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Preparing and organizing materials for a California sales tax audit is by and large a unique process based on the individual facts and circumstances of a particular matter. Document productions to CDTFA auditors should be in support of whatever the narrative the company is going to present in its defense and, by no means, should you haphazardly produce documents to the auditor. Every action taken in a sales tax audit should be designed to move you as quickly through the audit process as possible with the least amount of liability.
Our firm has done a lot of sales tax audits and we can speak very generally about some of the problems that we see most often with our clients or that we have encountered through the years.
Mismatches of Data Need to Get Addressed
When you file a sales tax return, it gets reported to the CDTFA. In the evaluation process to determine whether they are going to audit you, the CDTFA is looking not only at your taxable sales and your total sales, they are looking at your federal income tax returns and they are looking at the information that was reported on your 1099-Ks and any other publicly available information that they can find.
The biggest problem that people have right off the bat is sales tax returns and federal income tax returns not matching. You are reporting a higher or lower amount of the sales than you are on your federal income taxes.
There may be a natural explanation for it. You may have bookkeeping adjustments, you may have labor built into gross receipts, or you may have sales that were not in California or you may have exempt sales. There could be many reasons, but the problem that we see with clients is the clients fail to match their data and or they go in the audit without a proper explanation for why their data does not match.
The issue with this is that is suggests underreporting of sales tax liabilities, even if such underreporting does not occur. This, by the way, is how the majority of people who are under-reporting sales tax get caught.
Lining up all your primary sources of data (sales tax returns, federal income tax returns, internal accounting, sales summaries from POS, merchant account statements, 1099-Ks, etc…) is critically important so that you can see where the gaps are in information or what needs to be explained. Thinking that the auditor is going to be able to conduct the same analysis and come to the same conclusion about a discrepancy in your data is a fallacy. So, at the outset of the audit, get organized and be prepared to put your ducks in a row.
Invoicing Problems Need to Be Dealt With Prior to the Audit
Most invoicing systems were not built to sustain scrutiny from a California sales tax auditor and the second most common error that we see in sales tax audit preparation has to do with invoicing. We see more mistakes on invoicing and it is so hard to build a narrative when you do not have invoices that support it.
To be fair, 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. However, from a sales tax perspective, it is these little paper cuts that can add up and can lead to serious liability.
Your invoicing should be screened for issues prior to meeting with the auditor. While we are not recommending that you doctor invoices, we do suggest you perhaps provide some additional context when invoicing mistakes arise. By doing so, you are going to be able to take something that could otherwise turn into a big issue and neutralize it before it even reaches the auditor.
Poor Record-Keeping and How to Overcome it in Sales Tax Audits
This is a killer. Poor record-keeping and the inability to produce accurate primary source data is what dooms most businesses to relying on statistical sampling to complete an audit. Also, the task of refuting that sampling is made harder by a lack of historical books and records or accurate internal accounting.
You must be able to produce supporting documents for your return and potential audit. Here is a listing of some common documents and statements the CDTFA requires you to retain:
For resellers, whenever you sell an item to be resold by someone else, obtain the appropriate documentation from the purchaser such as a resale certificate. Retain any old certificates as well; maintain and update your records periodically.
Required records:
Record-keeping is one of the first things that we address with a client in an audit setting. We use a phrase called the “integrity of data,” which means that the more complete and fuller the data we provide the government is, the less likely the conclusions drawn in that data are likely to get challenged. You want to first identify any deficiencies in your records and then work to build supporting documentation around them.
Eliminate Confusion Surrounding What the Law is
There is a fair amount of confusion surrounding sales and use taxes. Even among tax professionals, this is a very complicated and highly specialized area of the law. What we see among some of our clients who have tried to start the audit process before hiring a California sales tax attorney to resolve their issues is that there is a fundamental misunderstanding between what they believe the law is or the what right way to do things is and the way that California interprets the law.
People operate under the false assumption that because they pay all their sales taxes in the manner that they think is correct they are not going to have any problems with the auditor. They take the attitude that because they “check the box” on doing what they are supposed to be doing (filing sales tax returns and paying) that they can just show the auditor some documents and everything will be ok.
However, do not forget that there is a reason that California has chosen to audit you and that your audit was no accident. Someone actively selected you for audit based on something that they saw. And, unless you have had an experience person review your sales and use tax compliance recently (and even then), you should always go into a sales tax audit thinking that you have a problem because you will have a problem.
Your problem is that you will have an auditor who is going to look over your books and potentially make a correction that might not be in your favor. Imagine you had a police officer following your car around while you are driving. Do you know chapter and verse of the vehicle code? Are you sure you are not doing anything wrong?
The long and the short of this is that you can prepare for the audit by knowing the law and knowing how to defend yourself if the auditor starts to challenge you. The auditor is not a California sales tax attorney, so you can use the fact that they have no legal training to your advantage in the audit.
If the preparation gets handled correctly and issues are as refined out as possible, the first meeting with the auditor should go pretty smoothly. You are going to want to make the materials produced to the auditor as clean and as easy to work with as possible, even if it requires a bit of extra effort on your part. Auditors prefer electronic data because it is easy to work with and manipulate into their audit reports. We recommend not handing over everything (keep within the scope of the request, but if it is possible to provide electronic data, you want to do so in most circumstances.
Is it a good idea to meet with your sales tax auditor?
Yes, 100 percent. Go meet your sales tax auditors, spend as much time as possible with them and drive them completely crazy. In all seriousness, the way that we have had the most success in the firm is by face-to-face contact. The more time you spend with these auditors as individuals, the more you get to know them, the more they will like you and the more latitude they will give you.
People naturally do business with people. Once you get to know, like, and trust somebody, then you start to develop a relationship with them. One of the big reasons we are successful is because we deal with these cases over and over and over and over and over again.
We deal with the same people repeatedly. I might not know every auditor in the San Diego office of the CDTFA but I know a ton of them. It is really important and we have developed that relationship because of face-to-face contact and because an auditor or manager who I am having a disagreement with is not going to take an unreasonable position.
They know they have to see me again and again and again and again and again. It is not like we are going to take a hard line on this case and hope this person never shows up again because there is a level of contact and a level of familiarity.
If you decide to represent yourself in the CDTFA audit — which I do not recommend — but if you do, you want to have as much contact and as much touch point with your auditor as possible. You are not going to be able to influence them or buy them dinner, or bribe them under that table, but just having that familiarity, developing trust and developing rapport is a very important strategic tactic.
I would absolutely recommend that you go and meet with your sales tax auditor. I would not recommend that you bring them into your business, though. I recommend that you actually go to see the TFA. The meetings will be a lot shorter. You will get the time to interact with them in the conference room, you can walk them through your documents, and you just give them a much better presentation by doing that.
A managed audit is when you sit down with the auditor and agree to basically perform a self-audit. A managed audit formulates a plan that is a contract and it is found under CDTFA Form 526.
A managed audit can be a good idea in certain situations because what you are doing is essentially filling out the auditor's work papers for them. You submit the work papers to the auditor along with some documentation for them to verify and if everything turns out okay, then the auditor will bless the audit.
In doing a managed audit, you have the potential to cut your interest rate in half. That can be pretty good savings depending on how much your liability is. However, the savings in terms of the interest can be outweighed by the length of time and the resources it takes to complete the audit.
Managed audits take a lot of work and if a client lacks the internal resources to do the audit for the auditor, it can be a huge waste of time, cost and energy.
The managed audit decisions should only be made with a tax representative in terms of discussing the strategy for the audit. Agreeing to a managed audit is a significant burden and can be a huge amount of work, so the decision should not be made lightly.
If you do the managed audit properly and you fill it out and turn it in and it reduces the amount of time that the auditor takes to look at the audit, you can set yourself up for success in certain situations.
How long does it take to complete the review of all of the documentation and tests? Sales tax audits take a lot of time; at least six months. Sometimes, they can stretch out to nine months. There are usually multiple rounds of back-and-forth particularly with statistical sampling, when things get complicated. That is generally the way that things will flow during the course of the audit.
Again, the most important time in the audit is the beginning, because you are setting the tone for the audit. You are creating a plan and then it is just about executing it.
If you do that, the audit process hopefully should work in your favor. Again, my advice in a sales tax audit is to always retain an expert. You need to have somebody in your corner who is going to go through these issues with you, help you develop your plan, negotiate with the auditor and make sure the statistical sampling is fair. That is really, really critical for many reasons.
What you do not want is when the audit starts to get off-track, because that is where a lot of the problems get kicked up. The clean-up for that is much more expensive, much more time-consuming, and much more of a headache than if you just did it right the first place.
Once the auditor has finished their investigations, there will be an exit Exit Conference where the findings are reviewed, and the auditor will prepare a Report of Field Audit or a Report of Investigation. A CDTFA supervisor may be in attendance as well.
Once the findings are presented, you have the chance to disagree with the findings and explain why. You will be given time to gather documentation and present any information you think supports your case.
After you have made your argument, the auditor may do one of three things:
After the official report is filed, you will later receive A Notice of Determination (billing), which will outline the taxes and/or fees you owe or A Notice of Refund.
If the CDFA owes you a refund, they will first check to make sure that you do not have any other outstanding tax liabilities with any state agency. If you do, the refund will be applied to that tax debt. If you do not, they will issue a refund warrant usually within four to eight weeks of the Report of field audit.
If you do have a sales tax liability assessed against you and do not plan to appeal, you will need to pay the amount due within 30 days of the assessment.
If you fail to pay within that time period, you will be charged a penalty of 10 percent of the amount owed. Interest is also charged on the amount owed and the interest rates vary. Persistent failure to pay will expose you to aggressive collection actions by the CDTFA such as liens, levies or seizure of property and assets.
If you still disagree with the findings, you will need to file an appeal (“petition for redetermination”) within that 30 day period. The CDTFA has a long appeals process, and at each stage you will be required to make your case.
In an audit situation, the reality is that you are generally assumed guilty until proven innocent.
If the supervisor was not present at your exit conference, you may now request a meeting with that person if you and the auditor are unable to reach an agreement about the audit findings.
You will again have the opportunity to present your information and reasoning while the auditor prepares a Report of Field Audit or a Report of Investigation. The CDTFA supervisor will analyze both sets of data.
If you are still unable to reach an agreement on the outcome of the audit, you may meet with a CDFA representative within 10 days of your meeting with the CDTFA supervisor. Otherwise, you may consider meeting with the District Principal Auditor (DPA) to discuss your disagreement with the audit.
The DPA is actually relatively helpful in resolving issues or clarifying the CDTFA’s position on them.
Afterward, you will have a follow-up meeting with the California Department of Tax and Fee Administration representative and make your presentation once again. At this point in the process, if you and the CDTFA continue to disagree about the audit and the case remains unresolved, the CDTFA will issue a Notice of Determination, and you may enter the Appeals process.
Once the Notice of Determination has been issued, you have 30 days to file a Petition for Redetermination using Form CDTFA-416. You may, instead, file your own petition but it must contain the following elements:
If you prefer, you can also request an oral hearing in front of the CDFA. You may also request an appeals conference where you can present your case.
At this point, you have the option to make a Settlement Review Request instead using Form CDTFA-393.
If you are not proposing a settlement and the case remains unresolved, there is a final step you can take.
You must go to court and attempt to prove your case. However, at this point, you are required to pay the proposed tax in full, although you will not be asked to pay any interest now.
The request for a judicial proceeding is a request for the court to review your information and the results of the audit. If the court finds in your favor, you will be refunded the tax you paid. If not, you will now be asked to pay the interest and any penalties as well.
The process for appealing a CDTFA sales tax audit begins at the exit conference after the auditor has finished their investigation. If the audit report cites potential underpayment of taxes, fees or additional amounts you owe and you disagree, you will generally be given a time period to collect evidence and make your case.
Your next step is to meet with the CDTFA supervisor and then the District Principal Auditor. If you do not convince them that the results are in error, you can file an appeal.
The CDTFA 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.
You receive a Notice of Determination, which is a notification that the CDTFA has determined you owe more taxes than you paid. If you want to file a Petition for Redetermination, the first step of the appeals process, you must wait until this notice is issued. You have 30 days from the mailing date.
If you file a petition before the Notice of Determination is issued or beyond 30 days after it is mailed, your petition will not be considered valid. The liability will be considered final, due, and payable.
The Filing Must:
If you wish you can include requests for:
The CDTFA reviews your position. At this time, it may ask for additional records or documentation to support your position. You may amend the petition with additional grounds for disputing the original determination as long as it is before the date the CDTFA makes its final decision.
Once the CDTFA notifies you of its conclusions, most petitions are resolved at this point. However, you may still wish to appeal if the CDFA staff denies your petition in whole or in part. You must confirm, in writing, your previous request for an Appeals Conference or a Department hearing.
If you have not already requested an appeals conference or have missed the deadline for responding to the Department’s conclusions, a Notice of Redetermination will be issued to you with the staff’s conclusion.
If you are continuing with the appeals process, you will receive a Verification of Appeals Conference Form, which must be completed and returned within 15 days.
The Appeals Conference is typically held in the CDTFA field office that prepared your audit unless you request otherwise. Once you are there, you may record the conference at your own expense, either electronically or by a court reporter, but you must provide a copy to the Appeals Division at no cost if it requests one. The CDTFA does not record these proceedings.
Your conference will be with an Appeals Division attorney or auditor who has had no prior involvement in your case. You will receive a Notice of Appeals Conference from the Case Management Section with the date, time and location. You must return the Response to Notice of Conference Form within 15 days to confirm your attendance.
You may waive attendance if you wish,and submit written arguments and documentary evidence in support of your appeal before or during the conference. If you want to do so after the conference, you will need the permission of the Appeals Division.
After the conference, the Appeals Division mails you a Decision and Recommendation based on all relevant arguments and evidence. The document contains an analysis, conclusion and recommendation for the resolution of your case. A letter will be included explaining the status of your appeal and any options you may have for further action.
If you agree with the Decision and Recommendation, the appeal ends, and the CDTFA will issue a Notice of Redetermination or Statement of Account based on the decision and recommendation from the Appeals Division.
If, however, you do not agree, you may be granted a hearing if you request one in writing within 30 days of the Appeals Division’s letter.
California has over 800 laws and regulations included in the Sales and Use Tax legislation, all with supporting documentation. There are also two guidebooks with 24 chapters between them and a list of around 110 sales and use tax-related statutes.
Let that sink in.
Just the thought of receiving a notice for a sales and tax audit can make you feel like David getting ready to meet Goliath.
If you attempt to represent yourself in an audit and make a single misstep at any stage, things can go south very fast. Once you lose control of the audit process and are left with the deficiency, serious consequences can start stacking up:
While dealing with the fallout of a CDFA sales tax audit is rarely pleasant, it is possible to mitigate the effect on your business, if you have the right help.
When you confront an audit on your own, you are dealing with the complexities of the system for the first time and navigating your way through this process without a map.
Hiring a qualified tax attorney is like choosing an experienced guide to lead you through a hazardous landscape. They know the territory like the back of their hand and can steer you away from pitfalls and back onto solid ground. Here’s what you can expect from your tax attorney:
If you have been selected for a sales tax audit, you can probably remember in excruciating detail the exact moment you opened that envelope. Chances are you are still reeling.
While receiving a sales tax audit proposal from the California State California Department of Tax and Fee Administration is a serious matter for any business, it is not reason to panic. The best thing that you can do is stay calm and contact a qualified tax attorney. With the right representation by your side you can find a clear path through this process and come out the other side with your business and your sanity intact.
The biggest problem that I see with most sales tax audits stems from the lack of proper control at the beginning of the audit. We encounter this problem a lot in our practice, so I will highlight this as an example. When people get notice that they are being audited for sales tax, the tendency is to take the notice and they give it to their CPA to deal with
The CPA is focused on this from a compliance perspective. They call the auditor and they ask, "What do you want?" and the auditor replies, "I want the documents that were issued on that notice."
The CPA gathers up three years of sales records and three years of purchase records on all the internal financials and the bank statements, and then they hand it over to the auditor. Then the auditor takes that information, they go off by themselves, and then they come back and they have a $100,000 bill, and then the CPA freaks out and the client freaks out. So the audit is done, and then somebody calls us and we get involved.
Most clients and most CPAs think about this from the angle of, "We will just produce the documents that the auditor asked for. We did not do anything wrong. We do not have anything to worry about. There should not be any harm in just turning over the documents. Why get an attorney involved?"
The answer to that is even if you have not done anything wrong, there is always the potential for risk in a sales tax audit because of the way things are calculated. So an attorney's job in the sales tax audit is not just to hand over documents and push paper. The attorney should be, number one, controlling the scope of the audit.
They should be controlling both the documents that are being requested and the methods that the audit is being conducted under, and then the attorney is there to help move the process along.
The attorney will move the auditor through the analysis, supervise the analysis, make sure things are being done correctly, make sure the auditor is relying on the most accurate method of testing available, whether that is looking at source documents or conducting proper statistical tests, and then going from there.
So having an attorney who has a knowledge of audit procedure involved early in the process, sets the tone for the entire audit.
It is so much easier to deal with things at the beginning and do them properly than to go back and try and correct things. It is more of an exercise, and time, and effort, and money to get that done when a lot of it could have been filtered out at the beginning.
If you take control of the process at the beginning, control the documents and everything about the audit, you are going to end up with a much better result. That is why it is really important to get an attorney involved early in these audits versus later on.
Sales tax audits are notoriously tricky. They consume a lot of resources, both in time, and energy and money. The goal with us and with our clients is to get out of the process as quickly as possible for the least amount of damage.
When we look at a CDTFA audit, we are looking at the cost-benefit of the situation. What is the cost to the client, what is the benefit of a certain action, and how best can we get out of the audit with minimizing our expenditure and being as efficient as possible with our resources?
One of the best ways that we do this is prior to creating the audit plan, we will try and pre-audit the client.
Pre-auditing the client is very important because it gives us a roadmap for how the sales tax audit is going to go and what the areas of risk are for the client. Once we have had the benefit of pre-auditing the client, we can develop a plan for the audit with the auditor. We can navigate the client through the least amount of risk possible with our agreed-upon plan.
This is the best way to approach a sales tax audit. In the meantime, while we are going through the audit process, an eye needs to be kept on the appeals process in case the audit goes south. Disagreements with the auditor can and do happen quite frequently. Even the best well-made plan sometimes will fall apart.
Therefore, it is important for our firm to stuff the record as much as possible with things that are going to be beneficial to the client. To the extent we have control over the preliminary audit report, that gives us a better avenue going into appeals in advancing the ultimate resolution in the case.
Ideally, we want to try and avoid the appeals process, if possible, or use it as a means to get the liability down further after a successful audit. But, depending on the auditor, depending on the methods of testing used, and depending on the size of the fight that we have to engage in, sometimes, that is not always possible.
Whenever possible, we try to minimize expenditure, conserve resources and fight for the best possible outcome for the client.
Sales tax audits are one of the areas of practice that I am most proud of at our firm. We have dealt with some very difficult cases and gotten some really phenomenal results. I credit that to the hard work and diligence of our team. Brotman Law really understands sales tax audits.
We understand the tax law surrounding why sales are taxable and why they are not taxable. We understand the tax procedure in terms of understanding the interactions with the auditor, their manager, and the district principal auditor, and then through the appeals process, and up through the Office of Tax Appeals.
Finally, we understand statistical sampling which is a very rare quality in attorneys. Most attorneys do not have a strong knowledge of statistics. It is not something that they teach you in law school. Statistical sampling and being able to sustain a data fight in the context of a sales tax audit is a very admirable quality.
We want to be on not only equal footing with the auditor, but we want to have the superior advantage during the entire audit because in our experience that is the way you get results for the client.
We use a very measured approach. We measure twice and we cut once, but our methods are strategic. They are designed to make the process as least burdensome for our clients as possible. They are designed to move them through the sales tax audit process quickly and with as little exposure as possible. We are very good at what we do in the course of sales tax audits.
We fight. We have a strategic tenacity and we do the best we can to leverage our efforts to get you the best result. I encourage you to sit down with us and give us the facts. Let us look at your documents and let us start formulating a strategic plan. Whether or not you ultimately choose to retain us, at least take advantage of the benefit of our knowledge so that we can look at your facts and guide you specifically through your situation.
Sales tax audits have the potential for a great amount of risk for people going through them. Even clients who make the mistake in thinking that because they have not done anything wrong they do not have any risk in an audit. The good news is with our help, strategic planning and expertise with the execution process, you can minimize your liability as much as possible.
As I have mentioned before, sales tax audits are very cumbersome processes. They involve a lot of documents and a lot of data and they take a while to get through. At our firm, efficiency is one of our key factors in the work that we do. We want to make sure that the work and the value that we are providing for clients are in line with their cost expectations.
With that said, sales tax audits are a lot of work. There is a lot of organization and presentation of the materials. There is a lot of tendency for disagreements in sales tax audits particularly when the auditor is using statistical samples.
Oftentimes, those statistical samples come out wrong on the CDTFA side and we have to correct them. It gets tough when you have an auditor and you get into a conflict with that auditor and the auditor will back down.
With that said, sales tax audits have the ability to drive cost. One of the things that we do to mitigate cost is by trying to minimize cost in three key areas. The first one is with decisions.
We would like to put our clients in the position to make quick and accurate decisions. The easier decisions come, the easier it is to deal with the sales tax audits and the lower the cost to the client.
Number two is documents. We work with the client and our team to streamline the document gathering, organization and presentation process. A lot of times, we can put the burden on the client and the client has internal resources to handle document organization and delivery much more efficiently than our staff or at least at a lower cost.
If that is not the case, we have a very talented team of junior staff members who have done a lot of sales tax audits and who can work through the process very quickly, assembling exactly what our senior team is going to need to defend the audit.
The third avenue is bureaucracy. Unfortunately, with most agencies, bureaucracy goes hand-in-hand. Occasionally, you are going to have good people in the CDTFA, who are going to move the audit through quickly and without hassle but also occasionally, you are going to have some bad people.
Most CDTFA auditors will fall within the middle but the goal, at least at our end, is to organize the audit to come to terms with the auditor at the beginning and to agree on an audit plan to move the audit forward as efficiently as possible. With those caveats said, what I tell clients is sales tax audits usually range between $5,000-$15,000.
Obviously, that is a pretty big range but it depends on the client, it depends on the amount of data that we are dealing with and it depends on the difficulty that we are having with the auditor. Rest assured, we are going to try and minimize the cost in the process.
We certainly are cognizant of the fact that a sales tax audit is a marathon and not a sprint and we want to save and allocate resources for when we are actually going to need them. We also want no illusions coming in about how big the process is and how much risk it is to you if it does not get completed properly.
That is the best estimate that I can give you about the cost of your matter. If you want to know more, the best way for me to give you a cost projection is by understanding the facts about your particular situation. When I can apply your facts to the situation at hand, I can give you a much better estimate of what the cost would be in your particular matter.
Use tax bears repeating because it can create so many headaches and it is an area where the CDTFA is really digging in their heels. In fact, use tax is one of the most miscalculated and unpaid taxes found during audits.
The use tax is a tax on the use of tangible personal property not otherwise subject to sales tax. Use tax is typically owed when someone purchases a product while paying less than the applicable sales tax or paying no sales tax at all.
Unless that buyer has an exemption, use tax is owed to the government. Use tax is also due when a product is purchased from outside the state for use within the state when the seller is not registered for, nor collects sales tax in that state.
Use tax in the past has not been the purview of the seller; the buyer owes the use tax. However, state governments are beginning to hold sellers responsible for it when it is not paid.
What to Do:
Use tax is a counterpoint to sales tax. For example, if I buy a car in Arizona, I can ship it to California because California is not charging me sales tax on that transaction because it is not occurring within the state. Instead, they charge me a use tax.
Use tax is levied on consumers of merchandise used, consumed or stored in the State of California. It does not matter where it was purchased. If you buy something from an online source that is not registered to collect California sales tax or else does not collect it, you are on the hook for paying the tax, which is the same rate as the sales tax.
Use tax is also imposed on leased merchandise such as cars, boats and planes. If you make a purchase in a foreign country and hand-carry it through U.S. customs into California, you must pay the use tax.
Use tax is the tax that I pay for importing goods into California. In situations where there is no sales tax, I pay use tax.
Sales and use taxes are mutually exclusive. You cannot be required to pay both sales tax and use tax for the same merchandise.
Tax Auditor Treatment of Use Tax on Leases
In general, during California use tax audits, use tax will only be asserted against the lessor since it is difficult to determine from the lessee’s records whether the lease is a “sale” under the Sales and Use Tax Law. Therefore, a review of the lessor’s records will be made to determine if any tax liability exists.
Whenever the audit of a lessee reveals that tax has not been collected by the lessor, and the auditor cannot determine that tax was properly due, an audit memorandum (Form CDTFA–1164) will be prepared and sent to the lessor’s district. During use tax audits, the auditor will not assert tax against the lessee.
An exception to the above general policy is that tax may be assessed against the lessee if the lessor is located out-of-state, and the property being leased is not mobile transportation equipment (MTE). If tax is assessed, Form CDTFA–1164 will be sent to the lessor’s current district showing the amount of tax assessed and the applicable periods.
In California use tax audits, taxpayers should be careful with resale certificates by the purchaser, because the auditor will pay attention to the nature of the goods to determine if a transaction was done in bad faith.
For example, if a jewelry store obtains janitorial equipment, and obtains certificates, the auditor will review this transaction very carefully, and may determine lack of good faith by the taxpayer, leading to serious consequences.
The auditor may contact the vendor to determine whether the vendor holds a valid resale certificate. In the event the vendor does not have a valid resale certificate, the tax generally will not be determined against the purchaser unless the sale occurred outside of California or is otherwise a transaction subject to use tax.
Form CDTFA–1164 will be prepared by the auditor setting forth the pertinent facts about the transaction. This form, along with any supporting documents, will be used as basis for investigation in California use tax audits.
The auditor will also prepare Form CDTFA–1164 if in the examination of sales invoices the auditor finds that the seller did not charge tax and has accepted a properly executed resale or exemption certificate in good faith and the auditor questions whether the buyer has in fact purchased the merchandise for resale or in fact an exemption applies.
The auditor should also prepare Form CDTFA–1164 where it is determined that a vendor is improperly computing tax on its invoices.
For example:
Unsupported sales for resale to Mexican migrants which are discovered during audits of California sellers will be disallowed against the seller. The auditor also will prepare Form CDTFA–1164 for such sales, which then will be forwarded to San Diego District Office.
Please note that if a purchaser who timely gives a resale certificate or purchases property for the purpose of reselling it makes any storage or use of the property other than retention, demonstration or display while holding it for sale in the regular course of business, the storage or use measured by the purchase price is taxable as of the time the property is first so stored or used.
Sections 6094 and 6244 provide that for property used under the following conditions the measure of the tax is the fair rental value of the property for the period of such other use:
During California use tax audits, if a specific charge is made for use of the property, this may be used as the measure of tax provided the charge is consistent with the fair rental value. Property used frequently for purposes of demonstration or display and used partly for other purposes.
The California Department of Tax and Fee Administration (CDTFA) administers the tax program for both business and property taxes for the State of California. Business taxes include:
Business taxpayers may take up their concerns directly with the main office of the CDTFA while property tax concerns are addressed by the local county office.
When you deal with the tax agencies of California, you may feel like you do not have any rights. These agencies can be aggressive and overwhelming to most individuals not used to dealing with them.
However, you do have rights, an important detail to remember any time the CDFA contacts you. Below is an overview of your rights as a taxpayer engaging with the California Department of Tax and Fee Administration.
Sales and use tax audits are stressful, and some agents do not go out of their way to help you feel calmer. Remembering and exercising your rights during a tax audit can reduce the tension.
During an audit, you have a right to:
A business tax audit covers the tax returns you have filed in the past three years. If for some reason, you have not filed returns for that period, the law allows the CDFA auditor to back eight years.
If you decide to appeal the audit findings, you have 30 days from the date of the Notice of Determination, which is the document you receive with the audit findings. During that time, interest on your tax liability will continue to accrue.
The CDTFA recommends paying the tax portion in full as soon as possible to stop the accrual of interest. Any amounts not due will be refunded with interest at the conclusion of the appeal.
If you miss the deadline to appeal, you will be required to pay your tax liability in full and file a Petition for Redetermination, a claim for refund in order to dispute the amount you owe.
To be awarded full appeal rights, the petition must:
You must respond to all correspondence during the appeal or risk denial of your claim.
The formal appeals process includes an independent review of your case by the CDTFA’s legal department. Several courses of action will be evaluated as a viable resolution.
You have some rights you may exercise regarding the appeals conference:
If your appeal is denied, you are required to pay the liability in full before you can pursue an appeal in a court of law.
You are legally obligated to report and pay taxes and fees when they are due. If you fail to pay on time and do not respond to their attempts to contact you, the California Department of Tax and Fee Administration can and will attempt to collect the debt, including such means as:
To avoid missing any correspondence from the CDTFA or any other taxing agency, you must be diligent about updating each agency with your current address and information about changes in business ownership.
During the collection process you have the following rights:
You also have a right to an Offer in Compromise if all of the following are true:
There is one circumstance where your right to be notified 30 days prior to the filing of a lien is not upheld and that is when you have received a jeopardy determination.
A jeopardy determination is a tax bill for immediate payment of the liability. You have several rights regarding this type of tax bill.
You have the right to:
You also have the right to claim a refund for payments you made that may have exceeded what you owe. You have to exercise this right within three years of the due date of the return for which the overpayment occurred or six months from the date of the actual overpayment, whichever is later. It must be in writing stating the basis for your claim.
You have the right to confidentiality and the right to know why you are being asked for information. You have the right to be told how the CDTFA will use any information you provide as well as any penalties or other actions that could occur if you do not respond.
As always, you have the right to prompt, courteous service and fair treatment free from harassment and inappropriate conduct. The following may not be considered in regards to your rights or the conduct of policies:
You can obtain copies of your account records from the CDTFA via email or postal mail. You can also receive them directly from the CDFA office that administers your account.
If the tax man cometh, remember … you have rights throughout any process you may go through with the California Department of Tax and Fee Administration. Also, you always have a right to an attorney to help you through the maze of tax laws and to stand compassionately by your side at any time.
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, I must inform you that any U.S. federal tax advice contained in this website is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter contained in this website.
