California Sales Tax Audits Step by Step: What to Expect from the CDTFA

Marc Boulanger • July 1, 2025

If you're a California business owner and you’ve received a letter from the California Department of Tax and Fee Administration (CDTFA), don’t panic — but don’t ignore it either. A CDTFA sales tax audit can disrupt your operations, strain your finances, and put you at risk for penalties or even business closure if mishandled.

In this guide, we'll walk through the step-by-step CDTFA audit process, explain what happens at each stage, and show you how a qualified CPA can help you reduce exposure and defend your business.

Step 1: Audit Notification Letter

Most sales tax audits begin with a written letter from the CDTFA stating that your business has been selected for audit. This will include:

The period being audited (usually 3 years)
The auditor's contact information
A request to schedule an initial appointment
A general list of records you’ll be expected to provide

This is your opportunity to get representation in place before speaking to the auditor.

Step 2: Opening Conference

At the opening conference, the auditor will explain the scope and nature of the audit. They’ll typically ask questions such as:

What type of business do you run?
How do you track sales?
Do you make exempt sales?
What point-of-sale (POS) system do you use?
Do you sell online or out-of-state?

Your answers can shape the direction and depth of the audit — and if you’re unprepared or inconsistent, the audit may expand.

Step 3: Initial Records Review

The CDTFA will request a wide range of records, including:

Sales journals or POS system reports
Purchase invoices
Federal and California income tax returns
General ledger or QuickBooks data
Bank and credit card statements
Sales tax returns (Form BOE-401)
Resale certificates for exempt transactions

Missing or disorganized records are one of the top reasons audits go badly. If your records don’t match your reported numbers, the CDTFA may estimate your sales using industry markup formulas.

Step 4: Audit Testing & Estimation Methods

Auditors will use one or more testing methods to validate your reported sales:

Observation tests (in-person review of operations)
Mark-up analysis (cost of goods sold vs. reported revenue)
Bank deposit analysis (to uncover underreported cash income)
Purchase ratio analysis (compare taxable vs. non-taxable sales)
Statistical sampling (when the audit period is too large)

If any method shows discrepancies, the auditor may apply that percentage to the entire audit period — often leading to tens of thousands in additional tax assessments.

Step 5: Preliminary Findings

Once testing is complete, the auditor will issue preliminary audit findings. This may include:

Total unreported taxable sales
Rejected documentation
Estimated taxes owed
Proposed penalties
Accrued interest

You’ll have a brief window to challenge these findings or provide clarifying documentation before the audit is finalized.

Step 6: Notice of Determination

If you don’t dispute the preliminary findings, the CDTFA will issue a Notice of Determination (NOD) — the formal billing notice.

This becomes your official tax bill and starts the 30-day deadline for appeal.

The NOD includes:

Total tax owed
Penalties (10%–25% typically)
Interest
Final date to file a petition

Step 7: Petition for Redetermination (Optional but Critical)

If you disagree with the NOD, you can file a Petition for Redetermination. This must be done within 30 days or the liability becomes final and enforceable.

The petition can lead to: