California Business Deals Freeze When Tax Audits Enter Picture

California is auditing with more data and more muscle. If you’re selling or buying a business in the state, the California Department of Tax and Fee Administration can instruct escrow to hold funds while it checks for unpaid sales and use taxes.

The biggest deal-killer shows up at closing: If tax clearance isn’t in hand, the buyer can personally be liable for up to the purchase price under successor-liability rules.

California’s sales-and-use tax audit program runs on a deliberate three-year cycle and targets the biggest, most productive accounts. Selection is increasingly data-driven.

Beyond routine cycles, auditors look for mismatches between what you report to CDTFA and the gross receipts on your federal tax return, unusual exempt-sales patterns, and industry risk. (Restaurants and other cash-intensive operations are perennial targets.)

Once an exam opens, expect the standard packet request: state sales and use tax returns, federal returns, sales journals, purchase records, bank statements, invoices, resale certificates and point-of-sale (POS) reports and daily “Z” register closeout tapes (end-of-day totals), and sometimes an on-site tour.

CDTFA uses five standardized lead-schedule methods:

• Manual adjustments
• Net tax
• Percent-error projections (sampling/block tests, markup on cost, business observation)
• Transactions (actual-basis exams, such as fixed assets)
• Tax recovery and expired rates (for items such as tax-paid purchases resold or bad-debt recovery)

Agents will mix and match these to reconcile taxable sales to your books and outside data. Statewide Compliance and Outreach Program adds pressure from the street level. In fiscal 2023–24, SCOP conducted 66,091 permit checks, referred 513 leads to audit, and generated $127.2 million with a strong benefit-to-cost ratio.

The law is explicit. Buyers are secondarily liable for a seller’s unpaid tax up to the purchase price unless they withhold enough or obtain a tax clearance certificate. Regulation 1702 and R&TC Sections 6811–6813 govern the rules, and CDTFA’s close-out guidance tells both sides how to proceed.

Practically, escrow should request clearance. CDTFA must, within 60 days of the latest of the buyer’s written request, the date of sale, or the date the seller’s records are available for audit, either issue the certificate or mail a notice stating how much must be paid as a condition of release.

Until then, escrow can stay on hold. Publication 74 also warns buyers to withhold enough—or risk being billed as a successor.

Audits end in a few ways—no change, tax due plus interest, a refund, or (in severe cases) referral for civil fraud and evasion or other enforcement.

Penalties follow a matrix. Failure to file and failure to pay are generally 10% each; negligence is 10%; fraud and evasion is 25%; and there’s a 40% penalty for knowingly collecting but not remitting tax.

Because audit and collections coordinate, a disputed balance can quickly lead to liens, levies, and garnishments if you miss deadlines—especially after a determination posts and the redetermination and appeal windows close.

Parties to a sale can take several steps to avoid surprises and keep deals moving.

Ahead of a sale: Have escrow request clearance early, and make sure the seller files final returns and provides records. Buyers should withhold enough until the certificate issues; otherwise, the buyer can be held personally liable for the seller’s unpaid sales/use tax (including related interest and penalties), but only up to the amount of the purchase price.

For operating businesses: Reconcile point-of-sale to bank deposits and filed returns; validate exemption support; test taxable-measure calculations the way auditors do (sampling, markup, observation); confirm district taxes and bad-debt recovery are handled correctly.

For remote sellers or marketplaces: Confirm registration and collection if your California sales exceed $500,000; CDTFA is increasingly selecting out-of-state accounts for audits.

If contacted: Respond promptly, manage records effectively, and document your methods, particularly in cash-heavy or mixed-channel models. Decide whether to resolve at exam or posture for appeals based on strength of your case. Contact a dual-licensed attorney-CPA who can map your nexus, clean up prior years, and install a comprehensive compliance system.

All parties must make clearance a must-have before closing. Request escrow to do this early and hold back enough funds until the CDTFA issues the certificate. This way, an audit won’t freeze your proceeds or follow the buyer after the sale.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

David Klasing is founder and managing partner of the Tax Law Offices of David W. Klasing in Irvine, Calif.

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