There has been so much news about the rising costs of tariffs and trade policy changes over the last few years. While tariffs may seem like just a customs issue to many taxpayers, they can directly affect California sales and use tax compliance. This is because tariffs change the cost basis and sales tax calculations. This is especially true in California where the California Department of Tax and Fee Administration (CDTFA) is stepping up ecommerce enforcement. Tariffs add another audit risk layer to those sales. Let’s look at how tariffs are creating a new CDTFA audit risk for California importers and online sellers.
Simply put, a tariff is a tax imposed by a government on goods and services imported from other countries. For this discussion, we are talking about tariffs President Trump is imposing on goods and services coming into the United States. California sales and use tax can intersect with import pricing and inventory valuation because tariffs can affect the cost basis of a product. They can also impact resale pricing, markup calculations, and changes in how those taxes are reported from marketplace facilitators.
Ecommerce has grown at a substantial rate over the last several years and with that growth comes new opportunities for business. But, it also comes with increased scrutiny from the CDTFA, which has stepped up enforcement efforts to ensure online sellers are properly collecting, reporting and remitting sales tax. These sellers include online marketplaces that use Amazon, Shopify and other direct-to-consumer sites. They are becoming more attractive audit targets because supply chains create more opportunities for tax reporting errors. There may be more discrepancies between customs records, income tax returns, and sales tax filings. These are big red flags for the CDTFA and increase audit risks.
So how do the increased tariffs play a role in audit risk?
One major area of concern involves tax calculations. Businesses that import products for use in California may owe use tax based on the cost of those goods. When tariffs increase the total landed cost of inventory, businesses sometimes fail to properly account for those additional expenses in their tax reporting.
Another way tariffs can trigger audits is because inventory valuation becomes more complicated when tariffs fluctuate or change rapidly. Businesses may revise costing methods, adjust margins, or modify supplier arrangements as a result of rising import expenses. Accounting records must clearly document how tariff-related costs were incorporated into inventory values. If not, CDTFA auditors may question the accuracy of reported taxable purchases or deductions.
Pricing changes also present a risk. Many ecommerce sellers respond to tariffs by adding surcharges, increasing retail prices, or restructuring shipping and handling fees. If sales tax automation systems are not updated correctly, businesses may accidentally under-collect or over-collect tax. As such, these errors can trigger the CDTFA to take notice.
Finally, many marketplace sellers use what’s known as drop-shipping arrangements and that can create a risk for audit. Drop-shipping is a type of retail fulfillment model where a seller takes orders but does not keep inventory in stock. Instead, the seller passes the orders to a manufacturer, wholesaler or retailer and that company ships the product directly to the customer. This creates complications because fulfillment centers or third-party marketplaces may face uncertainty regarding which party is responsible for collecting and remitting tax (i.e., does the seller or fulfillment center owe sales tax to California?). Tariff-related pricing adjustments can further complicate these arrangements.
Ultimately, tariffs create audit risk because they force accounting changes that may not always be reflected consistently throughout a company’s tax reporting systems. And California businesses face increasing audit exposure as CDTFA expands ecommerce enforcement that is directly impacted by tariffs. If you are a California business — especially one that operates on an ecommerce platform — I highly recommend speaking with an experienced tax attorney or professional who can make sure you are not overlooking tariff consequences and can make sure you are complying with the CDTFA
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.
