From the Tax Law Offices of David W. Klasing - How and When Should You Appeal a California Franchise Tax Board (FTB) Audit?

IRVINE, Calif., April 18, 2023 /PRNewswire/ -- California residents are highly familiar with the Franchise Tax Board when tax season rolls around. It is even likely that you may have owed money to the FTB at one point or another. In addition to collecting taxes from Californians, the FTB also performs tax audits to examine whether a company or individual taxpayer has taken a defensible position on their tax filings. If you are audited, rest assured, the state of California doubts the position you claimed is fully defensible.

Just like federal audits, California auditors take a prove it or lose its stance when it comes to claimed deductions and consider every deposit to a taxpayer's personal & business accounts as taxable income unless you can prove it is not. It is one thing to make mistakes or have difficulty fully substantiating returns that you have filed with California, it is quite another to get caught red handed filing obviously fraudulent California tax returns. If know for a fact that you cheated on the tax returns under audit do not hire the original preparer to defend you in the California audit as they are likely to be government witness number one against you if California should choose to prosecute you. Hire our dually licensed Tax Attorneys and CPAs to ensure the audit stays about tax penalties and interest and does not put your net worth and very liberty at risk. 

How does the FTB choose whom to audit?

To determine whether it is necessary to perform a tax audit, the FTB will analyze the following: 

• The audit and law enforcement history of the taxpayer.
• Referrals from other California Tax Authorities: i.e., EDD, CDTFA.
• Computerized statistical analysis of California and federal tax returns submitted by the taxpayer and especially differences between the two mandated by California law.
• Any statistically unusual deductions or exclusions claimed.
• IRS & third-party data regarding the taxpayer including W2's and 1099's.
• Professional licenses & real estate within the state coupled with non-filing or perceived underreporting of income compared to like professionals or property owners.
• Egg Shell Audits.
• Reverse Egg Shell Audits.
• Information gleaned from an IRS audit (most common cause of FTB audit).
• Suspected non reporting of California sourced income by a nonresident of California.
• History of Net Operating Losses.
• Taxpayers with a standard of living that is not supported by their history of reported income.
• Suspected underreporting or nonreporting / evasion of income from pass through entities & related suspected basis issues.
• Excessive or suspect unreimbursed employee expenses.
• Suspect charitable contributions.
• Suspect other state tax credits.
• Suspect filing status like head of household.
• Unreported or suspect sales of California real and personal property and 1031 exchanges.
• Abusive tax shelters.
• Suspected involvement with California's Underground Economy
• Suspect apportionment of entity net income to California by multi state businesses.
• Referrals from the California Bureau of Investigation or FTB's Criminal Investigation Bureau. 

There are several ways that the above could support a civil, eggshell, or reverse eggshell tax audit or criminal tax investigation by the FTB. For example, if you misplaced tax documents and consequently failed to report substantial amounts of income from a brokerage account, the FTB may interpret this as a deliberate attempt to hide a portion of your income. Understanding the red flags that could trigger an audit, eggshell audit, reverse eggshell audit or criminal tax investigation is vital for a taxpayer to lower their chances of being audited in the first place and for obtaining a favorable result if they come under scrutiny.

Inception of an FTB Audit 

After investigating the available financial records and public information of a taxpayer, the FTB will send them written notice explaining their decision to begin an audit of the taxpayer's finances. This letter will state the name of the auditor assigned to your case and will also often request information on the tax prep company or software you used to prepare your tax return.

The FTB will also request specific substantiation that pertains to the purpose of the audit. For instance, if the FTB suspects a business did not correctly calculate their employee payroll tax, the FTB would request documents, representations & substation relevant to this issue.

FTB Audit Results

After inspecting the documents provided by the taxpayer, FTB records, and IRS records, the auditor will determine whether you should be assessed taxes, interest back to the original filing date of the returns at issue, and penalties. Taxpayers who are deemed to owe taxes will be provided with a Notice of Proposed Assessment (NPA). The NPA will lay out all taxes owed and any penalties and interest the FTB added due to errors found on the taxpayer's return.

When the FTB issues an NPA, the taxpayer has two options. First, the taxpayer could accept the findings of the FTB and agree to pay the tax. This is often wise if potential criminal exposure has been encountered during the audit. If the FTB made a mistake as to the law or facts at issue in a straight civil audit, it is often advisable and makes economic sense to challenge the assessment by the FTB. Fortunately, we have dually licensed California Tax Attorneys and CPAs on staff that are knowledgeable, ethical, and experienced and successful in appealing the audit decisions of the FTB in warranted circumstances. We can help you determine when it may make economic sense to file an appeal and help you gauge the odds of success. 

There is also a slim possibility that an FTB audit will reveal that a taxpayer paid too much money in taxes. In this rare case, a refund is issued to the taxpayer for the over-assessment. In even rarer instances, the FTB could also find that the taxpayer does not owe any additional taxes at all and would then terminate the "no change" audit.

Our Solemn Pledge to Our Clients Contemplating an Appeal

We will never put our inherent need to make a living above the well being of a client by pursuing an appeal that does not make economic sense or have a sufficiently high likelihood of success, to make a buck at a client's expense like some of our competitors and known to do. 

How Do You Appeal an FTB Audit in California?

As mentioned, a taxpayer has the option of appealing the audit findings of the FTB within 60 days of their decision. When protesting the FTB audit, you need to provide legal and factual reasoning for the appeal and request a date for an oral argument. We excel at making legal and factual arguments which is perhaps the strongest reason to hire our dually licensed Tax Attorneys and CPAs to handle the appeal for you. At this point, you could also choose to pay the FTB tax assessment to stop the accrual of interest while the case is ongoing but that may not be advisable as in our experience it hardens the resolve of the FTB when they already have the money at issue.

The initial appeal of an audit will be presided over by an impartial representative from the FTB. You will be allowed to present legal documents, oral arguments, and other forms of evidence to attempt to prove that the results of the audit were incorrect on the law or the facts. After hearing the arguments of the taxpayer and the FTB, the tax assessment will be confirmed, withdrawn, or modified.

If you are unsuccessful with the FTB's internal appeals process, you have the additional option of pursuing an appeal through the Office of Tax Appeals (OTA). The OTA came into existence because of decades of egregious complaints of California residents and in state and out of state businesses that complained to the California Legislature of only being allowed 20 minutes to make a case in front of the Board of Equalization which consisted of elected officials that for the most part rubber stamped the actions of the various California Taxing Authorities from which they appealed. The OTA was California's attempt to parallel the perceived justice afforded to taxpayers by the Federal Tax Courts. Unfortunately, the administrative law judges hired to staff the OTA are to date largely ex-employees of the very California Taxing Authorities that they are charged with adjudicating. Unfortunately, the rubber stamping of the BOE is now being reduced to precedential case law by the OTA and the written opinions of the BOE became precedential decisions for the OTA to follow. In any event, the OTA must receive notice of your intent to appeal within 30 days of the conclusion of the FTB hearing. You would be well advised to hire legal counsel before proceeding with your appeal to this level.

The OTA will examine the evidence presented by you and the FTB and will provide a binding decision on the matter that has to date been largely in favor of the California taxing authorities. If the decision is unfavorable, you could request a rehearing if you have new evidence to present or if you want to attempt to claim the OTA made an error in the original hearing.

Your last option to appeal the FTB tax audit and the OTA is to file a lawsuit in California Superior Court.

As you can see, handling an appeal of an FTB audit is not a task that is easily handled. You may have months of work ahead of you if an FTB appeal is in your future where you believe that you were incorrectly assessed tax, penalties, and interest. Our dually licensed California Tax Attorneys and CPAs are here to help make the most of the appeals process.

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Public Contact: Dave Klasing Esq. M.S.-Tax CPA, [email protected]

SOURCE Tax Law Offices of David W. Klasing, PC