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Seven Important Questions (and Answers) about Sales Tax XYZ Letters

Letters-XYZ-Alphabet_GI-1163806852 JPGAre you familiar with the XYZ Letter? It’s worth taking a few minutes to better understand this sales tax correspondence, just in case one comes across your desk. The XYZ letter originates from California where the state’s Department of Tax and Fee Aministration is out in full force conducting sales tax audits to replenish dwindling state income.

Whether you have locations or nexus in California or you do business with a company tied to California, here are seven things you should know about XYZ letters:

  1. What is an XYZ letter? It is a letter that a California taxpayer under audit sends out to a customer from whom they did not collect tax or they do not have valid proof of exemption such as an exemption or resale certificate. This letter is used to help satisfy the burden of proving that the sale was exempt even though proper documentation was not obtained. It can also be used to prove tax was paid directly to the state by the purchaser.
  2. How should I respond to the letter?   Reply to the letter in a timely manner.  Clearly explain why the item purchased was exempt from tax by the nature of its use. Or, provide proof that use tax was paid. Either of these answers will help the vendor avoid liability under audit. If tax is owed, but not paid, your vendor may request you pay the tax due. Also, examine your compliance processes to avoid future oversights.
  3. Who writes the XYZ letter? The California Department of Tax and Fee Administration (CDTFA) provides sellers with sample letters and statement forms. The seller can customize the letters and put them on their own letterhead but these changes must be approved by the CDTFA.
  4. Where are the letters returned? Letters are either returned directly to CDTFA or sent back to the seller to be forwarded on to the Board. Return directions should be included with the letter.  If you are directed to return the letter to the CDTFA, a return envelope should be provided.
  5. How much time is given to respond? Typically, the auditor allows four weeks to receive responses back. If responses are sent directly to the CDTFA, the auditor should send copies of these letters to the seller. It is at the discretion of the auditor to accept late responses.
  6. What happens after the letters are returned? Don’t be alarmed if the auditor requests additional documentation from you.
  7. What are the risks of not replying?   While no one has a crystal ball to predict which companies will be selected for audits in the future, not replying to the letter and not correcting oversights may forecast an audit in your near future.

XYZ letters can be intimidating if recipients are not familiar with the process. Don’t panic! Even if the directions are vague the response procedures are fairly simple. Most importantly, take this opportunity to correct any sales tax errors on your end that may have caused this mistake. To help identify other areas in your business where costly sales tax oversights may occur, download 20 Signs it’s Time for a Sales Tax Tune Up.

20 Signs It's Time for a Sales Tax Tune Up

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Lauren Stinson, CMI
Written by Lauren Stinson, CMI
As a Principal with Cherry Bekaert, Lauren serves as the National Leader for the Sales & Use Tax practice within the Firm’s State & Local Tax group. Based in Cherry Bekaert’s Atlanta practice, Lauren is an expert on sales and use tax issues that directly impact manufacturers, technology businesses and eCommerce sellers on the state and national levels.

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