California Sales and Use Tax & Audit Guide
This guide is for businesses that need straightforward answers on the following California Sales and Use Tax subjects:
- Do I need to be collecting California sales tax?
- Should I be collecting or paying California use tax?
- What do I do if I should have been collecting but haven’t?
- I received an audit notice, what should I do?
- Guidance on fighting a sales tax assessment in California.
Who Needs to Collect California Sales and Use Tax?
Like most states, to be subject to California sales tax collection and its rules, your business must:
- have nexus with California, and
- sell or use something that is subject to California sales tax.
Nexus – How Is It Established in California?
According to the California Department of Tax and Fee Administration (CDTFA), sales tax nexus is created in California if a business has a physical presence in California, such as:
- Having employees, agents, or independent contractors for the purpose of taking orders, making sales or deliveries, or installing or assembling tangible personal property in California.
- Maintaining an office or other place of business in California.
- Assembling, installing, servicing, or repairing products in California.
- Owning, renting, or leasing real property or tangible personal property in California, including the use of a computer server in California.
- Delivering goods to California customers using your company-owned or leased truck.
- Maintaining inventory in California using a third-party fulfillment service, such as Fulfilled by Amazon (“FBA”).
NOTE: California has been extremely aggressive in pursuing online retailers that use FBA services. California requires the fulfillment center to divulge sellers that use its fulfillment services and have inventory in California. If you use FBA or another fulfillment service, you are likely on California’s sales tax radar.
Additionally, business that do not have a physical presence in California, can establish economic nexus by exceeding a certain annual sales threshold in the state. See the next section for details.
Economic Nexus (Wayfair Law) And Internet Sales in California
As of April 1, 2019, businesses located outside of California may also be subject to its sales and use tax laws. Specifically, California’s Wayfair law requires that a purely out of state business register with CDTFA to collect and remit sales and use tax if the business has sales of tangible personal property delivered into California exceeding $500,000 during the preceding or current calendar year.
It’s important to note that California counts all sales of tangible personal property toward the $500,000 threshold. This includes nontaxable sales, such as sales for resale.
Which Sales Are Subject to California Sales Tax?
If you have nexus in California, the next step is to determine whether the products or services you sell are subject to California sales and use tax. Like most states, unless an item is specifically exempt, sales and rentals of tangible personal property are subject to California sales tax.
While the general rules seem straightforward, the application of California’s sales tax rules and their nuances, complexities, and application to your business can get complicated. We recommend scheduling a time to review your specific situation with one of our sales tax professionals.
Common exemptions from California sales and use tax:
- Groceries, including candy, confectionary, and snack foods
- Medical Devices
- Prescription medicines
- Housing related utilities, such as gas, electric, water and steam
- Many Entertainment industry related purchases
- Many items used in farming or manufacturing.
Generally, services are not subject to sales tax in California with the exception of services that are “inseparable from the sale” of the tangible personal property. That said, there are a few services that are specifically subject to sales tax, such as digital or physical photographs and their related services.
California does not tax software or software as a service (SaaS) unless the software is delivered on a tangible medium.
Shipping & Handling
California has somewhat complicated rules on shipping and handling charges. The basics are as follows:
Shipping of non-taxable items:
- If the item being delivered is not taxable, the delivery charge is also non-taxable (that’s the easy part).
Shipping of taxable items:
- For taxable items, the delivery rules get tricky. So long as the shipping/delivery, freight, or postage is separately stated on the invoice and the charge is not greater than the actual delivery cost, it is not subject to California sales tax.
- If, however, the delivery charge is greater than the business’s actual cost, the portion of the charge that exceeds the actual delivery cost is taxable.
Delivery charges can become fully taxable if:
- Adequate records of delivery costs are not kept,
- The delivery is made with your business’s own vehicles,
- You make a separate fuel surcharge or “handling” charge,
- Delivery is part of the price for the item sold, or
- “Freight-in” is included in cost.
While the general sales tax rules seem straightforward, the application of those rules can get tricky when gray areas come up, and they inevitably do. These guides were developed by California to provide some industry specific guidance on the application of California sales and use tax.
- California Sales and Use Tax Guide for the Agricultural Industry
- California Sales and Use Tax Guide for Auto Repair Garages and Service Stations
- California Sales and Use Tax Guide for Gas Station Operators
- California Sales and Use Tax Guide for Barbers and Beauty Shops
- California Sales and Use Tax Guide for Wineries and Wine Distributors
- California Sales and Use Tax Guide for Liquor Stores
- California Sales and Use Tax Guide for Beer Breweries and Distributors
- California Sales and Use Tax Guide for Distilleries and Liquor Distributors
- California Sales and Use Tax Guide for the Dining and Beverage Industry
- California Sales and Use Tax Guide for Restaurants, Bars, Caterers and Hotels
- California Sales and Use Tax Guide for the Cannabis Industry
- California Sales and Use Tax Guide for Construction and Building Contractors
- California Sales and Use Tax Guide for Dry Cleaners
- California Sales and Use Tax Guide for Elective Ultrasound Services
- California Sales and Use Tax Guide for Fulfillment Centers
- California Sales and Use Tax Guide for the Gig Economy
- California Sales and Use Tax Guide for Green Technology
- California Sales and Use Tax Guide for Grocery Stores
- California Sales and Use Tax Guide for Gun Dealers
- California Sales and Use Tax Guide for Mobile Phone Vendors
- California Sales and Use Tax Guide for Car Dealers and Dealerships
- California Sales and Use Tax Guide for Photography
- California Sales and Use Tax Guide for Purchase of Log Homes
- California Sales and Use Tax Guide for Venue Rental Businesses
Determining Local Sales and Use Tax Rates in California
California’s base or statewide sales tax rate is 7.25%. However, most counties charge a local/district surtax on top of the 7.25%, increasing the total sales tax that must be collected and remitted by the seller. Those district tax rates range from 0.10% to 1.00%, and some areas may have more than one district tax in effect.
The district surtax applies if the sale is made within or delivered to a location within the respective county. As California is a mixed origin based state, state, county and local taxes are determined based on the seller’s location, while district taxes are based on the buyer’s location. State and local taxes are remitted to the state as part of the California sales and use tax return. The combined California + local sales and use tax rates for the largest 30 cities as of October 1, 2020 are listed below. A comprehensive list can be found here.
I Should Have Collected California Sales Tax, But I Didn’t
Unlike many of our competitors who offer a one size fits all solution and blindly suggest filing a Voluntary Disclosure Agreement (VDA) in each state, our sales tax professionals will work with you to determine the best and most cost-effective solution for your business.
If you determine your business has nexus but you have not collected California sales tax, the primary options are to:
- Register and pay back taxes, penalties, and interest, or
- Enter into a VDA to eliminate penalties (and in some cases reduce your tax liability and avoid interest).
Here is what you need to know about each option to make the best decision for your business:
Option 1: Register to Pay Back Taxes, Penalties, and Interest
Sometimes the best solution for a business is simply to register with California and pay back taxes, penalties, and interest. A VDA is not cost-effective if the past liabilities and penalties are minimal. Be wary of the tax professionals that recommend doing a VDA in these cases, they are looking to make a buck rather than looking out for your best interests. If you’re unsure what your past liabilities are, contact us and one of our state tax professionals will work with you to conduct an analysis and help you make the right choice for your business.
When to consider registration and payment:
- If you established nexus less than 3 or 4 years ago.
- The sales tax penalty is LESS than the professional fees charged for the VDA.
- Your business does NOT have a sales tax collected issue.
Beware: registering does not generally eliminate past liabilities
Option 2: Voluntary Disclosure Agreement (VDA)
California’s VDA lookback period: 3 years
In many situations, voluntary disclosures are a useful tool to reduce extended periods of past exposure. For example, if you should have been collecting sales tax for 10 years, the voluntary disclosure limits the lookback period to 3 years. As a result, the benefit of doing a VDA often turns on:
- Whether the VDA limits lookback period. i.e. – you established nexus more than 3 or 4 years ago.
- The sales tax penalty savings is MORE than the professional fees charged for the VDA.
- You have a sales tax collected but not remitted issue.
I Received a California Sales and Use Tax Audit Notice, What Should I Do?
California regularly audits businesses that are required to charge, collect, and remit various taxes in the state. Businesses that receive a sales and use tax audit notice should consider the following:
- Unless you have experience handling California sales and use tax audits, how can you trust that the state’s auditor is abiding by the rules and following proper procedure?
- How will you know when to provide documents or when to push back?
- Do you have a thorough understanding of your sales and use tax areas of exposure?
- Controlling the audit is paramount to the limiting exposure and shaping the results. Are you confident in doing that on your own?
If you are unsure of the answer to these questions and you do not have experience handling California sales tax audits, hiring a professional might be right for you. Contact us and learn how our sales tax professionals can give you the peace-of-mind and confidence you need during your audit.
Additionally, these resource pages are full of detailed information to help you evaluate critical decisions during your California sales and use tax audit.
- The Audit Overview & Selection Process
- The General Audit Process
- Statute of Limitations Extensions & Issues
- Managing the Sales Tax Auditor
California Sales Tax Audit Process
California sales and use tax audits usually follow the process laid out in the following flowchart. See the detailed guidance for each stage of the process in the sections below.
What to Expect After You Receive a California Sales and Use Tax Audit Notice
Many audits begin with an unexpected call from a CDTFA sales tax auditor. Shortly after the call, your business will receive an audit notice confirming that your business was selected for a (field or desk) California sales and use tax audit. Lucky you!! But before you celebrate too much, it’s a good idea to prepare for the audit. We highly recommend you start by getting a state and local tax professional involved.
What to Expect From A California Sales Tax Auditor
- Auditor will conduct pre audit research.
- Auditor will often schedule and perform an entrance conference.
- Records will be requested (many of which the auditor is not entitled to and does not need).
- Usually, the auditor will tell you that, as part of the audit, they are looking for any areas where your business is entitled to a sales tax refund. While it is technically their job to look for this, they very seldom (if ever) do.
What to Expect During The Audit
Once the necessary records are received, the auditor will:
- Conduct the sales tax audit by comparing your California sales and use tax returns to your federal income tax returns or bank statements to determine whether all applicable sales, or gross sales, were reported on your California sales tax return(s).
NOTE: A slight error in how tax was charged on even a single type of transaction, when multiplied over three years, can add up to a considerable sales tax liability.
- Once the auditor is confident all sales are accounted for, they will review your exempt and out-of-state sales.
Conduct a use tax audit – the auditor will request a detail of certain
documents / accounts to make sure use tax was properly paid on applicable
purchases. Common areas audited include:
- Advertising Expense
- Auto & Truck Expense
- Repair and Maintenance
- Rent (including related party rent)
- Office Expense
- Miscellaneous Expense
Despite publications to the contrary, if a business buys an item online without paying use tax, the business still has an obligation to remit the tax to California. This often leads to shocking results for the unsuspecting taxpayer during an audit.
After the Audit – Understand and Defend Your Businesses Rights
Upon completion of the audit, there will usually be an exit conference with the auditor. The auditor will produce an audit report with corresponding workpapers to support the California sales and use tax assessment. It is advisable to have a sales tax professional present during this meeting as this is your first opportunity to see the auditor’s findings and push back on areas where they have overstepped their bounds or misapplied California’s sales tax laws.
We recommend businesses refrain from agreeing to the sales tax assessment until a sales tax professional has reviewed it for issues that should be challenged. Many businesses wind up drastically overpaying the state because the business owner or in-house accounting personnel were not well versed in the sales tax laws that, if challenged, could have reduced their California sales tax liability.
The process of challenging a California sales tax audit assessment is discussed in detail in the following sections.
NOTE: If NOD deadline is missed, you have an additional 30 days to file in administrative court. If that deadlines are also missed, it can be very difficult to get case reopened.
Contesting Audit Findings with the Auditor
After an audit, the auditor will issue a California Notice of Audit Results (AKA the audit report). This document details the auditor’s findings so it’s important to carefully review and understand its implications. Any issues with the results are handled as follows:
30 days to contest findings with the auditor.
- Documentational issues (exemption certificates, proof tax was paid, etc.) and calculations are worth addressing with the auditor.
- Legal interpretations of sales tax law are often not resolvable at this stage.
- If a resolution cannot be reached with the auditor, the next step is to appeal/protest the issue with the California Department of Tax and Fee Administration.
Appeal / Protest with the California Department of Tax and Fee Administration
Any contested issues that were unresolved prior to the audit report being issued can be protested / appealed by the auditee. This is done after the California Department of Tax and Fee Administration issues the Notice of Determination.
- A protest / appeal must be done within 30 days of the Notice of Determination (NOD) issuance.
- If you miss the 30 days, you may have an additional 30 days to file in administrative or judicial court to challenge the audit findings.
- If both periods are missed, the assessment becomes final and it is very difficult to reopen the audit.
If you have received a Notice of Determination and have not at least talked to someone experienced in California State and Local tax, now is the time before these deadlines are missed.
Appeals Bureau Decision
If you cannot resolve the California sales and use tax dispute through the protest / appeal process, the California Department of Tax and Fee Administration will issue an Appeals Bureau Decision. The Appeals Bureau Decision gives you the opportunity to re-protest the assessment within the administration or file in California’s tax / administrative court, which is called the California Office of Tax Appeals. There are important deadlines, such as 30 days to re-protest or 30 days to file in administrative court.
Settling a California Sales Tax Liability
Along the way, or even after one the critical notices are issued, there is the possibility to settle your California sales tax case by negotiating with CDTFA. Often, you can get better results here than with the auditor. If you or your professional seldom does state and local tax work, it might be difficult to evaluate fair versus unreasonable settlements. DO NOT try to negotiate a settlement without an experienced California state and local tax lawyer or other professional.
Contest a California Jeopardy Assessment
California may issue a Notice of Jeopardy Determination in certain situations. The jeopardy assessment gives CDTFA accelerated rights and it may immediately begin to try and collect. Due to the jeopardy nature, the taxpayer only has a short period of time to contest the assessment and must place a security deposit to fight the issue.
California Administrative Court
If you cannot get your audit resolved within the agency or your deadlines have been missed, you still have one last shot to fight your California sales tax assessment by going to California Office of Tax Appeals. Likewise, and generally not recommended, along the way you always have the option to skip the agency protest and file in administrative court. That said, because neither party wants to spend the time and resources on the uncertainty of administrative court, continuing to challenge the assessment is often an effective way to maximize your settlement potential.
If your case is filed in administrative court, and the case proceeds to hearing, it is heard and decided by a neutral panel of administrative law judges. Our team has handled hundreds of administrative court cases and can help your company receive the resolution it is entitled to. It is very similar to a court hearing and having an experienced representative is imperative.
Other California Sales Tax Resources
Q:What triggers a tax audit?
A:You inadvertently waived a red flag or your company landed in the small percentage selected for a random sales tax audit. These red flags include: Cash-based businesses, prior audits that resulted in owed sales tax, your sales reported to the state didn’t match what you reported to the IRS, a high volume of exempt sales, filing a refund claim, or a high number of credits. There’s also a possibility that your business happens to be in an industry that your state suspects rampant under-reporting. Often times, they will target industries effected by complex sales tax laws.
Q:How do I prepare for a sales tax audit?
A:1. RESPOND to the notice; 2. Get organized; 3. Identify/hire your audit manager; 4. Notify your auditor of who they will be corresponding with; 5. Compare your sales tax returns against the federal tax return; 6. Test at least 1 month of exempt sales; 7. Reconcile your sales tax payable account versus your sales tax payments; 8. Review your fixed assets purchased — did you pay sales tax on them?; 9. Review your purchases on your key expense accounts to ensure tax was paid on your purchases.
Q:How long do sales tax audits last?
A:Audit duration can vary dramatically from state to state and from business to business. Waiver issues aside, an audit generally takes 3-7 months to complete. Surprisingly, some audits can drag on for a few years. Time factors usually swing on the size of the company, the ability to produce reliable and organized documentation, and the level of sophistication of the business.
Q:Can I do this myself or should I hire a sales tax lawyer or a sales tax consultant?
A:We all enjoy the occasional DIY project, especially when it saves us money. Before opting to go that route, consider the risk vs. rewards involved. Avalara recently conducted a study and found that the average sales tax audit costs around $115,000. When facing a sales tax audit, it is beneficial to have someone with knowledge of the financial implications on your side. That is where sales tax professionals, such as those at Sales Tax Helper LLC, can save you a lot of heartache and money by avoiding a few missteps.
Q:What accounting software and services do you work with?
A:TaxJar, Vertex O Series, Avalara, Vertex Cloud, Quickbooks, Proconnect Tax Online, Canopy, ONESOURCE, Sovo Intelligent Compliance Cloud, Intuit Lacerte, CCH SureTax, SS&C Advent Axys, Vertex Payroll Tax Q Series, Bloomberg Tax Advantage, VATBox, CSC Corptax Compliant, Oracle Tax Reporting Cloud, TaxCloud, Fast Enterprises, GenTax, Fast Enterprises FastUI, SAP Tax Compliance, Taxify, and ESKORT Compliance Solution.