Sales tax audits are generally the most time consuming and costly types of audits for taxpayers, especially those who do not keep adequate records. This is due to the fact that auditors are often times forced to perform complex calculations in order to estimate the amount of sales a business had over the audit period.
If you were selected for a sales tax audit by the California Department of Tax And Fee Administration (CDTFA), the process starts with the sales tax auditor sending what is known as an “audit engagement letter.” In the letter, the sales tax auditor will generally provide a list of basic information, such as sales tax and income tax returns, along with sales invoices and/or cash register tapes to compare to the tax returns, and a request for the taxpayer to contact the auditor. Once the taxpayer makes contact with the auditor, the first appointment is scheduled, where the listed information is required to be made available. At the initial audit meeting, the auditor will review the information provided and conduct a preliminary examination, comparing the numbers in the taxpayer’s books and records with the figures reported on the sales tax returns and federal income tax returns. After the preliminary examination, the auditor will determine whether a full sales tax audit is warranted.
If, after the preliminary examination, the Board of Equalization auditor determines that a full audit is warranted, additional information will be requested from the taxpayer. The type of information the auditor will request depends on the method the auditor determined is the best way to estimate sales. The proper audit method for each sales tax audit depends largely in part on the type of business involved. Generally speaking, sales tax audit determinations come from an estimate of a taxpayer’s sales during the audit period, based on a variety of tests conducted on an “observation period.”
There are many different methods an auditor use to calculate an estimate of taxable sales. One sales tax audit method, often used for retail establishments, is based on what is known as a “markup analysis.” Under this method, the sales tax auditor will compile a sample of the products offered for sale by the establishment and calculate an average markup percentage, then apply the calculated average markup to the taxpayer’s reported cost of goods sold to come up with an estimate of the establishment’s retail sales, comparing that estimate to the sales tax returns to determine a deficiency. In other cases, a BOE auditor may decide to use a “credit card sales percentage” test to determine taxable income. Under this method, the sales tax auditor will observe the sales of the establishment for a period of time to determine, on average, what percent of receipts come from credit cards, and what percent come from cash transactions. After determining an average for the observation period, the auditor will then review the taxpayer’s bank statements for the audit period to determine the amount of money deposited by the credit card processing company, and apply the calculated percentage to come up with taxable sales for the audit period. While there are many other varieties of sales tax audit methods, they all have one thing in common: each method results in a rough estimate of taxable sales, and each method relies on certain underlying assumptions to be true for the results to be accurate.
Sales tax issues may be extremely complicated. If you have any questions or if we can further assist you, please contact our California Sales Tax Audit Attorneys.
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