When it comes to tax audits, the IRS is not the only organization that conducts tax audits. The California Department of Tax and Fee Administration (CDTFA) focuses on sales tax audits among California residents and tax payers. The agency is responsible for administering sales and use taxes, and they use their audits to verify that businesses are accurately reporting and paying taxes. The CDTFA generally reviews retailers who sell items at a retail price, and the tax calculation is based on the gross receipts obtained from the retail sales.
Over the years, I have received panicked calls from business owners saying they are being audited by the CDTFA and need help to navigate the process. Let’s look at how the CDTFA carries out its audits and whether your California business is likely to face one.
The CDTFA carries out its audits by employing a variety of tests and techniques, and the test is influenced by the type of business being audited. The initial test carried out by the CDTFA is an in-depth comparison of the sales recorded in the business’ records and the sales reported on the sales tax return. The auditor will then determine the parameters of their audit, which includes the time period being investigated and the CDTFA has three years to start an audit.
The CDTFA may also perform a mark-up test, cash vs. credit test, use tax test, alcohol pour test, Amazon sales test, hot vs. cold, in-store and to-go test, etc. Each industry has its own set of standard tests. The CDTFA audits tend to be very aggressive and clients are presented with a very detailed Excel spreadsheet summary that can be very difficult to understand. It’s generally advisable to work with a California tax attorney to help you understand that document.
While CDTFA audits can be routine, there are common red flags that may increase the likelihood of your business being audited. Here are a few common audit triggers.
- Inconsistent tax reporting: Discrepancies in reported sales or tax liabilities from year to year are common audit triggers
- High-risk industry: Some industries, such as restaurants, liquor stores and construction, are more frequently audited due to the complexity and variability of their transactions
- Frequent amendments or late filings: Regularly amending tax returns or consistently filing late are also red flags — not just to the CDTFA, but to the IRS as well
- Audit history: If your business has been audited in the past and discrepancies were found, CDTFA may conduct follow-up audits
- Third-party reports: Sometimes when customers, vendors or other third parties make reports that contradict your figures, those notifications may trigger an audit
Once the auditor has reviewed the financial statements and makes comparisons, it will determine (if any) how much gross revenue has gone unreported and the taxes that are owed on that amount. You will then receive a bill for the amount due, plus interest and penalties. If the taxpayer or business owner does not agree with the CDTFA’s audit finding, they can appeal the decision to the Office of Tax Appeals (OTA) within 30 days. You and your tax attorney may also decide to settle with the CDTFA. When that happens, the agency reviews the audit and allows the taxpayer an option for settlement. Many audits that determine the business owes sales tax are being amicably resolved as part of this settlement program.
While a CDTFA audit may sound confusing and scary, it’s a common occurrence for many California business owners. My best advice is to not try to navigate a CDTFA audit on your own. It’s always best to work with an experienced San Francisco tax attorney who can help you see your way through the process and assure your business will survive the audit process.
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.
