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Facing Sales Tax Fraud Penalties in California? You Could Also Be Facing Criminal Charges

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    The California Office of Tax Appeals (OTA), which was created in 2017 to hear sales and income tax disputes against the Franchise Tax Board (FTB) and California Department of Tax and Fee Administration (CDTFA), recently sided with the CDTFA in an appeal filed by sushi restaurant Little Madfish, upholding 25% and 40% fraud penalties that, together, exceeded $100,000. The OTA, providing a rationale for its decision, pointed in its Factual Findings to numerous indicators of tax fraud justifying the aforementioned penalties, including “many gaps” in the restaurant’s sales orders; inadequate tip recordkeeping; and discrepancies between the taxable sales recorded on the restaurants’ books, and those that were actually reported to the CDTFA. If your restaurant, bar, or catering business might have engaged in similar practices, be on red alert: if the government has enough evidence to successfully assert fraud penalties against you, it may also have enough evidence to successfully prosecute you for tax evasion or other tax crimes. The best course of action is to consult a tax defense attorney now, before you are chosen for a tax audit – or worse, placed under arrest.

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    CDTFA Sales Tax Audit Leads to $113K in Fraud Penalties for Sushi Restaurant

    The appellant, Little Madfish, began operating during October of 2008. Approximately two years after opening, in November 2010, the restaurant was visited by a CDTFA inspector, who, according to OTA records, “made a note in the appellant’s file that… the business may need to be audited.” In the notes, the inspector pointed out that the restaurant’s “reported taxable sales did not reflect the $2,000 in sales per day” described by the restaurant’s manager. (As we frequently warn in our law blog, many tax penalties – and taxpayer indictments – begin with a state or federal tax audit, as this case exemplifies perfectly.)

    A subsequent audit revealed “unreported taxable sales” that were, on various occasions, either “not recorded in the appellant’s records” or “were missing or deleted from the appellant’s records,” according to the OTA. Through its examination of the company’s sales tax records and returns, “the CDTFA established additional unreported taxable sales of $560,365” for the period from October 2011 through September 2013. As the OTA also noted, “For the period October 1, 2010, through September 30, 2011,” – during which time “the appellant did not provide detailed records containing recorded taxable sales” – the CDTFA found “unreported taxable sales of $655,446.” Moreover, auditing revealed that the restaurant was not in the practice of reporting mandatory gratuities. However, by using data projections, “the CDTFA calculated audited taxable tips of $93,284.”

    Ultimately, the CDTFA determined the following: “For the period October 1, 2010, through September 30, 2013, the appellant reported a total of $1,155,873 in taxable sales, and the CDTFA calculated audited taxable sales of $4,498,784, resulting in an understatement of $3,342,911. On average, the appellant reported just 25.69 percent of its taxable sales for the period at issue” – barely a quarter of the true figure.

    Though the restaurant later filed for bankruptcy, it still received a sales tax bill “in the amount of $411,419.96 tax, plus applicable interest and penalties.” These penalties included “a 25 percent fraud penalty of $56,076.14, and a 40 percent penalty of $57,366.14 for failing to remit sales tax reimbursement collected from customers,” for a combined total of over $113,000. The appellant was, as stated above, unsuccessful in appealing these penalties before the OTA.

    Sales tax is a notoriously complex area of California’s tax regulation, yet one that has profound legal and financial repercussions for businesses that do not comply. If your small business has been chosen for a sales tax audit, would like to dispute the results of a completed sales tax audit, or is in jeopardy of being targeted for a criminal tax investigation, it is in your best interests to be proactive and consult a tax attorney immediately. A strategic response can limit fines and prevent prosecution, but only if handled deftly – and quickly.


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    At the Tax Law Office of David W. Klasing, we have over 20 years of experience representing California and out-of-state taxpayers in civil and criminal tax matters, including corporations, LLCs, partnerships, and sole proprietors. Whether your business requires tax audit representation, audit appeals representation, or criminal tax defense representation, our award-winning law firm delivers zealous, 24-hour support. Contact us online right away to arrange a reduced rate consultation or call the Tax Law Office of David W. Klasing at (800) 681-1295.

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