The First Steps in the California Sales Tax Audit Process
When you are the target of a California sales audit, the process starts by receiving a notice that you are being audited. First, the CDTFA will send you what’s called an audit engagement letter that tells you the terms of the audit, provides you a preliminary list of documents to gather, and a request to contact the auditor by a certain date.
The government’s audit request is usually for twelve quarters or three years of information. The auditor will also usually request a phone call to request an in-person audit meeting to review records and to go over any preliminary issues.
If you are going to hire a tax attorney to represent you in your California sales tax audit, or at least consult with one, the best time to do it is prior to responding to the auditor’s letter.
On the call, the auditor will usually have an agenda and will move through some preliminary questions that they have about your business, its recordkeeping, and how your company does business. Because California sales tax audits are very technical, auditors are used to taking the lead in the conversation, and so will drive forward. If you let them, they will control the pace of the audit and the scope of the information requested.
Generally, on the first call is where we push back a little bit (albeit politely). You do not actually have to give them all three years of records just because they say you have to, and the plan for the audit is open to negotiation.
The idea is that you want to agree with the auditor on a scope of documents being requested and why. You also want to agree on a general audit plan for making sure that this is being handled appropriately, it is being handled efficiently, and that progress is being made to move the audit forward.
The California sales tax audit process is a highly fact-specific and it is highly fluid, depending on what is being audited, why it is being audited and so forth, but the important thing to note is that much of the audit itself is open to negotiation.
Then, based on that agreed-upon plan, the auditor will give you a period of time, usually 30 days, to get your documents together to present them.
California Sales Tax Audit Process Step Two - Developing a Sales Tax Audit Plan
Good preparation and the tone of your first interaction with the auditor are very important, so you should take care to comply with all of the requests in the letter. You will have some flexibility in scheduling the audit and can ask for a reasonable amount of time to collect the required materials. Two or three weeks is standard. If you need more time you may be required to sign waivers.
A Waiver of Limitation is a document which will extend legal requirements if the auditor finds additional tax liabilities owed. As mentioned before, the CDTFA usually works with a Statute of Limitations: a three-year limit within which they must investigate and charge delinquent taxes in your tax return. This waiver extends that time limit.
A Waiver of Credit Interest is a document which will absolve the CDTFA of interest owed if the auditor finds a refund or credit owed to you.
It is in your interest to have a tax attorney review your case before you sign a waiver or other document which could affect your rights in the audit.
The next thing that you should do in the California sales tax audit process is to compile your key sources of data, including but not limited to, your federal income tax returns, your sales tax returns, your profit and loss statements, your sales summaries, your 1099-Ks, your merchant accounts, and any other piece of data that is a primary source document with relation to your taxable sales.
You want to take a look at this data and gather it all together because it is going to be one of the important starting points of your sales tax audit. It is the relationship between all these different data points that is going to impact the decision of whether the auditor moves into statistical sampling.
Once all this data is compiled, you need to assess your risk and potential exposure in the audit. Understanding that there is a reason why the CDTFA selected you for a sales tax audit, if you can identify that reason, you can take steps to mitigate it prior to presenting any information to the auditor.
When you are looking at risk, it is a good idea to get a tax professional involved because most people are not comfortable with assessing their own sales tax risk. At the very least, you should have a consultation with someone so that you can understand where the risk is, you can understand what the playing field is, and you can understand how to appropriately deal with the sales tax audit.
Notice that in all these steps, we did not say to contact the state. Before having any contact with the auditor, you want to make sure that you gather your documents together; at least an initial sampling of those documents so that you can look for discrepancies between those key areas of reporting and you want to know what your risk is going to the audit.
That way, you can understand how to develop an audit plan with the auditor that is going to be mostly in your favor. We would recommend taking those actions first and then reaching out to the auditor in order to begin the audit. This way you will be fully prepared to defend yourself against the CDTFA.