No one wants to be audited by the Internal Revenue Service (IRS). However, if the IRS examines your tax return and makes any changes to it, California taxpayers have an extra, often-overlooked obligation: they must notify the California Franchise Tax Board (FTB) of these changes. This requirement applies even if the taxpayer believes that the federal adjustment will not affect their California state tax liability. Unfortunately, many taxpayers are unaware of this rule or assume that the IRS will inform the FTB on their behalf — an assumption that can have serious, long-lasting financial and legal consequences.
Under California Revenue & Taxation Code § 18622, any taxpayer whose IRS return is altered — whether due to a voluntary change, an audit, a closing agreement, or a settlement — must notify the FTB within six months of the final federal determination. This notice is mandatory and is not contingent on the taxpayer’s belief about how the federal change impacts their California state tax position. Simply put, if the IRS adjusts your return, you have a statutory duty to report that change to California state.
What the Law Requires — and the Clock is Ticking
When a taxpayer notifies the FTB of a federal change within the required six-month period, the FTB generally has two years from the date of that notice to assess any additional California state tax. However, if the taxpayer fails to provide timely notice, then the FTB is granted a four-year window to assess additional tax, starting from when it receives “sufficiently-detailed information” from any source, including the IRS or a third-party report. In some cases, particularly where the taxpayer never files the required notice at all, the statute of limitations may remain open indefinitely.
This means that a taxpayer who believes a closed IRS audit also closes their California state tax liability may be exposing themselves to years of ongoing vulnerability. For example, if the FTB receives federal audit data through its automated exchange program with the IRS, and that data was never reported by the taxpayer directly, California may assert that the four-year statute is only beginning to run, or may even argue that the window to assess never closed.
What if You File for Bankruptcy After Failing to Notify the FTB?
Many taxpayers wonder whether old, unresolved state tax debt that stems from unreported federal changes can be discharged through bankruptcy. The short answer is: not if you failed to meet your legal obligation to notify the FTB.
In Berkovich v. California Franchise Tax Board, the Ninth Circuit dealt with precisely this question. Berkovich had undergone an IRS adjustment and failed to notify the FTB within the required six-month period. Years later, when attempting to discharge the resulting state tax liability in bankruptcy, the issue arose whether this old debt could be wiped out.
Under 11 U.S.C. § 523(a)(1), certain tax debts are non-dischargeable, including those where a taxpayer failed to file a return or provide an equivalent notice. The court concluded that Berkovich’s failure to notify the FTB of the federal change constituted a failure to file a return or equivalent notice under bankruptcy law. As a result, the tax debt could not be discharged, no matter how old it was. The consequence was clear and harsh: a procedural omission in the state’s eyes translated into permanent personal liability.
This case illustrates that failure to comply with California’s state notice requirements doesn’t just extend your tax audit exposure — it can make your tax liability bulletproof against future bankruptcy protection. The debt survives. The penalties accrue. The interest continues to build. And the taxpayer remains on the hook indefinitely.
Why the FTB Cares About Your IRS Tax Audit
It’s important to understand that the FTB does not passively accept your original California state tax return as gospel. In fact, California tax law is closely tied to the Internal Revenue Code, and the FTB is designed to capitalize on federal tax audit results to ensure consistency and compliance. When the IRS disallows a deduction, corrects income upward, or recalculates credits, those changes almost always impact the California state tax return.
To keep tabs on these adjustments, the FTB has a robust data-sharing system with the IRS, receiving daily and weekly reports that include CP2000 notices, IRS Form 4549 (Examination Reports), settlement agreements, audit closing letters, and criminal tax investigation outcomes. Once the FTB receives this information, even years later, it can open an audit, assess civil and criminal tax penalties, and demand payment unless the taxpayer can prove they already reported the change.
This means that even if you believe your IRS matter is resolved, you are operating under a false sense of security unless and until the FTB receives direct, timely notice from you.
Penalties for Failing to Notify the FTB Can Be Harsh and Long-Lasting
Taxpayers who fail to comply with § 18622 may face a variety of California state-level enforcement measures. These include:
- Extension of the Statute of Limitations: As noted, a failure to notify the FTB expands the time window for the state to make assessments. The window may become four years or, in some cases, may never close at all if sufficient notice is never received.
- Retroactive Interest and Late Payment Penalties: Once an assessment is made, the FTB charges interest retroactively from the original filing due date of the return. In addition, a 25% late payment penalty may apply.
- Accuracy-Related Penalties: If the FTB believes the taxpayer was negligent or substantially understated their liability, a 20% penalty can be assessed on top of the tax owed.
- Civil Fraud and Potential Criminal Tax Penalties: In more serious cases, such as where the taxpayer intentionally/wilfully misrepresented facts or ignored known audit outcomes, the FTB may apply a 75% civil fraud penalty or refer the case for a life-altering criminal tax prosecution under California state law.
IRS and FTB Audits Are Not the Same — and One Does Not Cancel the Other
One of the most common — and costly — misconceptions is that resolving your federal tax audit automatically resolves your California state tax situation. This is simply not true. Even if the IRS has issued a final report or you’ve agreed to an Offer in Compromise or closing agreement, the FTB retains independent enforcement authority and may take a more aggressive position than the IRS.
Additionally, if you handled your federal tax audit with the help of a CPA or enrolled agent, rather than a tax attorney, the attorney-client privilege does not protect your communications. That means everything you admitted or disclosed may become discoverable in a California state audit or enforcement proceeding.
If you are undergoing a high-risk tax audit, such as an eggshell or a reverse eggshell audit, or worse, an IRS-CI criminal tax investigation, it is critical to engage a dual-licensed Civil and Criminal Tax Attorney and CPA at the earliest stage possible to ensure that your California state tax risks are analyzed and mitigated concurrently with your federal tax exposure.
Contact the Tax Law Offices of David W. Klasing if You Are Facing FTB Enforcement or IRS/FTB Overlap Issues
If you have recently been audited by the IRS or received a final federal determination, you may face unexpected financial consequences if you fail to notify the California Franchise Tax Board (FTB) within the required six-month window. At the Tax Law Offices of David W. Klasing, we understand that many taxpayers assume a federal resolution automatically resolves their state issues. This critical misconception can lead to aggressive FTB enforcement, unexpected civil and criminal tax penalties, and long-term financial harm. For example, a self-employed contractor who agrees to a $100,000 IRS income adjustment but fails to file an amended California return can face years of back taxes, interest, and penalties once the FTB receives the IRS closing report. Similarly, a taxpayer who successfully settles with the IRS through an Offer in Compromise (OIC) might mistakenly believe that California will honor the same terms, only to receive a Notice of Proposed Assessment (NPA) demanding full payment of the original state liability. Worse, taxpayers who fail to notify the FTB can find themselves with non-dischargeable tax debts in bankruptcy, as seen in In re Berkovich, where the court held that unreported state tax debts survive even after federal discharge.
At the Tax Law Offices of David W. Klasing, our dual-licensed Tax Attorneys and CPAs provide comprehensive support to taxpayers facing complex IRS/FTB overlap issues. We can review your IRS tax audit outcome, ensure timely FTB disclosures, and prevent costly errors like missed notice deadlines, which can lead to indefinite statute extensions and compounded penalties. Our strategic approach includes evaluating bankruptcy dischargeability risks, shielding clients from self-incrimination, and negotiating with both the IRS and FTB to resolve overlapping tax liabilities as efficiently as possible.
Don’t wait for the FTB to act — if you are facing a California state tax assessment, received an IRS adjustment, or have concerns about your federal and state tax obligations, call the Tax Law Offices of David W. Klasing at (800) 681-1295 or contact us online to schedule a reduced-rate initial consultation today.
