The sales tax audit process is initiated by California’s tax agency, the Board of Equalization. But that does not mean taxpayers should wait to be audited to address their sales tax matters. In fact, there are several reasons to be “proactive”, rather than “reactive” regarding one’s California sales tax matters.
In the first place, being proactive gives you the opportunity to plan for a sales tax audit. You can then structure things as you desire; organize the relevant paperwork and anticipate certain objections.
Second, being proactive gives you the opportunity to minimize your potential sales tax liability / consequences. In turn, this helps reduce any inherent uncertainty regarding your sales tax planning. This is important because uncertainty often has the effect of placing a damper on business planning and investment.
Third, advanced sales tax audit planning gives you the opportunity to negotiate with the State regarding your sales tax liability. By conducting a “pre-audit” (as it were), you can anticipate the sales tax grey areas and respond appropriately. Sometimes it may even be possible to adjust your business structure to reduce or limit that liability. Sometimes that could be a simple as converting your business form from a partnership to a corporation; making an “S Corp” election; or something similar.
Essentially, the Taxpayer Bill of Rights seeks to “increase protection of taxpayers’ rights.” Of course, the very idea of a Bill of Rights for taxpayers presupposes that the Board of Equalization or the Franchise Tax Board may sometimes act outside the (true) tax laws. The Bill of Rights provides remedies to correct these errors. Rev. & Tax. Code § 7083 specifically authorizes an internal office to audit and facilitate taxpayer’s complaints:
“(a) The board shall establish the position of the Taxpayers’ Rights Advocate. The advocate or his or her designee shall be responsible for facilitating resolution of taxpayer complaints and problems, including any taxpayer complaints regarding unsatisfactory treatment of taxpayers by board employees, and staying actions where taxpayers have suffered or will suffer irreparable loss as the result of those actions. Applicable statutes of limitation shall be tolled during the pendency of a stay. Any penalties and interest which would otherwise accrue shall not be affected by the granting of a stay.”
The real teeth of a taxpayer’s legal protection is found in California’s Constitution and the Revenue & Tax Code itself.
For example, the Rev & Tax Code can give California taxpayers legal grounds to sue for damages that the Board of Equalization’s agents cause as a result of its failure to observe the tax laws. Specifically, Rev. & Tax. Code §7099 creates a cause of action for the taxpayer against the Board of Equalization if it should ever “recklessly” disregard a published procedure. California’s Rev. & Tax Code also prohibits the Board of Equalization from investigating, by way of audit or otherwise, “any person for nontax administration purposes.” Rev. & Tax. Code § 7092(a). But, on the other hand, the State of California is permitted to conduct audits of taxpayers—provided it is for a genuine tax reason. The courts do not allow taxpayers to resists audits on the ground that it is violates their Fourth Amendment right against unreasonable searches and seizures by the government.
To balance out the taxpayer’s power to sue the Board, though, the Rev. & Tax Code allows the state courts to penalize taxpayers where a suit is deemed “frivolous”.
Taxpayers are afforded additional protection under the Rev. & Tax Code. If, during litigation, the Board of Equalization were to take an unreasonable position then the taxpayer may be awarded reasonable litigation costs. This only makes sense. If the State were to assert without a sufficient legal basis that you owe it tax, and you are forced to defense yourself, it is only right that the State would be forced to pay for your legal defense. Stated more carefully, Rev. & Tax. Code § 7091 allows a taxpayer to recover legal fees and expenses when the Board of Equalization’s position is not “substantially justified.”