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Tax News
An inside look at our audit programs

The Franchise Tax Board convened a meeting with FTB Advisory Board "interested parties" on November 1, 2006. The purpose of the meeting was to discuss key audit issues, and give the Advisory Board an overview of the various audit programs. Discussing audit issues with interested parties supports our commitment to become a more transparent organization.

General tax audit program (personal income tax) audits

  • Real estate
    The General Tax Audit (GTA) program is conducting audits on mortgage interest, Internal Revenue Code (IRC) Section 1031 like-kind exchanges, and basis on real estate sales.
  • Qualified small business stock
    These compliance audits make sure taxpayers take the necessary steps to follow the basis reduction requirement when the replacement stock is disposed of. In addition, taxpayers should track their eligible gain in order to avoid exceeding the $10,000,000 lifetime limitation.
  • Board of Equalization (BOE) referrals
    In this new project, we base our audits on completed BOE sales tax audits that they refer to us. BOE's unreported sales audits may translate into unreported sales for income tax purposes.
  • Schedule C pilot project
    This pilot project comprises approximately 45 audits on automobile expenses reported on the Schedule C. The pilot's purpose is to educate taxpayers about the Schedule C auto expense deduction. Before we proceed with the traditional audit, taxpayers have the opportunity to self-comply by correcting the auto expense deduction originally reported on their tax return. We mailed 400 self-compliance letters by the end of December 2006.

Pass through entities program audits

Many key audit issues arise from partnerships and limited liability companies. Some of the principal audit issues include:

  • Dispositions of real estate: Verifying the amount realized, the adjusted basis of the property, and that the requirements for gain deferral are met timely.
  • California sourced gains: Verifying that nonresident partners properly report their distributive share.
  • Final year tax returns: Ensuring the proper recapture of items when a negative capital account exists.
  • Potentially abusive tax shelters: Analysis and modeling are ongoing.
  • Sales of partnership interests: Verifying that the interests are properly reflected, that income is properly recognized on distributions of installment notes, and that debt cancellation is correctly reported.
  • General income and expense items reported on partners' tax returns, including checking that partners properly report items from their K-1s.
  • S-Corporations audits:
    • Built-in-gains tax with emphasis on the valuations placed on the C Corporation assets on the date the entity converted to an S-Corporation.
    • Tax-exempt employee stock ownership plans (ESOP) acquiring an ownership of an S-Corporation in an attempt to shield from taxation the income the ESOP receives as flow-through income.
    • Verifying that installment income is correctly reported.
    • Verifying that tax credits, e.g., Enterprise Zone credits, are claimed correctly.
  • Estates and Trusts:
    • Grantor trusts, and charitable remainder trusts discovery projects.
    • Investment management fees deducted erroneously under IRC Section 67(e).

Revenue agent report/automated audit program

  • The Revenue Agent Report program brings in approximately $250 million in annual revenue, and is back on the upswing due to increased audit activity at the federal level.
  • The HOH compliance program audits approximately 250,000 of the more than two million filers who choose the HOH filing status. The program is currently working on a Web-based head of household questionnaire for taxpayers who receive an HOH audit letter. Instead of mailing us a completed paper questionnaire, taxpayers can go to our Website and complete an online HOH questionnaire, and submit it to us electronically.

Multistate audit program (corporate tax)

  • Amended tax returns
    When taxpayers file amended tax returns (CA Form100X) and do not clearly identify audit issues, it slows down the overall process for all interested parties.
  • Multistate audit (MSA) discovery team
    This team was recently established to look at the trend setting compliance issues, and ways to improve voluntary compliance with minimal intrusion. Some of the issues they're studying are the shifting of intangibles offshore, water's-edge issues, and claims as an indicator of future trends.
  • Tax shelters
    The MSA program is working with other state agencies, and cross training with the Pass-Through Entities Program to become more efficient in identifying potential tax shelters used by multistate and multinational companies.
  • Nevada corporations
    This audit project examines the growth of Nevada corporations attempting to avoid California taxes.
  • Credits
    Tax credits continue to be a major audit workload. Now that the manufacturer's investment credit has expired, there is more of an audit focus on the research and development credit.
  • Legal
    The impact on taxpayers of the recent Microsoft and General Motors court decisions was discussed during the meeting. Our Legal Department is considering holding public workshops to address this issue in more detail with the taxpayer community.
  • "One and done" pilot program
    This new pilot will explore an audit approach that will assist taxpayers with all FTB-related services when an audit is commenced. Watch for more information on our Website at www.ftb.ca.gov, and in future Tax News issues.