CA Business Owner’s Guide to State Income Taxes & FTB Audit and Appeal Process
Small Business Taxation in California
With higher than average state income tax imposed on business and personal income, California can be an expensive state to do business in. The state’s small businesses are particularly hard hit under its tax laws. California has a higher than average state income tax imposed on business and personal income. Even if your California business is structured as a pass-through entity, meaning income should only be taxed at one level; the California Franchise Tax Board may still be double-taxing your income.The Franchise Tax Board is the agency responsible for administering personal and business income tax in the State of California. While the state generally follows the lead of the IRS in setting policy, it does not do so in every instance.
Aside from having a higher than average state income tax,California imposes both business and personal income taxes on small business owners running pass-through entities.
Limited Liability Companies and S-Corporations are two examples of business structures that allow pass-through of business income to the owner(s).
The federal government does not collect personal income taxes on these business owners, seeing it as double taxation. However, California requires you to pay both business and personal income tax. These practices can nearly double a small business owner’s tax burden; depending on:
- The net income of the pass-through entity;
- The amount of personal income derived from the business;
- Among other factors.
High taxes, along with a high cost of living, make California a challenging state for entrepreneurs and businesses other than traditional corporations.
Types of Business Entities and How They Are Taxed
A traditional corporation that is taxable as an entity. Profits are not subject to the Self-Employment Tax.
Owner(s) must pay personal income tax on any dividends, potentially at a marginal tax rate as high as 33 percent. Any non-dividend personal income derived from the business must also be filed for personal income tax.
Tax advantages include income splitting while the disadvantages include potential double taxation of dividends.
It is a more complex entity from the accounting and legal viewpoints than LLCs, sole proprietorships, or partnerships.
Corporate Tax Rate: 8.84 percent or AMT of 6.65 percent depending on whether it claims net taxable income.
Provides similar legal and financial protection as a C-Corporation. Profits pass through to the owner who must pay personal income tax on those profits.
Owner(s) must be paid a “reasonable salary” which is subject to Social Security and Medicare withholding. Only if a reasonable salary is paid can there be a profit distribution.
Any tax savings will only take effect once the business is making a substantial income.
Owner(s) must pay a franchise tax of 1.5 percent of net income with a minimum of $800 even if the business shows zero or negative net income, which is waived in the first year of incorporation.
There are nine tax brackets for personal income tax from 1 percent to 12.3 percent. Corporate losses can be deducted from the individual tax returns of the shareholders.
Limited Liability Company (LLC)
A pass-through entity where net income passes through to owner(s) who then pays personal income tax at marginal rates from 1 percent to 12.3. The first taxes are due 75 days after the formation of the LLC.
Must pay a self-employment tax, about 15 percent, on all income. Net income is not taxed at a flat percentage rate; instead, it is taxed at a flat dollar amount based on multiple gross income tiers.
Gross Income Tax
$250,000 to $499,999 $900
$500,000 to $999,999 $2,500
$1M to $4,999,999 $6,000
Over $5M $11,790
Less than $250,000 pays a minimum franchise tax of $800.
Net income passed through to owner(s) is taxed at a marginal rate of 1 percent to 12.3 percent for personal income tax.
Filing Deadlines for Estimated Taxes:
Flexible in how profits and losses are split between partners.
Sole Proprietorship and General Partnerships
Personal income tax is paid on the owner's income. Business partners must pay personal income tax on income passing through from the partnership.
Not all entities or partnerships are so straightforward.
For example, LLCs and C-Corporations can elect to be taxed as an S-Corporation. Considering C-Corporations pay a marginal tax rate that is one of the highest rates in the United States, doing so makes sense.
C-Corporations can also engage in income splitting, in which the income is split in such a way that part is taxable to the corporation and part is taxable to the corporation’s owners.
Income splitting can allow each to be considered in a lower tax bracket.
C-Corporations and S-Corporations must split corporate profits and losses proportionally to the percentage of shares owned by each shareholder. LLCs are allowed more flexibility in sharing out profits and losses among partners.
State taxes in California tend to be higher than the average state taxes across the U.S. Also, the Franchise Tax Board, the agency responsible for collecting state income tax, permits double taxation of business owners whose companies are structured as pass-through entities.
The owners pay taxes on both business and personal income, even though it is the same pot of money in a pass-through entity.
Business structures can also be complicated as when an LLC elects to be taxed as a C-Corporation. Financial S-Corporations must pay a tax rate of 3.5 percent — 2 percent higher than a typical S-Corporation.
There are multiple tax brackets for personal income tax from an S-Corporation although corporate losses can be deducted from individual tax returns of the shareholders.
A small business owner who decides to set up shop in California should consult an experienced accountant and a knowledgeable tax attorney to determine what taxes must be filed, when they are due and how each business entity is taxed by the Franchise Tax Board.
Why Do I Owe State Taxes?
California is one of 43 states that collects state income taxes and currently has the highest state income tax rate in the U.S. at 13.3 percent. It comes in fourth for combined income and sales tax rates at 11.2 percent, behind New York, New Jersey and Connecticut.
We are here to explore the common reasons for higher state taxes in California and ways to ease the bite they take from your earnings and revenue.
California State Tax Agencies
Aside from the IRS, there are three major tax agencies in California that impact you as an individual and your business.
The Franchise Tax Board (FTB) is the agency responsible for administering the state income tax and corporation tax. It handles collections, penalties, and dispute resolution as well as a number of other state programs.
The Board of Equalization administers California’s sales and use tax, and taxes on fuel, alcohol, and tobacco. Businesses must register with the BOE to obtain permits and licenses.
The Employment Development Department (EDD) is one of the largest state departments, administering payroll taxes, unemployment, disability and many other state programs.
How do State Taxes Differ From Federal Taxes?
The Internal Revenue Service (IRS) of the federal government administers income taxes for the entire United States, according to the federal Internal Revenue Code.
However, state income tax codes can and do differ from federal law. Each of the 43 states taxing income has different tax laws. Additionally, states can charge sales and use tax; there is no federal sales tax.
Each state has its own department of revenue and may have very different tax refund statuses.
Before filing in any state, check its specific tax laws or consult a tax professional specializing in that state. California, for example, sometimes differs from the IRS on due dates for estimated quarterly taxes.
Can You Owe Taxes in More Than One State?
If you performed work in a state and tax was withheld from your income, you may owe or be due a refund from that state. If taxes were not withheld and you received a Form 1099 listing your earnings, you are not required to file in that state.
However, your 1099 income is subject to taxation by your state of operation or residence.
If you lived in more than one state during the tax year, you must file a state income tax return for each state to determine your refund status. It does not matter how long you resided in that state.
If you worked in or earned income from more than one state, you may need to file a return even if you did not live in that state.
For example, if you are a resident of California who contracted out to a company in New York and met one of these conditions, you need to determine refund status for both New York and California:
- You briefly traveled to New York for work
- You worked remotely from your home state
They get you coming and going.
Common Reasons for Increased State Taxes
When it comes tax time, there are several ways to find yourself owing more than you expected.
You may not have had enough withholding or deductions. This leaves more income to be taxed resulting in a lower refund or the need to pay additional taxes with your return. If you received unemployment, that is also taxable.
If you have previously been eligible for the Earned Income Tax Credit (EITC) and your income increased, your EITC may be reduced or eliminated entirely. Since the EITC is a direct deduction from your tax liability, the elimination of the deduction will increase what you owe.
Did you take an additional job or did your spouse start working? Again, if you did nor adjust withholding, you may come up short at tax time.
Other money eligible for income tax includes:
- Gambling winnings
- Social Security, if this was your first year receiving benefits
- You did not contribute to an IRA, increasing your taxable income
Finally, whether we like it or not, income taxes do go up every year. If you did not change your withholdings in response, you might not have enough withholding by the end of the year.
You may owe taxes or receive a lower than expected refund.
More reasons for increased taxes:
- Change in filing status
- Gain or loss of child tax credit eligibility
- Change in education or tuition deduction
- Change in home or property tax
- Change in military service
Keep accurate records of anything that may change your taxable income or tax status.
State Business Taxes
If you run a business in California, you are required to pay sales and use tax, which you can levy at the point of purchase and pass along to the CDFTA. Sales and use tax is required on all cash and credit card sales, installment sales, lay-away sales and trade-ins or property exchanges.
Depending on what you sell, you may owe excise tax.
If you also have employees, you must withhold income tax from their earnings and pay employment taxes (Medicare and Social Security), workers’ compensation and other taxes.
On the other hand, if you are self-employed, you must pay self-employment tax. You are paying both your contribution and an employer contribution into Social Security and Medicare.
Paying or Disputing Your Taxes
To avoid paying interest, penalties, and legal issues, pay your tax bill in full and on time. If you cannot pay in full, pay as much as possible to reduce the interest and penalty liability.
If you have a dispute with any tax agency, you must prepare a timely protest. The draft should include your statement of the right of appeal, a copy of the tax notification and documentation for relevant tax years, and statements of law and fact supporting your tax return position.
Be sure to file your return on time and pay in full. If you cannot pay in full, pay as much as possible to decrease the interest and penalties on the unpaid portion.
Penalties are based on the amount owed, and an extension does not give you more time to pay; it only extends the deadline for filing a return. You may be able to negotiate an installment plan or an Offer in Compromise.
A tax attorney is of great assistance if you find yourself in situations such as a tax dispute, late payment or inability to pay. A tax attorney can file accurate documentation and guide you through the intricacies of tax law in your state.
Preventing a High Tax Bill
To prevent unexpectedly high tax bills in the future, carefully manage your income tax withholdings and estimated payments. Learn what the current tax rates are, withhold sufficient amounts from your paycheck or pension payment.
If you are self-employed, your estimated tax payment should be increased.
If you live in the State of California or any of the other 42 states that levy an income tax, and you earn an income in one of those states, you will owe state income tax.
Always check the tax law in every state you receive earnings from or have lived in to avoid tax penalties at the state level.
Franchise Tax Board Assessments – Part One
A Franchise Tax Board (FTB) assessment is usually made on a tax year basis (i.e., per tax year). A missing FTB assessment is usually defined by which type of entity it is. For a non-qualified in California corporation, missing years are created when a business entity does business or derives income during a tax year but does not file a tax return.
For California qualified corporations, that is any time a qualified franchise tax filer does not file a return. Business activity and income do not determine the filing requirement for a corporation that has qualified through the California Secretary of State. Missing year assessments enable the FTB to assess taxes due in the absence of a tax return.
Missing year assessments can be set up by the Franchise Tax Board’s automated system or manually by its staff. FTB staff must evaluate the cost-effectiveness of setting up a missing year assessment if there is no indication of a company’s business activity, income or transferee assessments.
FTB staff will contact a business and will verify the following when making FTB assessments:
- Is the business entity actively doing business (in or out of California)?
- What kind of business does the entity conduct?
- What were the entity’s gross receipts for the certain year(s) of?
- Does the entity have any other locations?
- Verify all active addresses.
- Gather asset info (bank, accounts receivable, property, etc.).
- Does the entity use a Doing-Business-As (DBA) name? (This information is important if a lien or levy is required.)
If a missing year Franchise Tax Board assessment is justified, FTB staff must notify the business entity by mailing form FTB 4960 Notice to File Tax Returns. Then the Franchise Tax Board fills out the missing year assessment form FTB 6923A to determine the income basis of the assessment.
The following income sources are listed in priority order by the FTB:
- Taxpayer information
- California Department of Tax and Fee Administration (CDTFA)
- Prior year return
- Industry income average
- FTB determination
Jeopardy Franchise Tax Board Assessments (J/A) are issued when it is determined by the FTB that the collection of a tax or deficiency for any year, current or past will be jeopardized. J/As may be issued to a business entity, transferee (a party to whom taxpayer transferred property) or an assumer (someone who assumed obligations of taxpayer). A J/A is due and payable at the time assessed; the FTB may commence collection immediately after this is issued. FTB considers that the collection of tax might be in jeopardy if one or more of the following is established:
- Entity received income from illegal sources and has assets that are in immediate danger of attachment (attachment of third-party’s claim to assets) or assignment (assigned rights away to another person or business).
- There is evidence that the entity is assigning and/or placing assets in the name of a third party for the purpose of concealment.
- Entity is selling the business and has not filed tax returns.
- Entity has a previous history of collection difficulty or is a non-filer of tax returns and the entity has access to a large amount of cash or escrow funds and it is the last verifiable asset of the entity.
- Entity has unpaid liability from tax return(s) filed.
Taxpayer is then sent a Notice of Proposed Assessment, but unlike with regular NPA the taxpayer has:
- 30 days to protest that collections was not in jeopardy; and
- 60 days to protest on the grounds that the assessment was incorrect
The FTB can send a jeopardy assessment in conjunction with demand to pay delinquencies for all years that liens were placed against taxpayer’s assets; and/or an Order to Withhold for all delinquencies for years that liens were not already placed.
The following is the income basis for jeopardy assessments:
- Taxpayer information
- California Department of Tax and Fee Administration (CDTFA)
- Prior year return
- Industry income average
- Collection Filing Enforcement (CFE) basis
The FTB must send a taxpayer letter explaining what information they relied upon in issuing the FTB assessment, detailing the method of computation. Also, the FTB must prove a reason why it determined that the collection of the FTB assessment would be jeopardized by delay.
To stay collection actions, the entity must post a bond for 125 percent of the FTB’s jeopardy assessment amount; or alternatively, show substantial evidence that the funds are not in jeopardy. For further information on Collection issues, feel free to take advantage of our Collections guide.
Franchise Tax Board Assessments – Part Two
An assumer is an individual or business entity that accepts legal responsibility for another business entity when requesting a tax clearance. Usually, it occurs when a taxpayer entity changes its form, gets merged or ceases to exist.
Franchise Tax Board form FTB 3555 Request for Tax Clearance initiates this process. Once this form is accepted and the entity has completed the dissolution, surrender, cancellation or merger process, the assumer becomes responsible for the entity’s taxes and/or unfiled tax returns.
All returns remain subject to audit until expiration of the normal statute of limitations.
An assumer differs from a transferee because an assumer voluntarily assumes any subsequent liabilities or responsibilities for a business entity, where a transferee has the liabilities transferred to them regardless of their consent.
The FTB has indicated certain limitations with respect to assumers:
- an assumer cannot be a general or limited partnership; and
- the surviving entity of a conversion assumes the converted entity's liability without a tax clearance unless they are a domestic or qualified corporations that is converting to another type of entity.
The FTB will include the assumer in its automated system and will check with the Secretary of State whether the original business entity taxpayer truly merged, dissolved, canceled, etc.
Assumer Assessment Statute of Limitation
Please note that the statute of limitation for assumer assessments is one year beyond the statute for assessment of the original liability regardless of any extension.
Transferee assessments are issued when assets are inappropriately taken from a business entity, leaving the business insolvent and unable to meet its tax obligations. This process makes the transferee (the one who receives assets) responsible for the amount taken or the tax liability due (whichever is less).
A transferee can be any of the following:
- A company officer
- A stockholder
- A business entity
Examples of inappropriate transfers are:
- Corporate officers who receive improper compensation, such as excessively high salaries or expenses
- Stockholders who borrow from the corporation without repaying the loans
- Other corporations, partnerships or sole proprietorships that receive assets from the corporation without adequate compensation
The FTB will identify these types of transfers, and will make an assessment against the transferee. Transferee assessments are divided into two major categories, based either upon:
- law; or
For transferee assessments based upon “law,” a contract must exist in which a transferee agrees to pay a transferor’s tax.
The transferor is a party that gives away its assets to another; and a party that receives the assets is the transferee.
For transferee assessments based upon “equity,” all of the following requirements must be met:
- a transfer of assets;
- tax liability accrued before or in the taxable year the transfer was made;
- transfer made without full and adequate compensation;
- transferor left without assets sufficient to pay tax liability due to the transfer;
- transfer must have been to actual beneficial owners; and
- the creditor may be held as transferee only to the extent of the overpayment.
Before proceeding with a transferee assessment, FTB staff must exhaust all means available to collect the liability amount from the business entity first. The FTB must also determine proof of transferee before they impose an assessment.
Proof of transferee is determined with the following criteria:
- Identification of the asset transferred
- Evidence that the transfer left the transferor insolvent or defrauded creditors
- The value of the asset transferred
- Asset transferred after tax accrued or during tax year in which liability arose
Once the FTB determines these factors, the FTB sends Form 5900 to the transferee of the asset(s). Next, the agency waits 45 days from the mailing date before they take any collection action. For example, these actions may include the imposition of a lien on the asset(s) after the 45 day waiting period.
Transferee Assessment Statute of Limitation
Lastly, please note that the statute of limitations for setting up a transferee assessment is five years past the original due date of the tax return.
For subsequent transferees, the statute of limitations is within one year of the expiration of the previous transferee assessments’ statute of limitations (up to a maximum of three years).
Correction of Franchise Tax Board Notices
Sometimes a Notice of Proposed Assessment may require corrections. This generally occurs when the FTB receives new information from the taxpayer after they issue a Notice of Proposed Assessment. If the taxpayer submits valid supplemental information which justifies an adjustment of the proposed assessment; the FTB should make the correction.
Depending on the circumstances, the assessment may be corrected by a second Notice of Action or a Notice of Revision; it may be withdrawn and a new NPA (Notice of Proposed Assessment) issued; or in the case of protested NPAs, it may be restored to protest status.
If the taxpayer does not protest the NPA, the FTB must issue a Notice of Revision prior to the expiration of the 60-day protest period or within the prescribed time if assessment is deferred, which can vary. The Notice of Revision does not extend the 60-day period for the taxpayer to file their protest. The corrected additional tax may not be increased over the amount of the additional tax originally proposed.
In the case when Notice of Proposed Assessment is protested by the taxpayer, and a Notice of Action has already been issued, the FTB must mail a corrected Notice of Action within the 30-day appeal period.
If the FTB does not mail it within 30 days, then the assessment is restored to original status, which was protested by the taxpayer. When the FTB does mail the corrected notice, then the taxpayer now has 30 days to appeal the corrected amount of assessment counting form the date printed on the corrected notice.
In this case, the corrected additional tax may be increased over the amount shown in the notice of action, but may not exceed the amount of the additional tax originally proposed to be assessed.
The Franchise Tax Board can withdraw the Notice of Proposed Assessment and issue a correct one only if statute of limitations has not expired. In lieu of issuing a corrected Notice of Action or a Notice of Revision, the FTB’s internal manual suggests that the FTB withdraw the assessment and issue a corrected one when:
- The NPA contains a technical defect such as an error in the name, address, year or transposition of numbers.
- The supplementary information received from the taxpayer introduces new items of income or disallowance that may not be made a part of the corrected Notice of Action or Notice of Revision.
- The corrected amount of additional tax will exceed the original Notice of Action, Notice of Revision or the original NPA.
Franchise Tax Board (FTB) Audit Tips
Throughout my years of practice, I have developed a few helpful tips for dealing with a Franchise Tax Board (FTP) audit and auditors from the State of California. Franchise Tax Board audits are not nearly as common these days.
Most of my clients who receive contact from the FTB are contacted after they are subject to an IRS audit and merely sent a bill based on the adjustment in taxable income that the IRS has already calculated.
In other words, they let the IRS do all the hard work and send a supplemental bill later on. However, I hope that these few helpful tips will guide you in your dealings with the FTB. For more information on California state tax matters, please visit the Franchise Tax Board attorney services section of my website.
Keep in mind that the purpose of a FTB audit is to “effectively and efficiently determine the correct amount of tax based on an analysis of relevant tax statutes, regulations, and case law as applied to the taxpayer’s facts”.
As such, you need to treat the FTB audit as a routine examination of your books and records and nothing more, unless you suspect some ulterior motive or that the Franchise Tax Board auditor is fishing for additional information for a criminal case.
If you have done something criminal or feel that you are the target of a FTB criminal investigation, please do not delay and contact a qualified Franchise Tax Board audit attorney immediately.
The Flow of Information in a Franchise Tax Board Audit
Next, it is important to control the flow of information and how that information is communicated to the Franchise Tax Board. One of the things that I do for my clients when being retained to represent them in a FTB audit is to do a preliminary audit of their books and records. This helps me trace the history of reported income and substantiated deductions that the taxpayer has claimed on their return.
I also will go the extra mile by looking at their bank accounts, where the situation warrants it, and will perform a bank deposit reconciliation. This is where I trace all the information in their bank statements to confirm that it was reported property on their California state tax return.
Although these tasks involve extra work at the beginning of the audit, they can go a long way toward saving you a ton of potential tax liability. By pre-auditing a return, it will help me identify any issues that may become present before I meet with the FTB auditor.
This way, I can develop my audit strategy before walking into our first meeting with the FTB and know which directions I am going to try to steer the audit (trying to lead the auditor away from potentially disastrous queries for my client). In doing this, I can control the flow of information in the audit and usually will walk away with the best results for my client.
Tips for Franchise Tax Board (FTB) Audits
In this article, I will discuss another advantage of pre-auditing a return, the importance of the presentation of records in general, and the importance of your relationship with the auditor in order to gain successful outcomes in Franchise Tax Board audits.
The Importance of Organization in Franchise Tax Board Audits
Pre-auditing the return also has the added advantage of getting all your books and records organized and ready for the auditor prior to the audit. Appearances are very important in Franchise Tax Board audits as it helps to set the tone of an audit.
Think about it this way, if a taxpayer walks into an audit disorganized or with missing information, then how confident is the auditor going to be that the FTB tax return was prepared correctly? Not very. This is why it is essential to have all your books and records organized or as organized as possible before your very first meeting with the auditor.
Even if you have to delay providing information to the auditor, it is better to spend the extra time and having it organized instead of presenting a messy file for the auditor to have to dig through. Organization in FTB audits is critical for successful results.
In addition, having disorganized files will create more work for the auditor and create tension between the two of you. As I will cover in more detail in the next section, your relationship with the auditor is of critical importance. Providing clean and well-organized files for the auditor will go a long way to creating a good relationship.
Relationships During an FTB Audit
Speaking of good relationships, it is always important to keep in mind the golden rule of Franchise Tax Board audits: you will catch more tax breaks using honey, not vinegar. As such, active compliance and treatment of mutual respect is paramount on the path to a favorable resolution of your tax audit.
Remember, auditors are people too. If the audit becomes personal for them, you would prefer that they have a stake in your interest when they characterize your audit to management. Although IRS auditor audits are very formulaic because of the in-depth direction given by the internal revenue manual; preserving a good relationship with an IRS auditor can still go a long way in federal tax cases. California tax laws give even further discretion to FTB auditors and their supervisors, which provides further incentive to maintain the highest level of professionalism in your correspondence with the auditor.
Maintaining a good relationship with the auditor is particularly important because it leads to a good working relationship between the two of you, which facilitates compromise. This is one reason auditors prefer to make concessions to professional tax representatives; tax professionals are able to take the emotion out of the audit and engage with the auditor to reach the best resolution in the taxpayer’s interest.
Follow this same approach to ensure that your audit goes smoothly. Be professional and courteous with the auditor in all of your dealings. Be prompt to meetings and responsive in all of your responses to the auditor’s document requests.
Follow the same protocol and common courtesy that you would in any business setting and you will usually be vastly rewarded by a cooperative auditor who approaches your audit from an atmosphere of collaboration rather than one of antagonism.
Franchise Tax Board Protests – Part One
Franchise Tax Board Protests – Requirements of a Valid Protest
The California Revenue and Taxation Code provides that a taxpayer who disagrees with additional tax assessment can file a written protest against the proposed additional tax with the Franchise Tax Board. Once the FTB mails the notice of additional tax to the taxpayer, you must respond with a protest letter within 60 days. Note that the clock starts ticking from the date of notice which is written on the letter notice, and not when the taxpayer receives it.
This notice letter is called the Notice of Proposed Assessment (NPA), and it describes the procedures to follow if you would like to file a protest.
In summary, the following criteria must be met before a letter will be recorded as a protest:
- The letter must be timely.
- The letter must state the taxpayer’s name, account number and tax year.
- The letter must state the basis of the protest.
- The corporation must be active, not suspended.
A FTB employee compares the date the protest was received at Franchise Tax Board with the date of the NPA to determine that the protest was filed timely. FTB protests must be filed within 60 days of the date of the NPA. If the NPA was re-mailed to a better address, the 60-day period begins from the date the NPA was re-mailed. (The NPA copy will be stamped with “Re-mailed” and a date).
If it is determined that the protest letter was timely, then the protest will be recorded. Untimely protests will only be treated as timely if the delay was caused by the Franchise Tax Board.
Franchise Tax Board Protests – Recording a Protest
All correspondence to California FTB is forwarded to: Protest Section, Protest Control Desk, Mail Stop D-12. Protest Technicians record the protest, update internal systems and send an acknowledgment letter to the taxpayer who sent the protest to FTB.
After recording, FTB protests are reviewed by a protest unit manager, supervisor or a designated employee, who determine if this protest case can be handled by the Protest Unit, must be returned to the Protest Section for additional work or referred to FTB’s legal department.
A copy of the protest letter from the taxpayer is sent to the auditor who conducted the initial examination of the taxpayer. The auditor may respond to a letter and can provide additional information to the hearing officer who is responsible for resolving the dispute with the protesting taxpayer.
FTB protests that lack enough information or are barred by the statute of limitations (meaning that established by statute time period during which a taxpayer can protest is over), may be returned to the original unit in the Protest Section for further development and consideration. Hearing officers can discuss the case in such circumstances.
After completion, such case is returned to the Protest Unit along with a report for final determination. Then the auditor who conducted the taxpayer's audit is contacted for discussion of the case and possible revisions or withdrawal of the case against the taxpayer.
If the taxpayer or their representative disagree with the audit's recommendation, the taxpayer and representative must be informed of the protest and appeal process.
Franchise Tax Board Protest and Appeals – Part Two
Franchise Tax Board Protest Process
Taxpayers must file a FTB protest with the Franchise Tax Board, Protest Section, Sacramento, CA 95867. The protest can be filed either on FTB’s Form 3531 PROTEST or in the form of a detailed letter.
The taxpayer can request an informal oral hearing conducted in Sacramento or at one of the other FTB’s California offices. If the taxpayer does not request a hearing, then the Hearing Officer will send correspondence to the protesting taxpayer to allow them to submit information and documentation to determine whether the tax assessment is valid.
After resolution of the dispute FTB sends a Notice of Action to the taxpayer, where it notifies the taxpayer of the decision. If the taxpayer disagrees with the decision, they can appeal to the State Board of Equalization or pay the assessed tax deficiency or file a claim for refund if he or she already paid.
Different Types of Franchise Tax Board Protests (Classification of Protests)
In most cases, a Franchise Tax Board protest is undocketed, although some are docketed. Docketed protests are those involving some legal question concerning the assessed deficiency amount which has never been decided by court.
A hearing must be requested for a protest to become docketed. Docketed protests are referred to the FTB’s Legal division which resolves it and forwards appropriate information for issuance of the Notice of Action.
An undocketed FTB protest usually does not meet requirements for docketed protests and are handled by the Protest Unit without referring them to the Legal division. Sometimes undocketed FTB protests are returned back to the auditor to gather additional information or documents.
For example, such situations include assessments where the failure to furnish the information penalty was issued or substantial documentation must be gathered.
If the taxpayer protests the federal tax adjustment, such cases most likely will receive a code “PF” (Pending Federal), and will be referred to the Protest Control Desk for processing. When the taxpayer sends in the final determination, their file is routed to Corporation Audit. The case is then assigned to an auditor, who will act on it taking into consideration final federal determination.
The auditor then may reconsider the assessment and will present their findings to a taxpayer. If a hearing was requested in this case, the auditor’s letter should ask if a hearing is still desired. The taxpayer does not have to remind them of their desire to have an oral hearing and the auditor cannot discourage the taxpayer or the representative from exercising their right to an oral hearing.
Franchise Tax Board Protests Returned For Further Development
It may be determined that a protest should be returned to the originating auditor for further development. Further development implies gathering additional facts about the case. After sufficient facts are gathered, the auditor makes their analysis and sends the case along with recommendations back to the Protest Unit or Technical Resource Section within FTB.
If the taxpayer agrees with the auditor's recommendations then a Hearing Officer will issue the Notice of Action based on submitted recommendation. If the taxpayer and representative are not in agreement with the auditor’s recommendation, and they still require an oral hearing, the protest will be assigned to a Hearing Officer to conduct the oral hearing and resolve the case.
If a hearing was already requested by the taxpayer in a protest letter, then at this stage, the auditor should inquire if the taxpayer still wants a hearing. When communicating with a taxpayer, the auditor is not allowed to discourage the taxpayer from requesting an oral hearing.
A taxpayer has a right to hearing, and it is sufficient to request it only once in the protest letter.
There are certain requirements as to procedures followed by the auditor who is developing facts. First of all, the auditor should review the case independently. If the FTB withdraws the Notice of Proposed Assessment (“NPA”), the auditor must notify the taxpayer that a Notice of Action officially withdrawing the NPA will be issued in due course.
If additional information is required from the taxpayer, the auditor must request it in writing. In the initial contact letter to the taxpayer, the auditor must acknowledge the protest letter sent by the taxpayer to the FTB and the auditor is not allowed to ask the taxpayer whether they want to waive the oral hearing at that time.
Once all facts are gathered the auditor sends a position letter to the taxpayer explaining the auditor's position, findings and relevant law. A letter must have a paragraph in the end that gives the taxpayer an opportunity to agree or disagree with the auditor’s position.
If a hearing was requested, a separate paragraph should be included at the end of the letter that will allow the taxpayer or representative to waive the hearing. If any of the mentioned rules are broken by the auditor (or by rgw FTB), then it is better to promptly contact your tax attorney.
If the auditor has done the necessary additional work at protest, developed all the facts and communicated the legal analysis to the taxpayer and the taxpayer still does not agree with the auditor, the case must be referred to the Protest Unit as an unagreed case. The Hearing Officer assigned to the case will determine if a hearing is still required and will continue to work the protest case.
Even if the taxpayer agrees with the auditor's recommendation, except when the recommendation stands for withdrawal of the additional tax assessment from the FTB, but the taxpayer has not waived a hearing in writing, the case is treated if it were an unagreed case and is referred to the Protest Unit.
Franchise Tax Board Appeals
The Franchise Tax Board Appeals Process
The protester who wants to appeal the Franchise Tax Board’s decision, has 30 days to file appeal in writing from the day the FTB mails Notice of Action letter. If the taxpayer does not appeal within 30 days, the decision becomes final.
The FTB then sends the taxpayer written demand for payment, and the taxpayer must pay the amount demanded within 10 days from the day the Franchise Tax Board mailed the demand letter.
After the taxpayer files their FTB appeal, the FTB and the taxpayer will have an opportunity to provide additional information in support of their positions. An oral hearing will be conducted before the California Department of Tax and Fee Administration (CDTFA), unless both the FTB and that taxpayer waive an oral hearing.
Once CDTFA makes its decision, both the FTB and the taxpayer may request another hearing (rehearing) within 30 days of the decision. If no rehearing is requested, then the decision becomes final after the expiration of the 30-day period.
However, the decision is binding on the Franchise Tax Board, but not on the taxpayer. A taxpayer can pay the tax, then file a claim for refund, and then appeal in California Superior Court. After the California Superior Court has rendered its decision, either the FTB or the taxpayer may file an appeal on the decision to the California Appellate Court and/or the California Supreme Court and ultimately the U.S. Supreme Court.
Franchise Tax Board Appeals- Suspended Corporations
A suspended corporation is one that has had its corporate rights, privileges and powers suspended by the FTB or the Office of the Secretary of State (SOS). A corporation may be suspended for failing to file tax returns, pay taxes, pay assessments or file the necessary documents with the SOS.
Since a suspended corporation has no privileges or rights, it cannot file a protest or appeal while it is suspended. The taxpayer corporation must revive to good standing within the protest period or appeal period to have a timely protest.
Franchise Tax Board Appeals – Claim for Refund
The taxpayer may pay the tax deficiency demanded by the FTB and then file a claim for refund any time during the protest process. If the FTB denies the claim for refund, the taxpayer has 90 days from the mailing of the denial letter by the FTB to file an appeal with the CDTFA or file a lawsuit in Superior Court.
If the FTB does not take any action at all regarding the filed claim for refund, the taxpayer may still file a lawsuit in the Superior Court of California, despite the fact that the claim for refund was not officially denied by the FTB.