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, but 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 that may make it more likely that you will be selected.
If your business is largely cash-based, if you work in an industry known for high rates of non-compliance, if one of your vendors has been audited or if you have had tax problems in the past, you may be at greater risk of a sales tax audit.
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.