Identify areas of Recurrent Taxpayer Noncompliance Taxpayers’ Bill of Rights Annual Report to the Legislature

Sample Data from the Audit Process

We compiled and analyzed data from FTB's audit process to identify areas of recurrent taxpayer noncompliance. The data, some of which is derived from statistical samples, includes:

  • The statute or regulation violated by the taxpayer.
  • The amount of tax involved.
  • The industry or business engaged in by the taxpayer (sample data).
  • The number of years covered in the audit period.
  • Whether the taxpayer used professional tax preparation assistance (sample data).
  • Whether the taxpayer filed an individual or corporate tax return.

We reviewed the Notice of Proposed Assessment (NPA) information for assessments that became final in fiscal year (FY) 2020/2021. When we used sample data, the volumes and dollar amounts represent the sample study numbers projected to the total universe of assessments. We have displayed the data separately for corporate and individual tax returns. (For details, please refer to the tables within Appendix 1 – Assessments.)

Corporate Income and Franchise Tax

For corporation income and franchise taxes, the largest dollar amount in proposed assessments resulted from allocation and apportionment audits, which involves corporations doing business within and outside of California. (For details, please refer to Appendix 1 – Assessments, Table 1A.)

“Allocation” is the assignment of nonbusiness income to a particular state. “Apportionment” is the division of business income among states by the use of an apportionment formula. Within the apportionment formula, the sales factor is the most frequent audit issue for corporations. The higher rate of noncompliance associated with allocation and apportionment may be attributed to the complexity of the issues involved, as well as the diverse interpretations of the tax laws.

Appendix 1, Table 2 refers to taxes assessed on corporations. The industry group that was assessed the largest dollar amount was in the row labeled “other,” which includes agriculture, construction, utilities, transportation, communication, information, and other industries not classified in the sample.

We consider all corporation tax returns as professionally prepared because virtually all of them are prepared by in-house accounting departments or accounting or legal firms.

Personal Income Tax

For personal income taxes, the largest dollar amount in proposed assessments resulted from filing enforcement assessments, which refer to taxpayers who have not filed their California state income tax return after we notified them of their filing requirements. (For details, please refer to Appendix 1 – Assessments, Table 1B.)

We issue a separate NPA to the taxpayer for each tax year included in an audit adjustment. Individual taxpayers typically have audit changes for just one tax year, which was the case for 94 percent of individuals in FY 2020/2021.

The data indicates that tax professionals file about 64 percent of all personal income tax returns. In the absence of a paid tax professional’s signature, we consider that taxpayers self-prepared their personal income tax returns.

Taxpayer Filing Errors

FTB identifies the most common errors taxpayers make when they file their tax returns, and we evaluate how those errors may be avoided or corrected.

We compiled Personal Income Tax (PIT) and Business Entity (BE) taxpayer error information on approximately 25.5 million [1] tax returns (23.2 million of PIT returns and 2.3 million of BE returns) processed between July 1, 2020, and June 30, 2021. During this time, FTB sent approximately 1,288,000[2] return notices (1,120,000 PIT – Notices of Tax Return Change and 168,000 BE – Return Information Notices) to taxpayers who filed tax returns with errors that resulted in a change. This figure equates to about five percent of tax returns. We explain the errors in the notices and inform customers how they can resolve any discrepancies.

Adjustments on paper-filed tax returns accounted for 30 percent of the PIT and BE adjustments, even though only 10 percent of total tax returns were paper-filed. Adjustments on electronically filed tax returns (90 percent of total tax returns) accounted for the remaining 70 percent of the adjustments.

The two most common taxpayer errors, for all filing methods, are PIT wage withholding and PIT and BE payment/credit discrepancies. Together, these two errors account for 41 percent (36 percent for PIT and 5 percent for BE) of all taxpayer errors identified during the processing of tax returns.

Of all change notices sent, 12 percent contained a PIT wage withholding adjustment. Taxpayers claimed a PIT wage withholding amount that could not be verified based on the withholding information provided by the taxpayer or based on amounts reported to the California Employment Development Department (EDD) by the taxpayer’s employer.

The other most common taxpayer error identified during tax return processing is claiming the incorrect payment/credit amount. This error accounted for another 16 percent (13 percent for PIT and 3 percent for BE) of FTB notices sent to taxpayers that resulted in an adjustment. This error is also one of the most common reasons PIT and BE taxpayers or their authorized representatives call during our peak pre-filing season. FTB continues to use marketing campaigns to promote the use of MyFTB for both PIT and BE taxpayers and their authorized representatives. Taxpayers with a MyFTB account can review their withholding and estimated payment information in order to help them file accurately.

The Tables in Appendix 2 display the number of adjustments for PIT returns by tax return type and filing method, and they include a description of what typically caused each adjustment.

Footnote

  1. The total number of returns for the prior fiscal year was 18.7 million. The total number of returns for this fiscal year increased substantially to 25.5 million because this fiscal year encompassed two filing seasons with extended filing dates of 07/15/2020 and 05/17/2021.↵
  2. Compliance notices are issued after the return due dates, so volume reported excludes notices resulting from the 05/17/2021 due date.↵