A sales tax audit is a stressful and serious event. Unfortunately, it is an event that many retailers in the State of California will face at one time or another. A sales tax audit is performed by the California State Board of Equalization, also known as the BOE. If the BOE selects your business for an audit, you will be required to gather hundreds and sometimes thousands of records and prepare a wide assortment of summaries of these documents. In any audit, the first question that comes to the mind of many taxpayers is how far back in our records will the BOE ask us to go? If they do ask you to produce archived records that go back years and years, what are your rights? In this article, we’re going to look at a typical California sales tax audit, the statute of limitations in a sales tax audit, and how both might affect your business.
A statute of limitation is a law that sets a specific limit on the amount of time that can pass between an event and the beginning of the legal action that is related to that event. After the specified amount of time has passed, no legal actions related to the event in question can be filed. If a legal action is filed, after the statute of limitations has expired, it will more likely than not be dismissed. The statute of limitations applies to both criminal matters and civil matters. Different jurisdictions may have different statutes of limitations depending on the event or the crime involved. When talking about California sales and use tax audits, the statute of limitations is three years. That is, the BOE has three years from the date a sales and use tax return is filed to assess a taxpayer for unpaid taxes, interest and penalties.
California state and local sales and use tax rates as of April 1, 2017 vary among the taxing jurisdictions and range between 7.25% and 9.75%. The sales tax is usually passed on to the buyer of the goods, i.e., tangible personal property, as a part of the purchase price. The amount of sales tax that any retailer owes to the state is generally calculated by the amount of gross receipts from total retail sales that the retailer collected in a given tax period. The BOE assigns a filing frequency (quarterly, monthly, yearly) based on a retailer’s previously reported sales tax or on its anticipated taxable sales at the time the business registers with the state. It is a retailer’s responsibility to report its gross receipts to the state on this periodic frequency and pay the applicable tax accordingly.
With nearly 52 billion dollars in sales tax revenue being generated each year, you can bet that the BOE takes its task of monitoring and collecting sales taxes very seriously. That’s why they regularly conduct audits of California businesses in order to ensure tax compliance. It’s important to remember that auditors work for the State. The number one job of any auditor is to find errors or intentional misrepresentations that result in unpaid or underpaid sales and use taxes. These errors generate revenue and an auditor is judged, in part, by the amount of additional revenue they generate for the State.
Audit procedures vary from business to business. However, every auditor will examine a retailer’s sales tax returns, their tax worksheets, their state and federal business tax returns, as well as any applicable ledgers, account books, bank accounts and cash register receipts.
A sales tax audit can be triggered for almost any reason. In most cases, it’s simply your turn to be audited. (Most businesses in California can be expected to be audit at least once.) However, additional circumstances may exist that will make your business more of a target for an audit. These include:
In general, the statute of limitations for a sales tax audit (or any tax audit) is three years, if you have filed sales tax returns. This means that the BOE can audit the three previous tax years. So an audit by the BOE conducted in 2017 can cover 2016, 2015, and 2014, but not 2013 and earlier. It should be noted that if you have failed to file tax returns, the statute of limitations for an audit is eight years. In this case, the BOE can audit every year from 2016 all the way back to 2009. The reason for the increased length of time is because the failure to file regular tax returns may be indicative of tax fraud and evasion.
It should be noted that there are circumstances that can extend these two statutes of limitations. For example, if the BOE discovers that you have committed tax fraud or that you intended to commit tax fraud, they can audit your records for evidence of fraud beyond the three- or eight-year time periods discussed above.
Once the audit has been completed, you have the right to challenge the outcome. Your challenge can be resolved through an agreement with the auditor handling your case, that auditor’s supervisor, or the BOE principal auditor for the tax district your business is located in. If you cannot come to an agreement with any of the BOE’s audit representatives, you will receive a Notice of Determination from the BOE. It then becomes your responsibility to satisfy that determination by paying same or to formally appeal the determination by filing a Petition for Redetermination. You can find a complete discussion of the BOE appeals process here.
It should be noted that the BOE takes the audit process very seriously. You should do likewise. The Taxpayers’ Rights Advocate Office is available to assist you in determining who to contact at any point in the audit process, as well as to help with filing the required documentation. However, the best practice in any BOE sales tax audit situation is to contact a state and local tax attorney who is experienced in California sales tax law. He or she can protect your interests by handling your appeal before the BOE, negotiating a settlement or offer in compromise, or arranging an installment payment plan.