I want to talk now about the penalties that are associated with sales tax audits. Within California, and with most other states, there are two types of penalties. There are mandatory penalties and there are discretionary penalties. Those penalties range anywhere from 10 percent to 50 percent to 75 percent, or potentially greater depending on the particular grievance.
Mandatory penalties are usually with respect to the failure to file returns and the failure to pay taxes on time. With mandatory penalties, there is little way that you are going to be to get a penalty abatement for some of those penalties, absence of reasonable cause. The reasonable cause would be death or serious illness, or disability of owner or major shareholder, reasonable cause if you’ve lost your records in a fire or an earthquake or a natural disaster. It would be reliance on a tax professional which is a really critical one, or some other really great circumstance that mitigates abatement of the penalty.
The board, in general, is really hesitant to abate penalties, except in really deserving circumstances. As a result, you want to be really clear about what you’re asking for, and the reasons you are asking for it. However, if your evidence is lined up, you can go through the online process for abating penalties, which makes things much quicker and easier to abate certain penalties given really mitigating factors.
Discretionary penalties are usually assessed in the course of the audit, those are your negligence penalties, and then your quote on quote, your fraud penalties. Negligence penalties relate to conducts that were not necessarily intentional but was not the best. If you failed to produce half the invoices for a sales tax audit, your auditor can hit you with a 25 percent or 10 percent penalty. In the case of negligence penalties, the best chance in getting negligence penalties abated is with your first audit.
If you are going through your first sales and news tax audit, then it is general board procedure although not at the district level sometimes, but mostly in the at the headquarters level,l they won’t charge penalties for people who are in a first-time audit. The best way to do that is to reach out and ask the auditor not to penalize the client because there is growing justification that the client is going through heir first sales and news tax audit, there is nothing warranting a negligence penalty.
Certain circumstances though, when the client has really, really outrageous behavior, you’re going to have to talk it up to some sort of plausible explanation, like the records there, or something that is– something that explains a way that the conduct of the taxpayer, because in certain circumstance we have very huge, very large underreporting issues. The board is going to look less towards negligence and more towards fraud, and while negligence penalties are generally not assessed for first-time audits, fraud penalties are assessed.
The board takes this all or nothing position with respect to penalties. The point that you can defeat the notion that there is any fraudulent conduct, then you probably are going to avoid a 40 to 75 percent penalty associated with the audit, which should be really beneficial.
With respect to evasion penalties, I want to speak about the boards standard of evidence. I think it’s really important to understand what the board has to prove just to get over the hump that there was a fraudulent conduct being performed. Evasion penalties it’s not at like the criminal justice system, there is no beyond a reasonable standard, that there is, is there is a clear and convincing evidence standard. In situations where the client has falsified records, where there are substantial discrepancies between reported sales and actual sales, where there are, quote on quote, badges of fraud, false statements to auditors, inconsistent statements, willful– that would be considered fraudulent behavior.
The point is, the burden of proof relies on the Board to prove that type of conduct. Conduct that can be mitigated or explained away perhaps as a lesser offence, is going to really put a kink in the Board proving that clear and convincing evidence stand.
Now during the course of the audit, when there’s a substantial discrepancy, the Board is going to ask a series of questions to your client to try and determine the exact nature of why the substantial discrepancy exists. Your answers to those types of questions are very, very important in exonerating your client from a flawed penalty. To the extent that you can come up with a plausible explanation, where your client has some reasoning that would mitigate those penalties, you can avoid a pretty substantial adjustment during the course of the audit, which is a really great tactic to use when going after penalties.
Again, most of what you have with respect to penalties is an image problem. If you can convince the auditor, and the auditor sides with your client, and usually you’re going to get away with not having a fraud penalty during the course of an audit. One of the worst offences as far as the Board of Equalization is concerned, is knowingly operating without a permit. If you have an active business and you do not have a seller’s permit but are selling goods, the Board comes down pretty hard on that.
They do impose a 50% penalty on knowingly operating without a seller’s permit, but more frequently, they often pursue criminal charges in cases where it’s a large business, or a growing business. In cases where you encounter a client or a person that is knowingly operating without a seller’s permit, the immediate step to take is to get them into compliance, hopefully before the Board has just honored the fact they’re knowingly operating without a seller’s permit.
By reaching out to the Board directly saying that there has been an error, and by registering them for a seller’s permit, and then retroactively filing returns, you can avoid a lot of the penalties that are associated with knowingly operating without a seller’s permit. In addition, you’ll probably reduce any criminal liability that exists. If the conduct continues, and you let the Board catch you, then there are going to be consequences associated with that.
Again, the statute and the penalty is based on knowingly. If your client is not experienced in business, or doesn’t have any reason to believe that he would need a seller’s permit, or there is some other justification, you can try and argue the knowingly presumption even though the Board may catch you in the act of selling without a seller’s permit. Again, since those penalties are pretty severe, there’s something that’s fairly looked at. If you can create a reasonable doubt in the auditor’s mind, or in the Board’s mind, that your guy didn’t know what he was doing, then you can hopefully avoid the penalty in the future, based on that conduct.
Misuse of the seller’s permit is also a big cause for concern within the Board of Equalization. They charge a 10% penalty, or $500, whichever is greater, for each transaction where a purchaser knowingly uses their re-seller’s permit for personal gain to avoid tax. Those penalties can add up fairly quickly. In cases where you have misuse of a resale certificate, you want to try and minimize the damage as quickly as possible. Hopefully you’re catching the audit at a point before the client has produced any documents, or before the auditor has gone through the general journal, and realize that some of the purchases that were made were for personal use.
In addition, if the client is purchasing goods at a place where they would not ordinarily purchase goods, and was not appropriate for their type of business, you need to be ready to have a ready explanation. Short of a ready explanation, you want to try and concede a certain amount of purchases, give the auditor something to lean on, and try and minimize the conduct for the other purchaser. Misuse of seller’s permits is something that the Board takes very, very seriously, and as such, you want to be adequately prepared when you walk into an audit for the consequences of that.