Why does the State of California audit businesses to ensure compliance with sales and use taxes? How does the State determine whether to audit my business?

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Why does the State of California audit businesses to ensure compliance with sales and use taxes? How does the State determine whether to audit my business?

According to the Board of Equalization (BOE), the “primary objective” of a tax audit is to discern the “correct measure of sales tax.” It attempts to do this in a manner that involves the “least possible expenditure of their time.”

http://www.boe.ca.gov/sutax/manuals/am-04.pdf

Each district has its own discretion whether to audit a business. On the one hand, this creates flexibility, which can be either taxpayer favorable or taxpayer unfavorable. But, on the other hand, it also creates a level of uncertainty—which is bad for business. Even so, there are certain “factors” each district can consider in making its determination whether to conduct an audit. These factors can be broken up into the following questions:

  • Are accurate and complete records kept?
  • Does the markup on cost of goods sold appear adequate?
  • Are the persons preparing tax returns familiar with the law and the rules and regulations pertaining to their particular business?
  • Are the reported amounts reasonable considering the type of business, nature of the premises, the location in the community, etc.?
  • Do the reported amounts vary materially from period to period?
  • Is there a good system of internal control?
  • Is the taxpayer’s past record good?  (A prior bad sales tax audit result will almost certainly result in a re-audit three years later).

Once a business is selected for audit, the auditor will fill out Form BOE 1164, “Audit Memorandum of Possible Tax Liability.” The information on this Form is used by the BOE to discern whether to conduct an audit; it also helps discern whether there is any unpaid tax. For these two reasons, the BOE says, “the importance of preparing this form [by the auditor] cannot be overemphasized.” See:

http://www.boe.ca.gov/sutax/manuals/am-04.pdf