If the CDTFA is auditing your business’s sales tax returns, you may need to become familiar with the CDTFA’s mark up test. Taxpayers often ask how to prepare for an audit. A CDTFA tax auditor is concerned primarily in ascertaining whether the reported sales tax liability is substantially correct. Moreover, when the auditor determines that a taxpayer’s records are such that sales cannot be verified by a direct audit approach, the auditor must estimate the sales from whatever information is available. The CDTFA uses the following sources of information and procedures in determining probable sales:
- Bank deposits (section 0405.25)
- Gross profit and net worth analysis test (section 0406.40)
- Income tax returns (section 0406.50)
- Purchases plus mark-up (section 0407.10)
If enough information is available to do so, the auditor should use two or more of these methods to estimate the sales, and will compare the results of one method against the results of another. Moreover, the CDTFA considers a continuing low net profit or loss to be indicative of a possible understatement of total sales
What is the CDTFA Mark Up Test?
The CDTFA considers mark up procedures to determine audited sales (i.e., gross sales, sales of a deduction or taxable sales) to be vital part of sales tax auditing. On the hand, in an IRS audit, the auditor will rarely use a mark up analysis. The auditor will expand on this use whenever the opportunity presents itself. Therefore, it is vital that you check your federal income tax returns, sales tax returns, and profit and loss statements to confirm what the mark up ratio is, and to determine whether the records are consistent.
What is the Mark Up Formula?
You can calculate the mark-up, sometimes expressed as mark-on, by computing the amount added to cost to obtain the sales price; Moreover, the CDTFA generally refers to it in terms of percentages. You can calculate the percentage of mark-up by dividing gross profit by cost of goods sold: G.P./C.G.S. = % of M.U. Taxpayer’s often discuss gross profit in terms of percentages based on sales (i.e., profit margin) but seldom discuss markup based on cost. The auditor will attempt to make certain they are on common ground with the taxpayer when discussing gross profit and mark-up percentages.
Mark-up factor is the factor by which cost of sales is multiplied to determine total sales: C.G.S. x M.U.F. = S. The mark-up factor will always be the percentage of mark-up plus 100%. Moreover, in computing sales, you should use the mark-up factor as it saves one step (adding the amount of the mark-up to cost of sales) in the computation of sales. You obtain the mark-up factor by dividing sales by cost of goods sold: S./C.G.S. = M.U.F.
Before proceeding, one other point should be made. As stated, the CDTFA auditor may use Mark-up to determine sales; an auditor may also use this test as a short test in examining the mark-up produced by the taxpayer’s records. The auditor will check whether this mark-up satisfactory for the type of business involved. If it is, this may satisfy as verification of total sales, etc. Furthermore, the auditor can use this same technique to verify a deduction – for example, sales of food products in a liquor store. See AM section 0407.12.
CDTFA COGS Verification
A mark-up test and/or procedure to determine sales is only as reliable as the base from which the auditor is working. In other words, purchases or if available, cost of goods sold. Moreover, the CDTFA auditor will also attempt to verify the taxpayer’s purchases to ensure that the amount of cost of goods is correct.
If you are dealing with a CDTFA sales tax audit, including CDTFA penalties, and have questions about the CDTFA mark up test, contact a tax attorney today. Furthermore, taxpayers can appeal the CDTFA audit determinations through the CDTFA appeals process.