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 BOE sales and use tax audit can lead to income tax audit

Most tax preparers and their clients understand that changes made by the IRS during a federal income tax examination typically affect the client's corresponding California income tax return. However, it is less widely known that the same principle may apply to audit adjustments made to sales and use tax returns. Often, the California Board of Equalization's (BOE) adjustments to sales and use tax returns has a direct impact on both gross receipts and business expenses on the income tax return.

The BOE provides us with copies of sales and use tax audit reports for the audits that result in adjustments of additional gross receipts (total sales) (BOE Audit Manual, Section 0206.40). We review these sales and use tax reports to determine if an income tax adjustment is warranted, then advise the taxpayer in writing before making the appropriate adjustments. We have found that the most common income tax items affected by a sales and use tax audit are total sales (gross receipts) and cost of goods sold.

What actions should you take at the conclusion of a sales and use tax examination?

Review the audit report at the conclusion of a sales and use tax examination, to determine if any changes were made to reported sales (total sales and/or taxable sales). In situations where total sales were adjusted, review the corresponding income tax return to determine if an adjustment is needed. If you find the changes made by the BOE result in a change in California income tax liability for the corresponding tax years, your client should file an amended income tax return.