ASK THE EDD LAWYER- WHAT AREAS TRIGGER AN AUDIT OF YOUR INCOME TAX RETURN BY THE CALIFORNIA FRANCHISE TAX BOARD
By Robert S. Schriebman
The California Franchise Tax Board (FTB) recently published quite an extensive list of key audit issues that are of high priority and may trigger an FTB audit. These days an audit by one tax agency may expand into other tax agencies as well. For example, FTB audit findings might be shared with the SBE, especially when they concern taxpayers engaged in retail sales. The FTB has information sharing agreements with the IRS and the IRS has them with the FTB and EDD. More than ever before audits can seem to drag on indefinitely, and you can find the IRS knocking at your door as well.
There is a lot of similarity between the key issues triggering an FTB audit and the same issues triggering an IRS audit. Extra diligence is required when gathering your tax information and giving it to your return preparer. Do not assume that your return preparer prepared your return accurately based on the information given. Always review your FTB and IRS returns very carefully before filing them.
Here are a few of the key areas that will be of concern to the FTB in reviewing your return. The information came directly from the FTB in its newsletter dated April 1, 2014:
Like-Kind Exchange (IRC Section 1031)
Audits related to IRC Section 1031 continue to find noncompliance in the following areas:
- Gain computation errors (taxable boot due to debt netting; non-exchange expense items included in the computation).
- Invalid identifications (failing the 3-property 200%:95% tests; not acquiring substantially the same property that was identified; identifying a partial interest and acquiring a higher percentage interest).
- Including the cost of property improvements made after the exchange closed in the exchange (boot) calculation.
- Withdrawing cash out of the proceeds from the relinquished property.
Other State Tax Credit (OSTC)
The FTB uses third party data to verify tax payments were made to other states and to disallow credits claimed to those states which do not have a reciprocal agreement with California.
Head of Household (HOH) Filing Status
Common errors include:
- The qualifying individual’s income exceeds the gross income test of $3,700.
- Taxpayers who do not meet the requirements to be considered unmarried or considered not an RDP.
Head of household issues cause the U.S. Tax Court endless litigation. It is a very highly litigated matter, and there is hardly a week that goes by where I do not see the Tax Court issuing a decision in this area. Commerce Clearing House (CCH) has an outstanding annual publication entitled The Master Tax Guide. The Guide has an excellent explanation of the rules that can be followed with both the IRS and FTB in this area. Unfortunately, very few people read the Guide.
Employee Business Expenses
We may ask taxpayers claiming unreimbursed employee business expenses to provide documentation to substantiate their employer’s reimbursement policy to determine if their expense is allowable.
Some of the most common tax audit issues affecting pass through entities and related flow through to owners include:
Partnership/LLC Property Dispositions
Issues involving property dispositions reported by partnerships and LLC’s include like-kind exchanges (IRC Section 1031), foreclosures of real estate, and cancellation of debt (COD) income.
Abusive Tax Shelters
The FTB continues to see abusive tax shelters in a variety of situations to avoid state or federal tax. These types of transactions often involve the creation of entities or deductions without economic substance or a business purpose.
The best advice I can give you in regard to tax shelters is simply this: if it sounds too good to be true, don’t make the investment. The best tax shelters have always been home mortgage interest deductions and contributions to IRS and FTB recognized retirement plans. Your money is better off in a retirement plan than it is in a tax shelter, especially if you want to get a good night sleep this time of year.
The FTB verifies that credits, such as Enterprise Zone and Research and Development Credits, are reported correctly. In addition, we verify that the assignment of credits is properly reported by the assignor and the assignee.
An EDD lawyer, Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States.
As a trusted EDD attorney, has successfully dedicated more than 30 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House and the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.