California Board of Equalization Audits

The B.O.E. audits large businesses every two to three years and smaller businesses intermittently. Their staff is huge and audits can take months. The numbers are also huge with an eight to ten percent tally on all taxable sales [and that has been growing huge as well]. These people are very efficient with their little laptop computers and calculators in their briefcase. The BOE library is also huge and they have booklets for your little business about audit parameters and applications for most types of business. Most of their auditors are young, with good educational credentials, and are putting in their time to get five years auditing experience. Like the I.R.S. auditors, it qualifies them for the audit experience for the CPA exam without working for slave wages in the CPA back rooms, but unlike the I.R.S it does not give them the Enrolled Agent status. They have very high turnover and accordingly the newer auditors get the smaller businesses.

Sales tax is like a cancer, it grows deeper and wider all by itself. Sales tax now covers newspapers, all kinds of food items, restaurant food and drink, shipping and handling charges on your mail order, the coupon value at Costco, gasoline, and a huge percentage of everything we spend money for. Accordingly, there is an army of people anxious to collect it to feed the big brown Kodiak, not the little black bear, which is on the California flag.

The auditors do thousands of audits each year and have accumulated reams of statistics which tell them what your markup should be in a pizza restaurant, or what your markup should be for a grocery store. They used to do shelf tests of markup when they visited your business to determine your markup and then compare it to sales and purchases to find the missing sales. Now they are more sophisticated and go to their computer to look up what you should be selling and costing.

Terrifying Horror Story Where we Performed Tax Appeals.

A recent audit of a large restaurant exposed new tests and challenges. After introducing himself, the old-timer experienced auditor made an appointment to meet with the owner in the morning when he opened the doors. Then, like a new wife, he stood by the cash register all day long to record EACH SALE and log in the credit card sales VS the cash sales. Afterward he applied the percentages to the past two-year’s sales and found much of the cash sales were missing. Later on he applied a percentage mark-up for the purchases versus the sales to see what else was missing. The next month the client received a huge bill for almost a hundred grand. We fought the mark-up percentage on the basis this was a depression era for restaurants and that his sale price over the door had become his regular price. We took a whole day off and costed the whole menu item by item to show their cost figures were too low, we explained that the day they stood by the register there were many little league kids there and they used coupons and discounts. All to no avail.

We did several tax appeals and met with their people at the conference table in Riverside. After arguing for an hour they agreed to reconsider. The reconsideration resulted in the auditor standing by the cash register for another day. The percentage of cash sales missing was even higher than before. But they dropped their mark-up percentage and we got new audit results of half the original figure.

The client confessed that he had been hiring people drawing unemployment and welfare and paying them in cash. I advised that he could lose his resale permit if he continued the practice of hiding sales to pay the help. He changed his ways afterward. Meanwhile, the whole audit process took over a year from start to finish. He was tired of the business and more tired of the Great Recession so he retired and sold the business. There was another audit following because now they wanted to also see if there were assets sold that could be taxed. The audit was very short and not as nearly bad as before. They waived some penalties because the client had reformed at the second-half of the two-year audit period. He had sold the stock of his corporation per my advice to avoid paying sales tax on sale of assets.

Happy ending? No way. The B.O.E. sent a copy of their findings to the IRS and client received a corporate audit from them. Because he had a Net Operating Loss from the prior year he was cleared. No F.T.B. audit [yet] and no subsequent I.R.S. audit on the later audit [yet].

Happy Ending Audit. Once upon a time I had a recent new client who didn’t hide his earnings. His business was audited by the B.O.E. and even though he kept his own records and filed his own tax returns, he came out clean. The audit of the tiny business still took about three months with tons of correspondence back and forth. A happy camper indeed for this honest person who works seven days a week out of his garage.

Almost all businesses hide some income but if it includes taxable sales the owners are also hiding sales tax collected from clients. That makes the audit results higher and the penalties and interest larger. It is a contest that has continued all the way back from the dawn of Civilization.

Another Tragic Horror Story. A new client had bought a corporate business which manufactured construction materials. He continued making and selling the products as the prior owner had. Now, this business was purchased with a stock sale, not equipment and good will outside the corporation, so he was on the hook for any prior corporate misdeeds. Sure enough, there was a sales tax audit shortly afterward and there was a big problem. To avoid charging sales tax on house sales the B.O.E. charges sales tax on the construction materials the contractor or manufacturer uses. The prior owner had paid no sales tax on purchases for years [ever]. The new corporate owner got a bill for over six figures. There was no way out. He went through Hell for years paying it off and trying heroically to stay in business. That was twenty years ago and he is still one of our clients.

So, the general rule is that hiding sales or income is a risky business, especially if there is sales tax involved.

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sale tax audit