In California, businesses that engage in the sale of tangible personal property are subject to sales and use tax laws enforced by the California Department of Tax and Fee Administration (CDTFA). As part of its regulatory function, the CDTFA conducts audits to ensure compliance. These audits can be routine or triggered by discrepancies in tax filings, unusual deductions, or third-party information. Understanding the audit process can help business owners better prepare and reduce risk.

 

The audit process typically begins with a notice of audit, informing the business of the upcoming review. This notice specifies the audit period—usually covering the past three years—and outlines the documents the auditor will need to examine. Common records requested include sales invoices, purchase records, general ledgers, federal and state tax returns, bank statements, and any resale or exemption certificates issued or received.

 

Once the audit begins, the auditor may either visit the business in person or conduct the audit remotely as a "desk audit." During this phase, the auditor will verify whether the business properly reported taxable and non-taxable sales. This includes cross-checking reported revenue with bank deposits, comparing purchase invoices to claimed deductions, and reviewing out-of-state sales for valid proof of non-taxability. The goal is to determine whether sales tax was properly collected and remitted.

 

If records are incomplete or unreliable, auditors may use sampling techniques to estimate taxable sales. For instance, they may choose a representative time block (e.g., one quarter) and extrapolate findings over the entire audit period. They might also use markup analysis, where they estimate sales based on the cost of goods sold and expected profit margins. In more severe cases, they may rely on bank deposit analysis or data obtained from third parties such as vendors, credit card processors, or other government agencies.

 

At the conclusion of the audit, the CDTFA issues a Report of Field Audit or Desk Audit, summarizing its findings. If the auditor concludes that additional taxes are owed, the business will receive a Notice of Determination, detailing the amount of tax, penalties, and interest due. The taxpayer then has 30 days to either pay the liability or file a petition for redetermination if they disagree with the results.

 

Businesses that challenge the audit findings can pursue several remedies, including administrative appeals, settlement negotiations, or installment payment plans. If the matter remains unresolved, the case may be heard by the Office of Tax Appeals (OTA), an independent body that adjudicates state tax disputes.

 

To avoid adverse audit outcomes, businesses should maintain accurate and organized records. Keeping all sales and purchase documents, valid resale certificates, and detailed accounting ledgers is essential. Regular internal reviews and compliance with CDTFA guidelines also help minimize audit exposure.

 

In summary, sales tax audits in California are a structured process aimed at verifying tax compliance. With proper preparation, accurate recordkeeping, and professional guidance, businesses can effectively manage an audit and mitigate potential liabilities.