the perfect time to seek a course correction of any overpayments of sales and use tax that you may have paid.