Sales Tax Audits & Disputes (CDTFA)

What Is a CDTFA Audit?

The California Department of Tax and Fee Administration administers sales and use tax in California, along with excise taxes on cannabis, fuel, tobacco, and alcohol. When a business sells taxable goods or services, it’s required to collect sales tax from customers and remit it to the state. A CDTFA audit is the agency’s process for verifying that what a business reported on its returns matches what its financial records actually show.

Auditors compare sales tax filings against bank statements, merchant account activity, income tax returns, and general ledger data. When those sources don’t line up, the auditor draws conclusions about the difference. If exemptions were claimed, for resale, for out-of-state sales, for manufacturing inputs, the documentation supporting those exemptions will be reviewed carefully.

CDTFA is also a regular source of cross-referrals. An IRS audit, an EDD audit, or a business sale can each surface information that prompts the agency to take a closer look at your sales tax compliance. For more on how California sales tax and use tax differ and where each creates audit exposure, see our detailed breakdown.

What Types of Businesses Does CDTFA Audit Most Often?

CDTFA audits reach businesses across virtually every industry, but certain sectors draw more consistent attention. The common thread is documentation complexity, businesses with high transaction volume, mixed taxable and non-taxable sales, significant exempt transactions, or cash-heavy operations face more scrutiny because there’s more surface area for discrepancies to appear.

Industries that show up most frequently include:

• Retail and e-commerce, particularly businesses with multi-location operations, online sales into California, or sales of both taxable and non-taxable goods
• Restaurants and food service, where the taxability of food, beverages, catering, and service charges creates recurring audit issues. How gratuities and mandatory service charges are handled is a specific area of focus. Restaurants where the distinction between tips and gratuities has not been applied correctly can face substantial assessments, read more about how CDTFA approaches restaurant sales tax audits
• Construction and contracting, where the line between taxable materials and non-taxable labor affects how each job is reported, and where subcontractor relationships and equipment use tax create additional complexity
• Automotive dealers and service providers, where parts, labor, and vehicle sales each carry different tax treatment
• Cannabis businesses, which operate under overlapping state tax obligations and face some of the most intensive CDTFA scrutiny of any industry
• Manufacturers and distributors, particularly those claiming manufacturing exemptions or handling significant volumes of exempt resale transactions

If your business operates in any of these industries and has received an audit notice, the review is unlikely to be routine.

What Triggers a CDTFA Sales Tax Audit in California?

CDTFA audits are rarely random. They are typically initiated by something specific, a discrepancy in your filings, a referral from another agency, activity associated with a business transaction, or a complaint.

The most common triggers we see include:

Discrepancies between filings. CDTFA compares your sales tax returns against your income tax filings, bank deposits, and merchant account data. When reported gross revenue doesn’t reconcile across those sources, it flags the account for review. Even differences that have innocent explanations, intercompany transfers, timing issues, non-taxable revenue grouped incorrectly, can initiate an audit if they’re not documented.

High volumes of exempt or non-taxable sales. Every business in your industry reports roughly similar ratios of taxable to exempt sales. When your exempt sales ratio is meaningfully higher than industry norms, CDTFA pays attention. Documentation for those exemptions, resale certificates, out-of-state shipping records, manufacturing exemption documentation, will be the first thing an auditor requests.

Cross-agency referrals. The IRS, EDD, FTB, and CDTFA share data regularly. An IRS audit that identifies unreported income, or an EDD audit that surfaces payroll discrepancies, can each generate a referral that prompts CDTFA to review the same business.

Business sales and escrow activity. When a California business is sold, buyers routinely request a CDTFA tax clearance certificate. That request alone can trigger a review of the business’s sales tax history. Owners who haven’t done a pre-sale audit of their own records sometimes discover exposure through this process at exactly the wrong time.

Anonymous tips and competitor complaints. CDTFA accepts anonymous reports. Disgruntled former employees, competitors, and business partners have all been sources of audit referrals.

For a comprehensive breakdown of what triggers CDTFA audits and how the process begins, see What Triggers a California CDTFA Sales Tax Audit?

What Happens During a CDTFA Audit?

A CDTFA audit follows a defined sequence. Understanding each stage helps businesses respond strategically rather than reactively.

The audit notice. The process begins with a Notice of Audit Commencement identifying the audit period, typically the prior three fiscal years, along with a request for an opening meeting and an initial list of documents.

The opening meeting. The auditor schedules a meeting, in person or virtually, to understand how your business operates. This conversation shapes how your records will be interpreted before a single document has been reviewed. How clearly and accurately you explain your operations, and how consistently that explanation matches your documentation, sets the foundation for everything that follows. This is the stage where many businesses benefit most from having representation in the room. For a detailed walkthrough of what to expect, see Received an Audit Notice? How to Respond Without Making It Worse.

Records review. The auditor requests specific financial documentation, sales tax returns, general ledger, bank statements, income tax returns, merchant account reports, resale certificates, and purchase records. These sources are cross-referenced against each other. Discrepancies between them become the basis for questions and, often, proposed adjustments.

Statistical sampling. For businesses with high transaction volume, CDTFA auditors frequently use statistical sampling rather than reviewing every transaction. They select a representative sample period, typically a few months, and apply the error rate they find across the full audit window. A relatively small error rate in the sample period, multiplied across three years of sales, can produce a substantially larger proposed liability than the actual discrepancy warrants. The sample period matters: if it captured an unusual month, a one-time event, or a period that isn’t representative of how your business normally operates, the extrapolated result can be challenged. This is one of the most consequential stages of a CDTFA audit and one of the areas where professional representation produces the most consistent results.

Preliminary findings and proposed assessment. Once the records review is complete, the auditor issues preliminary findings and an opportunity to respond. Providing documentation that explains identified differences, with clear context, not just additional records, can result in significant reductions at this stage before any formal liability is established.

Notice of Determination. If the audit results in a liability finding, CDTFA issues a Notice of Determination stating the amount owed in tax, penalties, and interest. This notice also starts the 30-day clock to file a petition for redetermination. Missing that deadline finalizes the assessment and limits the options available to contest it.

How Far Back Can CDTFA Audit Your Business?

The standard CDTFA audit period covers three years of filed returns. In most routine audits, that’s the window an auditor will review.

The lookback period can extend to eight years in cases involving fraud, willful non-filing, or substantial underreporting. If returns were not filed at all for certain periods, those years may also be included in the review regardless of how far back they go.

One area that frequently surprises businesses: even a closed business remains subject to CDTFA audit if the state has reason to believe outstanding liabilities exist. Closing a business does not extinguish the state’s right to assess and collect unpaid sales tax.

What Is a CDTFA Notice of Determination?

A Notice of Determination is the formal document CDTFA issues when an audit results in a finding of unpaid taxes or fees. It states the tax amount owed, the penalties assessed, and the interest accrued from the original due date.

The 30-day window that follows the Notice of Determination is critical. Filing a petition for redetermination within that period keeps the case open and moves it into the appeal process. If the deadline passes without action, the assessment becomes final, collection activity begins, and the avenues available to contest the liability become significantly more limited.

A 10% negligence penalty is standard in most CDTFA audits. In cases where the agency determines that underreporting was intentional, penalty rates are higher. Interest accrues on the unpaid tax from when it was originally due, not from when the notice was issued, which means multi-year audits can carry substantial interest in addition to the base tax assessment.

Can You Appeal a CDTFA Assessment?

Yes. Filing a petition for redetermination within 30 days of the Notice of Determination initiates the formal appeal process. The petition should identify specifically where the auditor’s findings are incorrect and provide documentation to support that position. A clearly organized submission, one that makes the reviewer’s job straightforward, moves more effectively through the process than a general statement of disagreement.

After the petition is filed, CDTFA reviews the submission and responds. In some cases, adjustments are made at this stage. If the matter is not resolved, it proceeds to a hearing before the Office of Tax Appeals (OTA), which operates independently from CDTFA and reviews cases on their merits.

The full timeline for a contested CDTFA case, from audit through OTA decision, can span two to four years depending on complexity. That timeline, and what happens at each stage within it, is something we help clients navigate with a clear understanding of where they stand and what their options are.

How Milikowsky Tax Law Handles CDTFA Audit Defense

We represent California businesses in CDTFA sales tax audits, use tax disputes, excise tax reviews, and appeals. Our clients range from small retail operators to multi-location businesses with complex transaction histories. What most of them have in common is that they came to us after something specific happened, an audit notice, a proposed assessment, a notice of determination with a 30-day clock running.

In our experience, the cases where outcomes differ most significantly with professional involvement tend to center on a few recurring issues: a statistical sampling methodology that selected an unrepresentative period; resale certificates that were missing or improperly documented and got reclassified as taxable; a preliminary report that contained a calculation error that carried through to the assessment; or a petition that was filed without adequate supporting documentation.

None of those situations require litigation to address. They require knowing what to look for and how to present a response that gives an auditor or appeals reviewer what they need to make an adjustment.

Our process starts with understanding your business, how revenue flows, how transactions are recorded, where your exempt sales come from, and how your documentation is organized. From there, we analyze the auditor’s approach, identify where it can be challenged, and build a response that addresses the specific findings rather than the audit in general.

If you’ve received a CDTFA notice at any stage, initial audit, preliminary findings, Notice of Determination, or beyond, contact us to discuss where things stand.