CDTFA Audit Engagement Letter: What the First Letter Means and What to Do Before the Appointment

What the CDTFA audit engagement letter is and why you received it

The engagement letter is the CDTFA’s written confirmation that your seller’s permit account has been selected for audit, and by the time it arrives the auditor has already compared your returns to your federal income tax figures and your card totals. Regulation 1698.5 describes the sequence: contact to schedule, this letter to confirm, and a list of the audit period and the records wanted. Accounts get picked on a routine cycle, for a gap between federal gross receipts and reported sales, for exempt sales out of line with the industry, or because a customer’s audit turned up a resale certificate with your name on it. Cash businesses, contractors and anyone who sells for resale see more of these letters than most, and the letter usually comes with Publication 76, Audits.

The deadline on the engagement letter and what happens if nothing is done

The only date on the engagement letter is the appointment, and missing it costs nothing by itself, but ignoring the audit ends in a Notice of Determination built from the CDTFA’s numbers rather than yours. The appointment can be moved for a real reason. Silence is different: section 7054 of the Revenue and Taxation Code lets the CDTFA examine your books and section 6481 lets it compute what you owe from any information it has, so an auditor who hears nothing proceeds on federal return figures, Form 1099-K totals, bank records and an industry markup. The result is an NOD with a 30-day petition window under section 6561, usually carrying a 10 percent negligence penalty under section 6484. Under section 6487 the CDTFA has three years to issue a determination for each quarter, eight years where no return was filed, and no limit where fraud is found. When fieldwork runs long the auditor asks you to sign a Waiver of Limitation under section 6488 to keep the oldest quarters open, the first real decision in the audit.

What to do in the first 30 days

The first 30 days are for putting a representative in front of the auditor, reading your returns the way the auditor will, and producing the records for the audit period and nothing more. In order:

1. Write down the audit period, the appointment date and the auditor’s name; everything else on the letter is a list.
2. Decide who speaks for you, and if that is a lawyer or an accountant, file the CDTFA power of attorney, form CDTFA-392.
3. Set the sales tax returns next to the federal returns, because the gap between federal gross receipts and reported sales is the first thing the auditor computes.
4. Gather the records on the list for the audit period only, organized by quarter, and note what is missing before the auditor does.
5. Check the resale certificates: every sale reported as a sale for resale needs a certificate on file, taken in good faith, with the customer’s permit number on it.
6. Move the appointment if you need the time, then hold the opening conference with your representative present and let the records do the talking.

Your options once the audit begins

Three ways to run a CDTFA audit, two ways to end one, and the choice usually gets made in the first month whether or not anyone makes it on purpose.

• Handle it yourself, or with your accountant. A sole proprietor with a short audit period, complete records and no sales for resale can sit with the auditor; the risk is what you say, and an accountant in the chair does not carry a lawyer’s privilege.
• Hire counsel for the audit. The auditor deals with the lawyer, records go out under a cover letter, the sampling plan is negotiated rather than accepted, and the waiver is signed on terms or not at all.
• Ask for a managed audit. Under section 7076 of the Revenue and Taxation Code a business with good records can do the fieldwork itself under the auditor’s instructions, and interest on any liability is cut in half.
• Agree with the findings. If the exit conference shows a real error, agreeing early saves interest and often the negligence penalty argument; you can agree to some items and contest others.
• Contest them. The NOD carries a 30-day petition for redetermination under section 6561, then an appeals conference, then the Office of Tax Appeals (OTA), and payment is not required while a timely petition is pending, though interest runs.

What Brotman Law does with a CDTFA engagement letter

For an engagement letter our first thirty days go to taking over the contact with the auditor, running the auditor’s tests on your books before the auditor does, and setting the ground rules for records and sampling in writing. The power of attorney goes in the first week, and from then on the auditor talks to us. We pull every return in the period, the federal returns and the bank statements, and run the auditor’s reconciliation first: federal gross receipts against reported sales, card deposits against taxable sales, purchases marked up against recorded sales, and use tax on out-of-state purchases. Where the numbers do not tie we find out why first, because a difference with a reason is a schedule and a difference without one is a deficiency. We index the production by quarter, sit in the opening conference, and negotiate the sample periods before a single transaction is tested. We have represented 400+ clients in audits, and the first month is where most of the outcome gets set.

Do you need a lawyer for a CDTFA engagement letter?

Not always, and the honest test is the length of the audit period, whether you sell for resale or in cash, whether an owner could be reached personally, and how far apart the federal and sales tax returns are. A sole proprietor with a one-year audit, a small-dollar question, complete records and retail sales only can often send the accountant, and we would rather say so on the free 15-minute call than sell you work you do not need.

It is a lawyer matter when the audit period runs more than a year, when sales for resale or cash sales are a meaningful part of the business, or when an owner or officer could be held personally liable under section 6829 of the Revenue and Taxation Code once the business stops operating with sales tax unpaid, and on the day it arrives if the books have a problem you already know about.

How the monthly flat fee works for a CDTFA engagement letter

Many matters like this one run as a monthly flat-fee engagement: one number, agreed up front, that covers agency contact, deadlines, document responses and strategy until the matter resolves. It does not include the bookkeeping itself, an appeal to the Office of Tax Appeals or a separate income tax audit set off by the sales tax findings, each quoted on its own. The engagement ends when the audit closes with no change, when a Notice of Determination is paid or settled, or when you tell us to stop, and the fee stops with it.

Documents to gather

Seven sets of records answer nearly every question an engagement letter raises.

• The engagement letter itself, with the records list.
• The sales and use tax returns for every quarter in the audit period, with the worksheets behind them.
• The federal income tax returns for the same years, whether a Schedule C, a Form 1120 or a Form 1065.
• The general ledger, sales journal and purchase journal, exported from the accounting system.
• Bank statements for every business account, the card statements and the Form 1099-K for each year.
• Point-of-sale reports: the daily closing reports and any export the system can produce.
• Resale certificates and exemption documents for every nontaxable sale, and purchase invoices for anything bought out of state.

How far back does a CDTFA audit go?

Three years as a rule, or twelve quarters. Under section 6487 of the Revenue and Taxation Code the CDTFA has three years from the end of the month following each quarter, or from the filing of the return if later, to issue a determination, eight years where no return was filed, and no limit where fraud is found.

Should I sign the CDTFA waiver of limitation?

Usually yes, on limited terms, because refusing does not end the audit; it prompts an estimated Notice of Determination for the expiring quarters. The waiver under section 6488 can be limited to the quarters about to expire and to a fixed date, and a narrow one is usually the right call.

Do I have to meet with the CDTFA auditor myself?

No, because once a power of attorney is on file the auditor works with your representative, and the owner attends only the parts of the opening conference that need the owner. The auditor may still want to see the premises of a cash business and ask questions only the owner can answer, with counsel in the room.

What is the CDTFA auditor actually looking for?

Four things: sales recorded but not reported, exempt sales without the paper to support them, use tax on purchases, and, for a cash business, whether the recorded sales are believable at all. The tests are federal gross receipts against reported sales, card deposits against taxable sales, the resale certificates, untaxed purchases of equipment, and a markup analysis that projects sales from the cost of goods sold.

Can my bookkeeper handle the CDTFA audit?

A bookkeeper can produce the records and should not be the voice of the business in the audit. Nothing your bookkeeper tells the auditor is privileged, and a bookkeeper explaining why the books look the way they do is the most common way a records question turns into a negligence penalty.

How long does a CDTFA sales tax audit take?

Months, and often more than a year from the engagement letter to the Notice of Determination. The length depends on the business, the records and whether a sample is used, and fieldwork is not the end: the exit conference, the supervisor’s review and the notice itself follow.

Related pages

The other steps in a CDTFA sales tax audit, and two guide chapters.

• CDTFA audit attorney, the parent page
• The CDTFA records request
• CDTFA audit findings and the exit conference
• CDTFA Notice of Determination
• CDTFA responsible person liability
• CDTFA collections
• Should I hire a California sales tax lawyer for my sales tax audit?
• What triggers a sales tax audit in California?
• CDTFA seller’s permit revocation