Taxpayers often think of the Internal Revenue Service (IRS) as the ultimate authority on taxes. However, if you live or do business in California state, its tax agencies can create equally daunting and sometimes even more aggressive tax issues for you. California does not simply mirror federal tax law; instead, it enforces its own complex rules through multiple agencies. Each of these tax agencies – the Franchise Tax Board (FTB), the Employment Development Department (EDD), and the California Department of Tax and Fee Administration (CDTFA) – can initiate high-risk tax audits, assess taxes, and impose civil and criminal tax penalties that can exponentially compound your problems. It’s a perfect storm: high state tax rates, unique laws that don’t conform to federal rules, and vigorous enforcement & more often than not, rubber stamping appeals and tax court, combine to catch taxpayers off guard.
The Tax Law Offices of David W. Klasing is a boutique California tax law firm renowned for its dual-licensed team of Tax Attorneys and Certified Public Accountants (CPAs) who bring a combined 75+ years of tax and accounting experience. We offer an edge in understanding both the legal complexities and the accounting intricacies of tax disputes. Our firm has deep experience resolving the most complex civil and criminal tax issues at both the federal and California state level, from high-risk IRS tax audits and appeals to FTB assessments, EDD payroll tax disputes, and CDTFA sales tax examinations.
We know how downright frightening dealing with the IRS or California agencies can be for you, so our goal is to aggressively protect your rights while guiding you toward the best possible outcome in every forum. With clear communication and diligent advocacy, we strive to resolve your tax problems efficiently – whether it’s fighting an unjust audit result, negotiating a settlement, or helping you voluntarily disclose past non-compliance before it turns into a life-changing criminal tax case. If you have received any federal or California state tax audit notice—or suspect a tax audit or criminal tax investigation is brewing—contact us online to schedule a reduced-rate initial consultation, or call (800) 681-1295 today.
FTB, EDD & CDTFA—Three California Agencies That Trigger Civil and Criminal Tax Nightmares
In California state, three central agencies administer and enforce tax laws, each posing unique challenges for taxpayers. Understanding their roles is key to appreciating how they can create tax issues for you:
Franchise Tax Board (FTB)
The FTB administers California’s income tax (personal and corporate) and is often considered California’s equivalent of the IRS for state income tax matters. The FTB can audit your California tax returns and assess additional state tax if it believes you underreported income or took improper deductions. It operates under rules that sometimes give it a longer reach than the IRS – for example, the FTB generally has four years after you file to audit (compared to the IRS’s usual three-year limit). The FTB aggressively pursues residents (and even former residents or out-of-state businesses) for taxes, leveraging California’s high 13.3% individual tax rate and 8.84% corporate tax rate to pull people into its tax net. The agency’s tactics can be tough: if you fail to file a return after an FTB demand, they may file one for you with an inflated tax bill and impose a “demand to file” penalty of 25%. The FTB’s collection powers are strong as well, and it’s not afraid to issue bank levies or garnish wages to collect delinquent California income taxes. They also prosecute tax crimes and make referrals to the IRS Criminal Investigation division. They also share audit results with the IRS and visa versa.
Employment Development Department (EDD)
EDD enforces payroll taxes and California’s strict AB 5 “ABC” test for classifying workers. Reclassifying contractors as employees can saddle a business with back withholding, unemployment insurance, disability insurance, interest, 15 percent late-deposit penalties, and fraud penalties, plus personal liability for owners who “willfully” evade payroll tax. Learn more about EDD tax audits here.
California Department of Tax and Fee Administration (CDTFA)
The CDTFA (formerly part of the State Board of Equalization) administers California’s sales and use taxes and various other special taxes and fees. If your business sells goods or provides services in California, even in the absence of physical presence, if sufficient economic presence, you likely must collect sales tax and remit it to the CDTFA. Auditors will examine your gross receipts, compare them to income reported on federal tax returns, and look for discrepancies indicating unreported sales. If your records are incomplete, the CDTFA may estimate your sales, often unfavorably, leading to inflated tax assessments. Like the FTB and EDD, the CDTFA wields heavy civil and criminal tax enforcement tools. If a corporation fails to pay its sales tax, the CDTFA can hold corporate officers, owners, and other responsible persons personally liable for the unpaid sales tax. Click here to find more about CDTFA tax audits.
The Domino Effect: One Audit Begets Another
Federal and California state tax agencies swap data constantly, so a single adjustment rarely stays isolated. If the IRS changes your tax return, California law gives you six months to report the federal adjustment to the FTB; miss that deadline, and the state’s statute of limitations stays open indefinitely, allowing the FTB to assess tax, interest, and elevated penalties years later. Even if you do nothing, the IRS eventually transmits its audit results to Sacramento, where the FTB will recompute your state tax and issue a bill. Conversely, state findings travel upstream: EDD payroll-tax reclassifications, CDTFA sales-tax understatements, and FTB income-tax adjustments flow to the IRS, often sparking fresh federal examinations or clandestine criminal-tax referrals, especially when unreported income or worker misclassification is involved.
California tax agencies are also known to keep their eye out for potential referrals to tother California agencies. i.e. if the CDTFA determines that sales were underreported by $100,000 or more in one quarter because cash sales were not reported, it will inform the FTB whom might inform the IRS criminal tax division. This scenario creates a perfect storm of criminal tax exposure.
Because the agencies compare files in real time, taxpayers frequently endure simultaneous tax audits: an IRS business exam triggers an FTB follow-up, or an aggressive FTB audit prompts the IRS to re-open additional years. Each adjustment fuels the next; a $10,000 federal omission can morph into equal state income, payroll, or sales-tax assessments, compounding interest, and stacking penalties on both sides. The lesson: always assume the IRS and California “share notes.” Address federal and California state exposure together—amend returns promptly, coordinate responses, and resolve every jurisdiction—otherwise, a settled issue can re-emerge months later as a new, bigger bill or criminal tax investigation & prosecution.
Unique California Civil and Criminal Tax Penalties and Taxpayer Exposure
California state imposes a range of severe civil and criminal tax penalties that can significantly increase a taxpayer’s financial exposure, particularly when combined with federal assessments. Unlike the IRS, which typically caps accuracy-related penalties at 20% or 75% for fraud, California state has a more aggressive penalty structure in some instances. Here are some of the most significant penalties:
40% “Double” Accuracy Penalty
Unlike the IRS’s standard 20% accuracy-related penalty for substantial understatements, California state can impose a 40% penalty in certain high-risk cases, such as tax shelters, abusive tax transactions, or items that could have been disclosed during the state’s 2003 tax amnesty program. This penalty can stack on top of the federal 20% penalty, resulting in a combined 60% hit on the same underpayment – a crippling amount when interest is added.
50% Interest-Based Amnesty Penalty
California’s unique amnesty-related penalty applies if a taxpayer had an unpaid balance eligible for the 2003 amnesty but did not participate. The FTB can impose a penalty equal to 50% of the interest that accrued on the original tax debt, calculated from the original due date of the return. Unlike typical penalties based on taxpayer behavior, this is a one-time, purely punitive charge, which can dramatically increase the cost of resolving old tax liabilities.
Demand to File Penalty (25%)
If the FTB issues a demand to file a missing return and the taxpayer ignores it, a 25% penalty can apply, even if the final tax due is reduced or eliminated. This penalty is based on the FTB’s proposed assessment before credits or deductions, potentially resulting in a large penalty even when the actual tax owed is zero.
Frivolous Tax Argument Penalty ($5,000)
Both the IRS and FTB impose a $5,000 penalty for submitting returns with baseless tax arguments, like the discredited “wages aren’t taxable” position. Taxpayers making such frivolous claims can be hit with double penalties at the federal and state levels.
EDD Payroll Tax Penalties
Employers face severe penalties for failing to file payroll tax returns or misclassifying workers. The EDD can impose a 15% penalty for late filings and significantly higher fines ($5,000 to $25,000 per violation) for intentional misclassification. In extreme cases, the EDD can refer matters for criminal tax prosecution, leading to possible prison time for responsible parties.
CDTFA Sales Tax Penalties
The CDTFA can impose a 10% penalty for late filing or payment of sales tax, a 25% penalty for substantial underreporting, and a 50% fraud penalty for intentional evasion. Businesses without a valid seller’s permit can also face criminal charges for continued sales. Other miscellaneous criminal sales tax charges are possible.
California Tax Fraud Penalty (75%)
Like the IRS, California state imposes a 75% civil fraud penalty if the FTB determines that a tax deficiency was due to intentional fraud. This is on top of the federal 75% penalty, meaning a taxpayer could face a combined 150% penalty for the same underpayment before interest. If either the IRS or California has the evidence to assert the fraud penalty, they are also in a position to criminally prosecute.
The cumulative effect of these penalties can be financially devastating. For instance, if the IRS imposes a 75% fraud penalty on a $100,000 understatement, that adds $75,000 in federal penalties. If California imposes its own 75% fraud penalty and potentially another 40% accuracy penalty, the total penalties can exceed the original tax owed, making the financial impact potentially catastrophic.
Contact the Tax Law Offices of David W. Klasing if You Face Federal or California State Tax Problems
At the Tax Law Offices of David W. Klasing, our dual-licensed Civil and Criminal Tax Defense Attorneys and CPAs have decades of experience representing clients in high-risk IRS audits, FTB income tax disputes, EDD payroll tax examinations, and CDTFA sales tax audits and federal and California criminal tax investigations. We understand how quickly a single tax issue can snowball into a multi-agency inquiry, significantly increasing your financial and legal risks. If you’ve undergone an IRS audit, we can assist in promptly amending your California returns within the six-month window required to close the state’s statute of limitations, avoiding long-term exposure to additional penalties.
For businesses, we provide critical guidance on worker classification under California’s strict AB 5 standards, reducing the risk of EDD audits and misclassification penalties that can quickly spiral into criminal tax investigations. Our firm also prepares clients to face aggressive audit tactics, such as bank-deposit analyses and lifestyle-expense tests, by ensuring bulletproof financial records that effectively rebut common erroneous audit assumptions. If you have past non-compliance, such as unfiled returns or hidden offshore accounts, we guide clients through federal and California voluntary disclosure programs to minimize penalties and avoid life-altering criminal tax referrals before the IRS or FTB takes action.
If you have received a tax audit notice or suspect that you may be under federal or California criminal tax investigation, don’t wait for the situation to spiral out of control. Early intervention is essential to prevent latent civil and criminal tax issues from escalating into severe financial or legal problems. As dual-licensed Tax Attorney-CPAs, we can handle federal and California state tax disputes simultaneously, invoke privilege in sensitive interviews, and coordinate defenses to avoid conflicts between agencies. Contact the Tax Law Offices of David W. Klasing for a reduced-rate initial consultation to protect your rights and financial future. Call us at (800) 681-1295 or reach out to us online today.
