Have a Professional Handle Your Company’s Sales Tax Audit
Most states audit businesses for sales tax, sometimes resulting in assessments that can be a huge financial burden on the business. These sales tax assessments often go unchallenged because the business owner or in-house accounting personnel are not familiar or experienced with the sales tax laws that could reduce the sales and use tax liability of the business. As a result, many businesses are overpaying astounding sums to their State.
The panic of a California sales tax audit often begins by receiving that dreaded phone call from a California sales tax auditor. Usually, after the inquiry phone call and formal notice is issued, a California sales tax auditor can audit 3-4years of business activity from when a return was filed, and they could possibly go back to the inception of business if a California sales and use tax return was not filed. The slightest error, when multiplied over three years, can add up to a considerable amount of sales tax liability. These audits are often triggered by seemingly insignificant things like not having the correct paperwork.
Why Do Business Owners Overpay State Sales Tax?
Our skilled team of Sales and Use Tax experts have found that there are 3 main reasons why businesses overpay State Sales Tax rather than appropriately challenging the assessment:
- They do not have a Sales Tax expert handling their audit and they assume their accountant or CPA can take care of it.
- They do not know if the assessed amount is incorrect.
- They think they cannot afford a sales tax attorney or sales tax expert.
What to Expect During a California Sales Tax Audit
Notice from Department & Meeting Request
An California sales tax audit begins with a notice from the Department. From there, an initial meeting is set to discuss the nature of the business that has been audited. From there, the California sales tax audit examination begins.
Audit Plan & Examination
After an audit plan is developed, the auditor will perform an examination by comparing the taxpayer’s books and records to the items reported on the California sales tax return. Upon completion of the examination, the California sales tax auditor will issue a report with sales and use tax adjustments. It is important to know that you have the right to have a California sales tax consultant, sales tax attorney, or other sales tax professional represent you during your audit by completing a power of attorney form.
Examining your Sales During a California Sales and Use Tax Audit
Unlike a federal tax audit, a California sales tax audit is a tedious and exhausting process, to say the least. The California sales tax auditor’s goal is to find your business’s skeletons in the closet. There will be disagreements with the auditor as to whether they are entitled to documentation or not, whether certain transactions are taxable, where the audit takes place, and how long the auditor has at that location to do the audit. While many business owners, tax attorneys, and CPAs believe that the state can do as they please and push your business around, they cannot. A competent and experienced sales tax professional knows when and how to push back and when to tell the state no. During a sales tax audit, the auditor will request a wide range of documents. It is critical to have a California sales tax professional on your team to determine which documents the auditor is entitled to and which they are not. For example, the auditor will first determine whether all sales or gross sales were reported on your sales tax return. Often the auditor will compare your sales tax return to a control document like bank statements or your federal tax return. This will allow them to make sure all sales were reported. The tax auditor will also make sure you can provide proof on your exempt sales. In general, the auditor can review the last 3-4 years during the tax audit.
Examining your Purchases During a California Sales and Use Tax Audit
Most people are surprised to learn that a California sales and use tax audit involves an examination of your business’s purchases as well. On the use tax side, the auditor generally checks to make sure you properly paid tax on items used or consumed by the business. Despite publications and tax lawyers’ advice to the contrary, if a business buys an item online without paying %state% sales tax, the business has an obligation to remit use tax. Along with untaxed purchases of equipment, this can result in shocking results for the unsuspecting taxpayer.
California use tax issues for certain types of business are more robust. For example, businesses that are in construction or real property improvement industries have low exposure on the sales side of an audit, but often have a very high potential for exposure on the purchase side. Most items purchased and installed into the real property are often taxable to the business and in many industries, normally nontaxable services, like labor, may be subject to use tax. For the uninformed business, a large assessment of its purchases can put them out of business.
Upon completion of the audit, there will usually be an exit conference with the auditor. The purpose of the exit conference is to review the work papers. It is advisable to have a tax professional present during this meeting. Eventually, the audit will culminate in a Report of Field audit or a report of the investigation that summarizes the findings.
Post Audit & Exit Conference
The most valuable piece of knowledge is knowing that at the end of a California sales and use tax, the audit is not over. Following the California sales and use tax audit, if you disagree with the adjustments that cannot be resolved with the auditor, a notice of proposed determination, or similar notice, is issued. It is critical that if you wish to protest the notice, you must do so within a short timeframe, often 30 to 60 days. After filing, the Department will review and either withdraw the assessment, request additional information, or schedule for an informal conference. If you do not agree with that decision you can generally file for reconsideration with the agency or appeal the decision to tax or administrative court. While it is not required, it is often advisable to have an attorney handle your case in administrative court. For more information, please visit our corresponding pages.
California Sales Tax Audit FAQs
You inadvertently waived a red flag or your company landed in the small percentage selected for a random California sales tax audit. These red flags include: cash-based businesses, prior audits that resulted in owed sales tax, your sales reported to the state didn’t match what you reported to IRS, a high volume of exempt sales, filing a refund claim or a high number of credits. There’s also a possibility that your business happens to be in an industry that your state suspects rampant under-reporting. Often times, they will target industries effected by complex sales tax laws. Learn More
1. RESPOND to the notice
2. Get organized
3. Identify/Hire your audit manager
4. Notify your auditor of who they will be corresponding with
5. Compare your sales tax returns against the federal tax return
6. Test at least one month of exempt sales
7. Reconcile your sales tax payable account versus your sales tax payments
8. Review your fixed assets purchased, did you pay sales tax on them?
9. Review your purchases on your key expense accounts to ensure tax was paid on your purchases
10. Look at our complete list that explains these steps in more detail: here
Audit duration can vary dramatically from state to state and from business to business. Waiver issues aside, an audit generally takes 3-7 months to complete. Surprisingly, some audits can drag on for a few years. Time factors usually swing on the size of the company, the ability to produce reliable and organized documentation, and the level of sophistication of the business.
We all enjoy the occasional DIY project especially when it saves us money, am I right? Before opting to go that route, consider the risk vs. rewards involved. Avalara recently conducted a study and found that the average sales tax audit costs around $115,000. When facing a sales tax audit it is beneficial to have the expertise of the financial implications on your side. That is where Sales Tax Professionals such as SalesTaxHelper can save you a lot of heartache and money by avoiding a few missteps. Learn More
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