A recent decision by the California State Board of Equalization (“SBE”) reminds us that when an IRS audit results in the payment of additional income tax, the adjustments must be reported to the California Franchise Tax Board (“FTB”). In Appeal of LSI Logic Corporation (2009), the taxpayer settled an IRS audit by signing IRS Form 870, which is a consent to the immediate assessment of tax, on September 30, 2002. The IRS posted the audit adjustments to the taxpayer’s Business Master File (“BMF”) account on November 12, 2002. On December 6, 2002, the taxpayer entered into a Closing Agreement on Form 906 with the IRS for all years included in the audit. On December 23, 2002, the IRS posted another entry in the taxpayer’s BMF account reflecting the Closing Agreement but without further assessments.
The taxpayer reported the federal adjustments to the FTB on June 4, 2003, by filing amended California returns. On June 30, 2006, the FTB issued a Notice of Proposed Assessment based on the federal adjustment. It is not clear whether the taxpayer had not paid additional tax with its amended returns or the FTB was just assessing some additional amount.
California Revenue & Taxation Code (“R&T”) Section 18622 requires taxpayers to report federal audit changes within six months of the final federal determination. If the taxpayer reports such changes within six months, R & T Code Section 19059 allows the FTB two years from such reporting to assess additional California tax. If the taxpayer reports such changes after six months, R & T Code Section 19060(b) allows the FTB four years to make the assessment. If the taxpayer never notifies the FTB of the federal changes, R & T Code Section 19060(a) allows the FTB to assess additional tax any time.
Thus it was critical to determine the date of the final federal determination. R & T Code Section 18622(d) provides this is the date on which the adjustment is assessed pursuant to Section 6203 of the Internal Revenue Code. That section in turn provides that the assessment is made by recording the liability of the taxpayer in accordance with rules and regulations prescribed by the Secretary of the Treasury. Based on this, the SBE concluded that the assessment was made on November 12, 2002, the date of the first BMF posting. The NPA was timely because the taxpayer’s amended returns had been filed more than six months after the federal assessment so the FTB had four years to make its assessment. The taxpayer had argued that the federal assessment was not made until December 6, 2002, when the Closing Agreement was signed. Their amended returns would have been filed within six months if this had been the relevant date and the FTB would only have had two years to make its assessment.
The problem this presents for taxpayers is that in the normal course, they do not necessarily know when the IRS has recorded the assessment. Most settled audits are concluded without Closing Agreements and the IRS cannot make an assessment until the taxpayer signs the Form 870. In such a case, if the taxpayer files its California amended returns within six months of the date on which it signs the Form 870, it should be safe.