Sales Tax Criminal Investigation

A criminal sales tax case in California typically arises when an individual or business intentionally evades or fraudulently handles sales and use tax obligations, violating laws administered by the California Department of Tax and Fee Administration (CDTFA). These tax cases are serious and should be handled by a tax attorney with significant sales tax experience.

1. Background on CDTFA Sales Tax in California

Sales tax in California is imposed on retailers for the privilege of selling tangible personal property at retail, calculated as a percentage of the sales price (currently 7.25% statewide, with additional local taxes increasing rates up to 10.25% in some areas). Retailers are responsible for collecting sales tax from customers and remitting it to the CDTFA. Use tax applies to goods purchased out-of-state for use in California when sales tax isn’t collected by the seller. Failure to comply with these obligations, especially with intent to deceive, can lead to criminal tax charges.

2. Triggers for a Sales Tax Audit

The process of a criminal tax case often begins with a routine sales tax audit conducted by the CDTFA, which oversees sales and use tax compliance. Sales Tax Audits are a primary mechanism for identifying discrepancies that may suggest tax evasion or fraud. Several factors can trigger an audit:

• Random Selection: Many businesses are audited simply because it’s their turn, as the CDTFA systematically reviews retailers to ensure compliance. Most California businesses can expect at least one audit over time.
• Red Flags in Tax Filings: Late or incomplete sales tax returns, significant underreporting of sales, or discrepancies between reported sales and bank deposits can raise suspicion. For example, a used car dealer who reported only $6.8 million of $1.8 million in sales triggered an audit that led to a criminal case.
• Industry-Specific Risks: Certain industries, such as restaurants, bars, convenience stores, or cash-intensive businesses like used car dealerships, are more likely to be audited due to the potential for unreported cash sales.
• Third-Party Tips: The CDTFA’s Investigations Bureau may receive reports of suspected tax evasion through its Tax Evasion Hotline (1-888-334-3300) or from whistleblowers, competitors, or disgruntled employees.
• Discrepancies in Records: Auditors compare sales tax returns with other records, such as federal income tax returns, bank deposits, or point-of-sale system data. Significant unexplained differences can prompt further scrutiny.
• Prior Non-Compliance: Businesses with a history of late payments, failure to file returns, or prior penalties are more likely to be flagged.

During an audit, CDTFA tax auditors request documentation like receipts, invoices, register tapes, and ledgers. They may use techniques like markup audits (estimating sales based on cost of goods sold) or undercover “pour tests” at bars to verify reported sales. If auditors detect minor errors, they may assess civil penalties (e.g., 10% for late filing or 25% for negligence). However, evidence of intentional misconduct escalates the matter to a serious criminal sales tax matter. Criminal tax attorneys are usually hired at the beginning of the audit to assess exposure to criminal charges.

3. Indicators of Potential Criminal Activity

For a tax audit to transition into a criminal investigation, auditors must find evidence of intentional tax evasion or fraud, as opposed to negligence or honest mistakes. Key indicators include:

• Falsified Records: Maintaining multiple sets of books or altering records to underreport sales.
• Substantial Discrepancies: Large, unexplained gaps between recorded sales and reported tax, especially if the deficiency is significant relative to reported amounts.
• Skimming Cash Sales: Underreporting cash transactions or using software to manipulate point-of-sale data, a practice auditors are trained to detect by comparing sales to cost-of-goods-sold metrics.
• Willful Disregard: Ignoring specific tax advice or failing to comply with known legal requirements, such as collecting sales tax but not remitting it.
• Misuse of Certificates: Using resale certificates to evade taxes on goods used personally rather than for resale, which is a misdemeanor under Revenue and Taxation Code Section 7153.
• Failure to File Returns: Intentionally not filing sales tax returns, especially over multiple periods, which extends the audit look-back period from three to eight years.
• Knowledge of Obligations: Evidence that the taxpayer held permits or licenses in prior periods, indicating awareness of tax requirements, yet failed to comply.

The CDTFA must establish intent to evade taxes through “clear and convincing evidence” for civil fraud penalties, but criminal cases require a higher standard of proof (“beyond a reasonable doubt”). Intent is often inferred from circumstantial evidence, as direct proof is rare. Defense strategy by a tax lawyer must focus on the “intent” and “willfulness” of the potential tax fraud or criminal tax defendant.

4. Escalation to Criminal Investigation

If auditors suspect intentional tax evasion, they refer the case to the CDTFA’s Investigations Bureau, which specializes in identifying and investigating tax evasion and fraud. This marks the shift from a civil to a potential criminal matter. The Investigations Bureau employs sworn peace officers and non-sworn analysts who:

• Conduct In-Depth Investigations: Special agents may interview witnesses, execute search warrants, seize records (e.g., tax returns, ledgers, or financial statements), and analyze bank records to uncover unreported income or hidden assets.
• Collaborate with Other Agencies: If unreported sales suggest broader financial crimes (e.g., money laundering or income tax evasion), the CDTFA may refer findings to the California Franchise Tax Board (FTB) or the IRS Criminal Investigation Division. For instance, unreported cash sales could trigger an FTB income tax audit or federal charges.
• Focus on Intent: Investigators assess whether the taxpayer knowingly underreported sales, failed to remit collected taxes, or falsified documents with the intent to defraud. Questions like “Did the taxpayer intentionally underreport sales?” or “Was the failure to file returns deliberate?” guide the investigation.

5. Referral to Prosecutors

If the CDTFA Tax Investigations Bureau finds sufficient evidence of criminal activity, the case is referred to a state prosecutor, typically the California Attorney General’s Office or a local district attorney’s office. The prosecutor evaluates whether to file charges based on:

• Strength of Evidence: Proof that the defendant knowingly and deliberately evaded taxes, often supported by falsified records, witness testimony, or financial discrepancies.
• Severity of Offense: Cases involving large tax liabilities (e.g., over $25,000 in a one-year period) are more likely to be prosecuted as felonies rather than misdemeanors.
• Public Impact: Prosecutors prioritize cases where tax evasion significantly deprives the state of revenue.

Common charges include violations of California Revenue and Taxation Code Sections 7153 (misdemeanor sales tax evasion), 7153.5 (felony evasion for liabilities over $25,000), or 19706 (willful tax evasion). Prosecutors must prove beyond a reasonable doubt that the defendant had a legal duty to collect/remit taxes and intentionally failed to do so.

6. Potential Criminal Charges and Penalties

Once charges are filed, the case enters the criminal justice system. Possible charges and penalties include:

• Misdemeanor Sales Tax Evasion (Rev. & Tax. Code § 7153): Punishable by up to one year in county jail and fines up to $5,000. Applies to smaller-scale evasion or misuse of resale certificates.
• Felony Sales Tax Evasion (Rev. & Tax. Code § 7153.5): For tax liabilities exceeding $25,000 in a one-year period, punishable by up to three years in state prison and fines up to $20,000 for individuals or $500,000 for businesses plus any taxes which were not paid.
• Criminal Tax Fraud: Involves falsifying returns or hiding income, with penalties including up to five years in prison and fines up to $250,000 for individuals or $500,000 for businesses plus actual tax loss.
• Civil Penalties: In addition to criminal penalties, the CDTFA may impose civil penalties (e.g., 25% for fraud, 50% for evading taxes on vehicles/vessels/aircraft, or 40% for failing to remit collected taxes). Interest accrues on unpaid amounts.

Defendants may also face restitution orders to repay the evaded taxes, as the CDTFA can collect court-ordered restitution like delinquent tax liabilities.

7. Tax Defenses and Legal Considerations

Taxpayers facing a criminal sales tax investigation can mount defenses, often with the help of an experienced tax attorney. Common defenses include:

• Lack of Intent: Arguing that discrepancies resulted from negligence or honest mistakes, not deliberate fraud. For example, a defendant might claim a bookkeeping error or reliance on faulty advice.
• Mistaken Identity: In corporate cases, claiming someone else in the organization was responsible for the fraudulent filings.
• Statute of Limitations: The statute of limitations for tax evasion is typically three years from the date the return was due or filed, though it’s eight years for non-filers or cases involving fraud. If charges are filed beyond this period, the case may be dismissed.
• Negotiating Settlements: Before charges are filed, a tax attorney may negotiate with the CDTFA’s Settlement and Taxpayer Services Bureau to resolve the case through payment of taxes, penalties, and interest, potentially avoiding criminal prosecution.

Early tax lawyer’s involvement is critical, as statements made to investigators can be used against the taxpayer. Attorneys can also challenge audit findings, file petitions for redetermination, or seek relief through the Office of Tax Appeals.

8. Preventing Criminal Escalation

Businesses can reduce the risk of a criminal sales tax case by:

• Maintaining Accurate Records: Keep detailed sales records, receipts, and tax worksheets to substantiate filings.
• Timely Filing and Payment: Submit returns and remit taxes according to the CDTFA’s schedule (monthly, quarterly, or annually).
• Consulting Professionals: Work with accountants or tax attorneys to ensure compliance, especially in complex or cash-intensive businesses.
• Responding to Audits Promptly: Cooperate with auditors and provide requested documentation to avoid suspicion of intentional misconduct.
• Reporting Suspected Errors: If errors are discovered, file amended returns immediately to correct mistakes and avoid penalties for evasion.

A criminal sales tax case in California typically begins with a CDTFA sales tax audit triggered by random selection, red flags in filings, or external tips. If auditors uncover evidence of intentional evasion—such as falsified records, unreported cash sales, or failure to remit collected taxes—the case may escalate to the CDTFA’s Investigations Bureau. Investigators gather evidence to prove intent, and if substantiated, the case is referred to prosecutors for charges like misdemeanor or felony tax evasion. Penalties can include jail time, substantial fines, and restitution, making early legal intervention crucial. Businesses can mitigate risks by maintaining compliance and addressing issues proactively with a sales tax attorney.

Consult a Criminal Tax Attorney

Contact us today at 310-788-9820 to schedule a confidential consultation. Let our experienced sales tax attorneys assess your case, organize your evidence, and represent you through the complexities of a CDTFA Sales tax criminal investigation.