A call or letter from the California Department of Tax and Fee Administration (CDTFA) saying your business has been selected for a sales and use tax audit is stressful, but it doesn't have to be a crisis. The CDTFA's own audit guide notes that audits frequently don't change the amount owed, and that overpayments are considered as well as underpayments. How well you prepare, and how you handle disagreements, can make a real difference. Here's how a CDTFA sales tax audit works, step by step, based on the agency's own publications.
New to the agency? Start with our overview: What is CDTFA?
What a CDTFA audit is checking
According to CDTFA Publication 76, Audits, the auditor's job is to verify that you reported correctly. In a sales and use tax audit, the auditor is trying to answer questions like these: - Did you report all gross receipts from sales of merchandise and taxable labor and services? - Did you report use tax on equipment and supplies you bought without paying tax, for example from out-of-state sellers or for resale? - Did you claim deductions (like sales for resale) properly? - Did you allocate local tax correctly and use the right rate in special tax districts?
(CDTFA Publication 76, Audits)
How the audit starts
The CDTFA says it rarely starts an audit without giving you notice first. Here's what Publication 76 describes: - First contact is usually by phone. If the auditor can't reach you, they may write or visit. - The audit period is usually three years. The auditor will tell you which records to have ready and set a start date and location. - You normally get two to three weeks to prepare, and you can ask to delay the start. - Long delays may come with a Waiver of Limitation. This extends the time the CDTFA has to bill you. Understand it before you sign. - Location is flexible. The audit can happen at your business, at your accountant's office or at a CDTFA office. - You can have a representative handle it. Tell the auditor at the first contact, and they'll schedule with your representative. You can also ask to have all your CDTFA accounts audited at the same time.
How far back can the CDTFA go?
Generally, the CDTFA has three years to issue a deficiency determination if you filed returns. If you didn't file returns, that period is eight years. Those limits don't apply in cases of fraud or intent to evade. (CDTFA Publication 76; Revenue and Taxation Code §6487)
This is one reason to bring unfiled sales tax returns current. It's also why that Waiver of Limitation matters.
Records the auditor may ask for
The records depend on your business, but the CDTFA expects all records that bear on your tax to be made available. If you refuse, it may issue a subpoena. Key rules from Publication 76: - Keep required records for at least four years, and keep audit-period records until the audit and any appeal are finished. - Watch your point-of-sale system. If it overwrites data in less than four years, you're expected to export and keep that data. - If records are missing, tell the auditor what you do have. You may need to reconstruct records, or the auditor may estimate. If the CDTFA finds you owe more because of inadequate records, it may charge a negligence penalty.
(CDTFA Publication 76; see also Publication 116, Sales and Use Tax Records)
Good bookkeeping is the best audit preparation. If your books are behind, our accounting and bookkeeping services can help you get them in order.
How the auditor tests your records
Preliminary tests
The auditor usually starts by comparing: - Total sales on your books with the sales on your sales tax returns - Total sales on your books with the sales on your income tax returns - Tax you collected with the tax you reported - Claimed sales for resale with your resale customers
They may also check purchase invoices for items bought without tax, or test your markup on cost.
In-depth review and sampling
If the tests point to errors, the auditor may examine every transaction or use a sample. The CDTFA says its auditors generally try to use a statistical sample, and when sampling is used, the auditor should discuss the sampling plan with you before finalizing it. Under statistical sampling, the auditor selects enough transactions to draw a conclusion about all the transactions under review, so the sample design matters. Many audits use both methods, for example reviewing asset purchases in full and sampling sales.
Amended returns during the audit
Amended returns filed after your account is assigned for audit count as additional records. Payments made with them are credited to the audit, which stops interest from accruing on that amount.
(CDTFA Publication 76; Publication 147, Computer-Assisted Audits)
The Managed Audit Program
Some businesses qualify for the CDTFA's Managed Audit Program, a kind of self-audit done under CDTFA instructions. If you complete a managed audit and owe additional tax, Publication 76 says that for some programs, interest is charged at half the rate that would otherwise apply. Publication 53 explains who qualifies. (CDTFA Publication 76)
The exit conference and audit findings
When the fieldwork is done, the auditor holds an exit conference with you or your representative, sometimes with a supervisor present. The CDTFA says: - Auditors are required to give you copies of all the audit working papers, normally with indexed schedules and narrative explaining the tests. - Even if you have a representative, you should consider attending. - If you agree, the report is reviewed. You'll then receive a Notice of Determination (a bill) or a Notice of Refund. If nothing is owed, you get a letter accepting your returns as filed.
If you disagree
Disagreeing at this stage is normal, and it's often the cheapest point to fix errors: 1. Tell the auditor and provide supporting documents. The auditor generally holds the final report to give you reasonable time. 2. Meet with the audit supervisor if you still disagree. 3. Meet with a CDTFA representative. You'll get a letter giving you ten days to make an appointment. If you don't respond, the CDTFA assumes you agree, and the report moves to billing.
You can also prepay some or all of the proposed amount with form CDTFA-1 to stop interest. The CDTFA says prepaying doesn't mean you agree with the findings.
After the Notice of Determination: the 30-day deadline
This is the deadline that matters most. Within 30 days of the Notice of Determination, you must either: - Pay the billed amount, or - File a petition for redetermination (an appeal)
If you do neither, the CDTFA adds a penalty of 10% of the unpaid tax, the determination becomes final, and collection (including liens and levies) can begin. (CDTFA Publication 76; Revenue and Taxation Code §6561)
What you need to know about the petition: - It must be in writing. It must state the amounts you dispute and the specific grounds, and be signed by you or your representative. - You can file online through your CDTFA account or use form CDTFA-416. A letter also works. - A timely petition generally prevents collection of the petitioned amounts until the appeal is resolved (except jeopardy determinations). (CDTFA Regulation 35007) - Interest keeps running during the appeal. The CDTFA suggests paying at least the undisputed portion. If you win, overpaid tax is refunded with interest. - A Jeopardy Notice of Determination has a shorter deadline: 10 days. (CDTFA-416)
If the dispute isn't resolved with CDTFA staff, it can go to the CDTFA's Appeals Bureau for an appeals conference and then, if necessary, to the Office of Tax Appeals, an independent state agency. You can also ask for your case to be considered under the CDTFA's settlement program while the appeal is pending. If you miss the 30-day deadline, you can still pay and file a claim for refund. (CDTFA Publication 17, Appeals Procedures)
Common mistakes to avoid
- Treating the first call casually. The auditor uses it to learn about your operations and the records you keep.
- Handing over disorganized records, or records that don't match your income tax returns, without an explanation.
- Signing a Waiver of Limitation without understanding what it extends.
- Not asking how a sample was designed before it's finalized.
- Skipping the exit conference or ignoring the 10-day letter.
- Missing the 30-day petition deadline.
- Forgetting the final sales tax return when you sell or close a business. See CDTFA final sales tax: what you need to know.
Frequently asked questions
How long does a CDTFA sales tax audit take?
It depends on the size of the business, the condition of the records and whether there are disputes. Publication 76 doesn't give a standard timeframe. The CDTFA notes that audits tend to go more efficiently when businesses have time to prepare, so organized records help.
How many years does a CDTFA audit cover?
The audit period is usually three years. The CDTFA generally has three years to bill if you filed returns, and eight years if you didn't.
Can someone else deal with the CDTFA auditor for me?
Yes. The CDTFA says you can have an authorized representative, such as your accountant or bookkeeper, handle the audit. Tell the auditor at the first contact. Representation is set up with a power of attorney (form CDTFA-392, or online through your CDTFA account).
What happens if I disagree with the audit results?
You can provide more documentation, meet with the audit supervisor and then a CDTFA representative. After you receive a Notice of Determination, you have 30 days to file a petition for redetermination.
Does a CDTFA audit always mean I'll owe more?
No. The CDTFA says audits frequently don't change the amount owed, and overpayments are considered as well as underpayments.
How Tax Resolution Plus can help
Our founder, Shawn Zali, spent 7+ years at the California Department of Tax and Fee Administration (CDTFA). That gives our team an inside understanding of how the agency approaches audits. From our office at 2575 McCabe Way, Suite 210, Irvine, CA 92614, and by phone across California, we can: - Act as your authorized representative with the CDTFA - Review your records before the auditor does and spot gaps early - Question sampling methods and audit findings with documentation - Prepare your petition for redetermination and represent you through the appeal - Get your bookkeeping and sales tax filings in order going forward
We can't promise any specific audit outcome, but we'll tell you plainly where you stand. Learn more about our California tax audit representation and audit representation services.
Facing a CDTFA audit? Book a free 30-minute consultation or call (866) 900-9001.
This article is general information, not tax or legal advice. Results vary with each business's records and facts, and CDTFA rules and procedures change, so check the linked CDTFA publications for current details.