California Income Tax Audits & Problems
There are two types of California State Tax Audits:
- Piggy-back Assessment Tax Audits
- Originating State Tax Audit
Piggy-back Assessment Tax Audits
When you are audited by another entity, for instance, the Internal Revenue Service, notice of the tax audit and its results are automatically provided to the State of California Franchise Tax Board (FTB) through an intergovernmental information sharing agreement. Local and other state agencies may report financial information to the Franchise Tax Board as well.
We recommend that you never ignore a Notice of an Assessment that is based upon an IRS tax audit. The notice you receive is a Notice of Proposed Assessment (NPA) and there are very clear and final deadlines associated with it. However, often there is much that can be done to minimize or eliminate the associated tax liability and penalties. Therefore, be sure to contact your tax attorney immediately upon receipt of any such notice.
Considerations During and After an IRS Audit
The California Revenue and Taxation Code provides that when the IRS assesses additional tax (i.e., conducts an audit and there is a deficiency), the taxpayer must file a report (or an amended tax return) with the Franchise Tax Board within six months after the final federal determination of the change or correction. If this is done, the Franchise Tax Board has two years to make its assessment.
However, if a report is not filed within the six months, the statute of limitations is extended to four years from the date the report is made. As such, it is important that you discuss with your attorney when and how to report any IRS audit assessment to the State of California.
Originating State Tax Audit
The California Franchise Tax Board may also identify a tax return to perform its own audit and look for tax problems. Common triggers for a California Tax Audit are: residency issues, water's-edge tax elections, or a tip from an informant.
Once a return is identified for a tax audit, the auditing agent will send out a Notice of Audit as well as conduct their own investigative review, which can include, but is not limited to:
- Public information (such as annual reports or SEC Form 10-Ks).
- Information obtained through third party sources (federal tax returns, other state agencies).
- Information that should have been attached to the California return (missing schedules or supporting information).
FTB Tax Audit Appeal Procedures
If a taxpayer is subject to a FTB audit examination and subsequently a tax assessment is issued and affirmed by the Protest Unit, the taxpayer has the option to take its case directly to Superior Court or to the Board of Equalization. If a taxpayer chooses to take the case to the Superior Court, they must first pay all amounts due for the tax year, including the tax assessment, any other final amounts, penalties, fees and interest, and file a claim for refund. The Superior Court will generally hear the arguments of the case and review the facts submitted to the court before reaching a decision. Once the decision is reached, either party can appeal the decision to the Court of Appeals.
Court Of Appeals
All tax cases decided by the Superior Court can be appealed to the Court of Appeals for further review. The Court of Appeals will determine if the Superior Court reached the correct decision by generally affirming or reversing the Superior Court's decision (Cal. Civ. Proc. Code section 904.1). The Court of Appeals will generally make the decision based on correct legal standards and evidence provided during the Superior Court case, and they rarely will hear new evidence at the appeals level. Once the Court of Appeals issues a decision, either party can petition for review to the Supreme Court.
Board of Equalization Appeals
As an alternative to the California court system, taxpayers in a tax case can appeal the findings of the FTB to the State Board of Equalization (BOE) as long as they’ve exhausted all administrative remedies. The BOE is comprised of five elected Board Members who serve as the appellate body in final actions of the FTB. The five elected members issue opinions and render decisions interpreting California's income tax laws after obtaining all relevant facts about the case. Once the elected members render a decision, either party can petition the BOE for a rehearing within 30 days of the decision. If a rehearing is denied, then the proceeding at the BOE ends. The FTB has no other recourse once the proceeding ends with the BOE. However, taxpayers who are not satisfied with the decision reached by the BOE can seek additional relief through the State court system as discussed above.
Claim for Refund
If a taxpayer’s claim for refund is denied, the next available option is to file an appeal with the State Board of Equalization, or to bypass the BOE appeal process and bring an action directly to Superior Court.
Appeal decisions rendered by the Board of Equalization are final and binding on FTB, but not on the taxpayer. Appeals brought to a Superior Court can be appealed by either the taxpayer or FTB in the California Appellate Court or the California Supreme Court, and ultimately the U.S. Supreme Court.