The Internal Revenue Service (IRS) administers tax laws and penalties on the federal level. In California, the state equivalent to the IRS is the Franchise Tax Board (FTB), which collects and reviews California tax returns for businesses and individual taxpayers. Like the IRS, the FTB routinely conducts audits to ensure that businesses and individuals are reporting their income, paying their tax debts, and complying with other state tax laws under the California Revenue and Taxation Code (RTC). And, like the results of an IRS audit, the results of an FTB audit may be challenged, or “appealed,” by taxpayers who disagree with FTB findings. The question is, how does a California taxpayer begin this process? In this article, our California tax attorneys will help you understand some basics about the rules and procedures for challenging (“protesting”) an FTB decision through the Office of Tax Appeals (OTA).
FTB Audit Process in General
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.
Did You Receive a Notice of Proposed Assessment (NPA) from the Franchise Tax Board (FTB)?
You may be reading this article because you recently received a Notice of Proposed Assessment (NPA) from the FTB informing you of unresolved tax liabilities. There are two versions of the NPA:
- FTB Form 7275 (Personal Income Tax Notice of Proposed Assessment Information), which is for individuals
- FTB Form 5830C (Business Entity – Notice of Proposed Assessment Information), which is for businesses
As FTB Form 7275 states, “The Notice of Proposed Assessment (NPA) informs you that we intend to assess additional tax and/or penalties. You have a right to protest the NPA, which must be submitted within 60 days of the NPA date, or submitted by the Protest By date.” This reflects the provisions of California Revenue and Taxation Code § 19041(a), which states, “Within 60 days after the mailing of each notice of proposed deficiency assessment the taxpayer may file with the Franchise Tax Board a written protest against the proposed deficiency assessment, specifying in the protest the grounds upon which it is based.”
If you received an NPA from the Franchise Tax Board, do not panic. As state law provides, you have an opportunity to appeal, or protest, the FTB’s findings. If your protest is successful, you may not have to pay the additional tax debts or tax penalties the FTB would otherwise assess against you.
As the FTB explains in FTB Notice 2018-01, each protest will be assigned to an FTB official called a “hearing officer” for review. This hearing officer might represent the FTB’s Legal Division or its Audit Division, depending on the situation. If the protest is directed to a hearing officer in the Legal Division, it will be referred to as a “docketed protest.”
Because the FTB recently changed its internal procedures for processing Legal Division (docketed) protests, taxpayers would be wise to familiarize themselves with the updated regulations, which are discussed at length in FTB Notice 2018-01. Our Irvine tax attorneys will discuss these procedures momentarily, but first, will provide a brief overview of how to protest a proposed FTB assessment.
How to Protest a Proposed FTB Assessment Online or in Writing
You may make your protest online, by mail, or by fax. Needless to say, filing online ensures faster delivery with no risk of lost mail. You may make a protest online by following these instructions:
- Navigate to the FTB website.
- If you have an account already, log in. If not, you will need to register as a new user.
- Once you have created or logged into your account, click the “Account” link.
- Click the “Proposed Assessments” link.
- Choose the correct NPA number, and follow the prompts to complete the online submission process.
If you are submitting a written protest, which may be either mailed or faxed, be sure the protest includes all of the following information. Failure to include the following may cause processing delays that complicate your case:
- Your contact information
- Contact information for the person handling the protest
- Your TIN or SSN
- The amount in question
- The tax year in question
- A statement of facts (an overview of your argument), which must be supported by evidence, laws, and factual information
- Whether you agree with any detail or aspect of the proposed assessment
- Your signature (or that of your attorney)
Finally, keep the following points in mind:
- Whichever method you choose, you must file the protest within 60 days of the date specified on your NPA.
- Filing a protest will not prevent interest from accruing, which can be accomplished only by making a payment to the FTB. However, before issuing a payment to the FTB, you should discuss your tax liabilities with a knowledgeable Los Angeles tax attorney.
- You have the option to have a representative handle your documentation for you. It is highly advisable to hire a tax professional for FTB audit representation. In addition to managing deadlines and paperwork, your tax lawyer will also ensure that your rights are not being violated, and will work to keep any financial penalties to a minimum.
Appeals will be directed to the California Office of Tax Appeals (OTA), which was created last year.
Processing FTB Docketed Protests
Returning to the matter of changes to the processing procedures for docketed protests (protests referred to the Legal Division), here are a few highlights that taxpayers should be aware of:
- According to FTB Notice 2018-01, “The goal will be for staff to make initial contact with the taxpayer or the taxpayer’s representative within 120 days, or less, of the filing of the protest,” which means you should expect to hear from the FTB within four months of your submission.
- The contact described above will contain “a request to establish an agreed hearing date if a hearing has been requested,” and may contain a request for additional documents or information.
- Importantly, italics our emphasis, “Issues not raised by the taxpayer… in writing within the 60-day protest limitation period ordinarily will not be considered unless these issues can be considered and resolved within the above timeframe for processing docketed protests.”
- After the protest hearing (where applicable), the “taxpayers or taxpayer representatives ordinarily
will be required to file an appeal with the Office of Tax Appeals (OTA).” No appeal may be filed until the FTB issues a Notice of Action.
For additional information, taxpayers may wish to:
- Explore the OTA website
- Read our previous article discussing California’s Taxpayer Transparency and Fairness Act of 2017
California Tax Lawyers Providing FTB/OTA Audit Representation
If you intend to protest the outcome of an FTB audit, you should consult an experienced tax lawyer to ensure that you are taking the best course of action to protect yourself. At the Tax Law Offices of David W. Klasing, our tax professionals have been representing Californians in tax appeals before the IRS and FTB for over 20 years and will take your case all the way to litigation if necessary to put you in the best position possible. We have an in-depth understanding of OTA audits and FTB procedures, and will work tirelessly to protect your best interests from day one of your matter. For a reduced-rate tax consultation concerning an IRS audit or IRS appeals, an OTA audit or protest, or other type of tax audit or appeal, contact the Tax Law Offices of David W. Klasing online, or call (800) 681-1295 today.
Also, we’ve expanded our offices! In addition to our offices in Irvine and Los Angeles, the Tax Law Offices of David W. Klasing now have offices in San Bernardino, Santa Barbara, Panorama City, and Oxnard! You can find information on all of our offices here.
Basics of IRS Appeals Representation
