Car dealerships are obvious targets for state sales tax audits. They have relatively high sales prices per transaction, so the state revenue agency can audit a large sales volume with relatively few transactions. In turn, small mistakes can result in large amounts of tax gained by the state.
Perhaps more importantly, DMV records are available to verify the business’s sales. With the DMV records, the state can simply pull the dealerships DMV sales, back out the sales tax paid, and assess the difference leaving the taxpayer to prove the rest.
In California, a recent case shows the potential unfortunate consequences when a company gets that dreaded audit notice. As routinely done, California asked for all documentation of a financial nature for the audit period and the dealership provided federal tax returns. While the dealership’s California sales tax returns roughly matched the $3.6 million reported for federal purposes, about $2 million were reported as exempt sales. That left the California taxpayer to prove that it had about $500,000 of exempt sales for resale and $2 million of exempt labor. Similarly, the DMV data showed about $3.6 million of car sales by the dealership, which was presumably taxable.
The California Department of Tax and Fee Administration started with the 3.6 million presumably taxable car sales and backed out the $1 million reported by the California car dealership. Unfortunately, the taxpayer was only able to prove that it had about $165,000 as sales for resale, or sales shipped outside of California. CDFTA issued a notice of determination for $290,000 and a 10% penalty and interest for a total of over $300,000 in tax due.
As taxpayers in most states have the opportunity to purse, this taxpayer went through the administrative appeal process. The taxpayer was only able to shave about $10,000 of tax off during the agency protest. It filed in California’s administrative / tax court, which is called the office of tax appeals (OTA).
It is unclear from the filings, but it appears that the taxpayer did not dispute the total sales calculated by CDFTA during the sales tax audit. Instead, the taxpayer primarily relied on the theory that sales should be reduced because of returns or repossessions. Other than handwritten notations on invoices, the taxpayer provided little, if any, evidence to support the unwinds. Consequently, the OTA was left with no choice but to sustain the assessment.
Coming out of COVID, states are hungry for lost revenue, and businesses should expect increased audits on the horizon. Just as the pre-pandemic days, the state car dealerships make the perfect targets.
The state revenue agency can easily audit them using third party data and efficiently collect large amounts of revenue with little effort and relatively few transactions. If you or your client is a car dealership, it is critical to make sure your sales match those reported to DMV and your exempt sales are properly accounted for.