Ecommerce has grown at a substantial rate over the last several years; specifically post-pandemic. With that growth comes new opportunities for business. But, it also comes with increased scrutiny from state tax authorities. In California, that tax authority is the California Department of Tax and Fee Administration (CDTFA), which has stepped up enforcement efforts to ensure online sellers are properly collecting, reporting and remitting sales tax. Many ecommerce businesses assume that selling through marketplaces like Amazon, Etsy and Shopify means their sales tax obligations are fully handled. However, that is not correct and that assumption can lead to audits and significant liabilities in the form of ecommerce audits.
Online marketplaces like Amazon and eBay may sometimes collect tax for some transactions. However, sellers may still have obligations outside the marketplace. Additionally, California has the right to request sales information from entities such as eBay, Etsy, Amazon and other online retailers in order to assess sales tax. This means that Internet retailers – those who may have no other tie to a state but for Internet sales made by people in the state – may be subject to pay sales tax to that state. This was not the case previously.
The CDTFA assesses ecommerce for audit by cross checking marketplace reports, payment processors, federal tax returns, and shipping data. Some of the common sales tax mistakes that trigger CDTFA audits include unreported direct website sales from marketplaces such as Shopify, Amazon and WooCommerce. Oftentimes, the seller assumes the marketplace (e.g., Shopify) is handling the tax obligations. But, the reality is that it’s the seller’s responsibility. Another audit trigger is double reporting or underreporting sales or purchasing inventory tax-free, but then using it for tax purposes.
The CDTFA has identified risk areas through ecommerce audits. Some of the risks include calculating sales tax incorrectly and then not collecting, and paying, the correct amounts. This can be especially confusing in a state such as California with its complex district tax structure. That is, California has a base rate of sales tax, but some districts may have additional taxes that need to be collected. Other risk areas include improper documentation for exempt transactions, missing sales records, and inconsistent accounting data.
If the CDTFA decides to audit your ecommerce business, you will receive a notice of audit in the form of an initial contact and information request. They may request documents such as sales reports, marketplace statements, bank statements and merchant processor records. After doing its research and reviewing the documentation, the CDTFA will provide its audit result and, if applicable, its assessment of tax, penalties and interest. Those penalties may include back taxes for multiple years, interest and possibly negligence penalties.
CDTFA audits are becoming more common as the state targets online sellers and as ecommerce sellers face complex sales tax compliance obligations. If you’re a California ecommerce business contracting with marketplace facilitators, it’s important to be proactive and not assume the marketplace is handling your tax liability. Always work with an experienced California tax attorney or professional to help you understand these nuances and what’s best for your business.
Allison Soares is a partner and tax attorney at Vanst Law LLP. It doesn’t matter the issue: audits, collections, appeals, international disclosures, grumpy people— Allison enjoys fixing problems. In addition to her legal work, she has worked in accounting and utilizes that knowledge to her advantage while handling cases involving EDD audits from San Francisco to San Diego.
