California Use Tax Audits: What Online Sellers Need to Know

Sales Tax and Use Tax

According to CDTFA, sales tax is imposed on retailers and generally applies to their gross receipts from retail sales of tangible personal property in California. Use tax is imposed on consumers: when sales tax does not apply, use tax generally applies to the sales price of property bought from a retailer for storage, use, or other consumption in California.

The statewide rate is 7.25 percent, which includes local taxes under the Bradley-Burns Uniform Sales and Use Tax Law. Voter-approved district taxes make the total rate higher in many areas.

When an Out-of-State Online Seller Must Register

In South Dakota v. Wayfair, Inc. (2018), the U.S. Supreme Court overruled the physical-presence requirement for requiring a remote seller to collect a state’s tax. California then amended Revenue and Taxation Code (R&TC) section 6203. Beginning April 1, 2019, a retailer whose combined sales of tangible personal property for delivery in California, together with those of related persons, exceed $500,000 in the preceding or current calendar year is engaged in business in California and must register with CDTFA and collect use tax.

Physical presence still matters. CDTFA explains that retailers that store inventory in California, including inventory held at a fulfillment center operated by a third party, are generally engaged in business in the state and required to register. CDTFA also explains that a person who sells merchandise in California and makes three or more sales in a 12-month period is generally required to hold a seller’s permit.

Marketplace Sales

Under the Marketplace Facilitator Act, beginning October 1, 2019, a marketplace facilitator that is registered or required to be registered with CDTFA is treated as the seller and retailer for the sales it facilitates and is responsible for the tax on those sales. CDTFA states that a seller whose retail sales are all facilitated by a registered marketplace facilitator is not required to register for a seller’s permit or a Certificate of Registration – Use Tax.

Sellers that also make direct sales, such as through their own website, may still have registration and reporting obligations for those sales.

Inventory Purchases and Resale Certificates

Purchases of merchandise for resale are generally not subject to tax. CDTFA explains that sales for resale should be documented with a valid resale certificate, which must state that the property is purchased “for resale”; phrases such as “nontaxable” or “exempt” are not acceptable.

Use tax becomes an issue for items a business buys for its own use, such as equipment and supplies, when the seller did not collect California tax. CDTFA explains that a business with a seller’s permit reports these amounts as purchases subject to use tax on its sales and use tax return for the period in which the item was first used, stored, or consumed in California.

Businesses Without a Seller’s Permit

A business that is not required to hold a seller’s permit may still need to register as a “qualified purchaser” under R&TC section 6225. CDTFA explains that from January 1, 2024, through December 31, 2028, this generally includes a business that makes more than $10,000 per calendar year in purchases subject to use tax, excluding vehicles, vessels, and aircraft, on which the tax has not otherwise been paid. Qualified purchasers report and pay use tax annually, by April 15 for the prior calendar year.

Records That Matter in an Audit

In a sales and use tax audit, the most important records for an online seller are the ones that show what was sold, where it was delivered, who collected the tax, and what was purchased without tax. That includes sales reports for each channel, marketplace facilitator reports, purchase invoices, and resale certificates.

Penalties and Interest

CDTFA’s Publication 75 describes a 10 percent penalty for filing a return late and a 10 percent penalty for paying late, with the combined penalty for a period generally limited to 10 percent of the tax due. The penalty for failing to file a return is 10 percent of the tax on each bill, and an additional 25 percent applies if the failure to file was due to fraud or intent to evade the tax. Interest is charged monthly on unpaid tax.

When CDTFA issues a bill, it is generally due 30 days from the date it was issued, and an additional 10 percent penalty applies to the unpaid tax unless an appeal is filed by that due date.

Coming Forward Voluntarily

CDTFA’s Out-of-State Voluntary Disclosure Program (R&TC § 6487.05) limits the period for assessing unpaid use tax to three years instead of eight and allows CDTFA to waive late filing or late payment penalties. To qualify, a retailer must be located outside California and not previously registered with CDTFA, be engaged in business in California, register voluntarily, not have been contacted by CDTFA or its agents about its California activities, and show that the failure to file or pay was due to reasonable cause rather than negligence, intentional disregard of the law, or intent to evade. The program does not apply to use tax on a business’s own purchases or to anyone who holds or has held a seller’s permit.

The Bottom Line

For online sellers, California sales and use tax compliance comes down to three questions: Is the business required to register? Who is responsible for tax on marketplace sales? Is use tax due on the business’s own purchases? Clear answers, supported by organized records, make a CDTFA audit far more manageable.