They say in life timing is everything. Nowhere in the state tax world is that statement more important than complying with the state filing requirements for reporting changes to federal taxable income. All states require corporate taxpayers to report changes in federal taxable income. In theory, the task of reporting adjustments to federal taxable income to the various states should not be a daunting task. However, anyone who has been responsible for the reporting of federal changes knows in reality due to a lack of statutory and regulatory guidelines and uniformity among taxing jurisdictions the reporting process is extremely complex, cumbersome and time consuming. A taxpayer is generally required to notify the state if there has been a change in federal taxable income that was reported on a previously filed return. The triggering event for the filing requirement in most states is a final determination at the federal level. However, the term "final determination" may not be defined and there is no uniform approach to determining what constitutes a final determination at the federal level.
For example, Alabama would conclude that the federal determination is final when the taxpayer and the IRS agree to the change. A final determination may also be an administrative order or judicial decree that may not be appealed. In contrast, states like Delaware, Georgia, and Hawaii provide no guidance and merely state that an amended return is required if the amount of federal taxable income has changed. Idaho, on the other hand, considers a federal audit final when all issues have been resolved. States such as California, Massachusetts, and Texas have attempted to provide more detailed definitions of "final determination." The different approaches to defining the triggering event for reporting changes to federal taxable income are just one example of the complexities encountered due to the lack of definitions, common terms and basic uniformity. These complexities are compounded by the timing of the state reporting, e.g., 30, 60, 90 days from the final "federal determination," the potential of a different timing requirement for refunds, the lack of conformity with the Internal Revenue Code ("IRC") and the state return filing methods.
This article will address the timing issues that arise as a result of the interaction between the federal procedures, the state reporting requirements in determining a "final determination" and the state return filing methods.
I. The Federal Audit and Appeals Procedure
It is important to have a working knowledge of the federal tax audit and appeal procedures, because these procedures are the triggering events for determining the timing of reporting changes in federal taxable income to the states. The Internal Revenue Service ("IRS") has the authority to determine if corporate income tax has been properly reported and paid. In general, the IRS has three years from the due date of the return to assess the deficiency. However, the taxpayer and the IRS may agree in writing to extend the period of time in which the IRS may assess tax. The consent to extend the statutory period generally takes one of three forms: (1) a fixed period consent, Form 872; (2) an open ended consent, Form 872-A; and/or (3) an extension that is restricted to extending the period for a specific issue. A taxpayer has three years from the date of filing a return or two years from the date the tax was paid to file a federal tax refund claim. As with assessments, the parties may agree to extend the statutory period in which a claim for refund may be filed. If the parties have agreed to extend the statutory period for assessments, the period in which a claim may be filed is extended to six months after statutory expiration for issuing an assessment. An extension of the federal statute and the type of extension will impact the state filing requirements. For example, an extension that is restricted to a specific issue may result in a final determination for some but not all of the federal adjustments. Thus, potentially triggering a reporting requirement for some but not all of the federal adjustments.
There are a number of possibilities resulting from a federal audit that may and will impact a multistate or multinational corporate taxpayer's state reporting requirements. Multistate/multinational corporate taxpayers generally file a federal consolidated return that includes a number of entities. As a result, the federal audit of a consolidated return may result in adjustments that differ by entity. For example, the audit may result in no adjustments to one or more of the consolidated entities, whereas other included entities may have adjustments that impact the consolidated group's taxable income but not necessarily the separate corporate entities taxable income. Upon conclusion of the audit process, the taxpayer may agree with all of the adjustments proposed by the IRS. Alternatively, there may be no agreement with respect to proposed adjustments or an agreement with regard to some but not all of the proposed adjustments. Each of these scenarios gives rise to issues that will impact the state filing requirements.
A. Agreed Federal Audit
Agreed adjustments will be reflected on a Form 4549, Income Tax Examination Change. To the extent a taxpayer agrees with the audit adjustments, the taxpayer will sign Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment. By signing Form 870, the taxpayer waives the right to notice of deficiency and consents to the additional tax. The agreed tax may be immediately assessed. In general, the execution of the Form 870 will preclude the taxpayer from contesting the adjustment in the United States Tax Court ("Tax Court"). However, the taxpayer is not precluded from filing a refund claim with the IRS. It should be noted that the IRS is not bound by this form and is not required to sign it. Also, the IRS is not precluded from issuing additional assessments during the course of the audit. As a result, during the course of an audit a number of Forms 870 may be issued and signed by the taxpayer. The question, is does the issuance of the Form 870 by a taxpayer constitute a "final determination" triggering a state reporting requirement.
B. Unagreed or Partially Agreed Federal Audits
In those instances where an audit is unagreed or only partially agreed, the IRS will issue a Form 4549-A or 4549-B, Income Tax Change, which provides the tax adjustments. These forms, unlike Form 4549, do not provide for taxpayer consent. To the extent any of the proposed adjustments are agreed, the IRS will request that the taxpayer sign a Form 870. The unagreed items will be reflected on a Notice of Proposed Deficiency, commonly referred to as a "30-day letter." The 30-day letter will detail the nature and amount of the proposed adjustments. A taxpayer has 30 days from the date of the letter to file a protest with the IRS Office of Appeals ("Appeals Office"). If a protest is not filed within 30 days, the IRS will then issue a statutory notice, commonly referred to as a "90-day letter." Upon issuance, the taxpayer has 90 days to file a petition with the Tax Court to contest the deficiency. What, if any, impact does the issuance of a 30 day letter have with respect to triggering the state reporting requirement? Absent a specific statutory requirement, the argument would be the taxpayer by filing the appeal is now engaged in the IRS appeals process and the matter is not final.
C. The Federal Appeals Process
Upon receipt of a 30-day letter, a taxpayer must file a protest and specifically request that the case be considered by the Appeals Office.  Failure to respond within 30 days will trigger the issuance of a 90-day letter. Upon receipt of a 90-day letter, a taxpayer may request that the matter be addressed by the Appeals Office. However, such a request must be made prior to the expiration of the time for filing a petition with the Tax Court. If a matter is addressed by the Appeals Office, the final report may take one of several forms. The Appeals Office may issue a Form 3610, or, alternatively, a Form 5278, which sets forth the adjustments to the audit results made by the Appeals Office. This form details the adjustments made at the appeals level and the tax effect of those adjustments. In addition, depending upon the amount of the tax liability, the Appeals Office may also prepare a report for the Joint Committee on Taxation ("Joint Committee"). Issues which are resolved at this level are final and would trigger a state reporting requirement in those jurisdictions which do not apply the concept of "final" determination to the entire audit.
The taxpayer also has an opportunity to resolve (e.g., settle) a matter at the appeals level. The settlement of a non-docketed case by the Appeals Office may be memorialized by use of one of several forms. The Appeals Office may request that a taxpayer sign a Form 870. Alternatively, the taxpayer may sign a Form 870-AD, Offer to Waive Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment. The Form 870-AD prohibits re-opening the case by both the taxpayer and the IRS and is effective only upon acceptance by the IRS. Specifically, the taxpayer agrees not to sue for a refund. However, the execution of a Form 870-AD by the IRS does not constitute a binding contract between the taxpayer and the IRS. While, the execution of the Form 870-AD may not be a binding contract on the IRS it would be considered a final determination for purposes of triggering a state reporting requirement. The Appeals Office may also issue a closing agreement - either a Form 866 or Form 906. Form 866, Agreement as to Final Determination of Tax Liability, provides finality as to the specific tax liability. Form 906, Closing Agreement on Final Determination Covering Specific Matters, provides finality to specific issues. The execution of a Form 906 is a binding contract between the parties and concludes the dispute. It should be noted that the IRS rarely uses this form to close an audit. The execution of either of these forms would be characterized as a final determination for triggering a reporting requirement for the issues/adjustments.
If, after consideration by the Appeals Office, the issues cannot be resolved or an agreement cannot be reach by the parties, the Appeals Office will prepare a 90-day letter (e.g., statutory notice of deficiency). The taxpayer has 90 days from the date of the notice to file a petition with the Tax Court. Upon filing of the petition, the case becomes a docketed matter. It is possible to reach an agreement with the IRS on a docketed matter. If such an agreement is reached on some or all of the issues prior to trial, a Stipulation of Agreed Deficiency will be filed with the Tax Court. To the extent some or all of the issues remain unagreed, the matter will proceed to trial before the Tax Court. The state reporting requirement may be triggered by resolving some of the issues and filing a Stipulation of Agreed Deficiency with the Tax Court.
D. Federal Claim for Refund
The IRS is authorized to credit the amounts of overpayment against any tax liability of the taxpayer who made the overpayment. The IRS may also refund the balance. In general, a claim for refund is made by filing an amended return, Form 1120X. The claim must set forth the amount to be refunded, the basis for the claim, and the support for the claim. A corporation that has incurred a net operating loss, a net capital loss, or an unused general business credit may file an Application for a Tentative Refund, Form 1139, within 12 months of the end of the year in which the net operating loss, capital loss, or unused credit arose. The filing of a Form 1139 may trigger a state reporting requirement as it could be characterized as a change in federal taxable income.
Should a taxpayer file a claim for refund after receipt of a 30-day letter, the claim will be treated as a protest of the notice of deficiency. If the claim relates to the matter pending in the Appeals Office, it will also be addressed by the Appeals Office. The unanswered question from a state reporting perspective is whether a refund claim that is converted to a protest trigger a reporting requirement. There is no definitive answer but the analysis should start with how the jurisdiction would characterize the 30 day letter.
A refund suit may be filed not earlier than six months and not later than two years from the date of the refund claim. It should be noted that the parties may extend the two years period by filing a Form 907, Agreement to Extend the Time to File Suit. The extension of the period may also impact the timing of the state filing requirements. No refund or credit in excess of two million dollars may be paid until the report of such refund has been submitted to the Joint Committee. The payment may be paid no earlier than 30 days after the report has been submitted. The payment of the federal refund is likely a final determination and the triggering event for reporting the changes to federal taxable income at the state level. However, it should be noted, that a number of states have different reporting requirements and reporting time limits for refunds.
II. Impact of State Filing Methods on RAR Reporting Requirements
A. Federal Conformity Impact on Reporting RARs
In analyzing the federal adjustments a determination has to be made as to whether the adjustment has an impact on state taxable income under the specific statute. The extent to which a state conforms to the IRC will have a direct impact on that analysis. Federal conformity in general refers to whether the state tax base conforms to or corresponds with the federal taxable income. As a general rule, there is some level of conformity to the IRC, but the states are not uniform in the adoption of the IRC. There are three basic ways state income tax laws cross reference the IRC: (1) piggy back the code as it exists in the tax year; (2) static federal base reference as to a specific date; and (3) enact specific provisions of the IRC. In addition, numerous states have decoupled from specific provisions. There is little guidance on whether a final federal adjustment that has no state impact is a triggering event for state reporting purposes. Absent specific guidance it may be logical to assume if there is no state impact there should be no reporting requirement.
B. Manner of Filing Impacts the Reporting Requirements
The different state return filing methods add further complexity to the state reporting requirements. The manner in which a return is filed may impact not only the timing of the state reporting requirements but also what adjustments are required to be reported. There are three basic approaches to computing and reporting taxable income at the state level: separate return filing methods, combined reporting method, and the consolidated return method. Each of these methods due to individual state tax policies has variations which create additional issues with respect to reporting federal audit changes. The fundamental question relates to whether a "final determination", e.g. the triggering event relates to each separate corporate entity, all of the entities included in the return or all of the entities included in the federal consolidated return.
1. Separate Return Method
A number of states require or allow taxpayers to file using the separate return method. On a separate return basis each taxpayer with nexus in the taxing state computes its own income, deductions, and credits, as well as its own apportionment factors. The individual taxpayer then files a return and pays tax based upon its separately computed apportionable taxable income. Although the starting point for computing taxable income may be federal taxable income there are state specific addition and subtraction modifications to federal taxable income, e.g. depreciation, taxes imposed on or measured by net income, credits and/or dividends, that must be taken into consideration. Further, while the starting point may be federal taxable income, the unitary business principle must be applied to determine the scope of the state tax base. The states' jurisdiction to tax is limited to a taxpayer's unitary business income. Thus, certain income including gains and losses may be excluded from the state tax base. The entity's state taxable income will then be apportioned using the company's separate apportionment ratio. As noted, state taxable income does not necessarily conform to the income reported on the federal return. For purposes of complying with the state reporting requirements, the federal audit adjustments must be analyzed on a separate company basis to determine if (1) any of the adjustments are agreed and final and (2) do any of the adjustments impact state taxable income. To the extent there are final federal adjustments that impact separate company taxable income the state filing requirement should be triggered. The unanswered question relates to whether a state report is required if the federal adjustments do not impact state taxable income.
There are a number of variations of the separate return filing method. For example, a state may allow affiliated corporations with nexus in the taxing state to elect to calculate and apportion taxable income on a separate company basis, but report the separately calculated apportionable taxable income on a single return, e.g. nexus combination on a post-apportionment basis. Thus, affiliated entities that meet a statutorily-prescribed relationship test are permitted to report their taxable income, calculated on a separate entity basis, in the aggregate on a single return. While, technically, this reporting method may be considered a separate return filing method, it does acknowledge the relationships of an affiliated group of corporations. If a taxpayer has elected to file in this manner the analysis of the federal adjustments becomes more complex. As each separate entity's final adjustments must be analyzed and a determination made as to whether there is a reporting requirement, e.g. the adjustments are final and the adjustments impact the computation of state taxable income. The reporting requirement is made more complex due to the likelihood that some of the return members may have federal adjustments that are not final. The application of the concept of "final determination" becomes important; is it applied on an entity by entity basis? If the answer is yes then multiple amended returns may be required to be filed as the issues are resolved at the federal level.
2. Combined Reporting Methods
The unitary business principle is the foundation of the traditional method of combined return reporting. This method dictates that the apportionable tax base includes the income of the entire unitary business group without regard for the business's organizational structure. Under the unitary principles all members of the unitary business group are in theory treated as a single entity requiring the taxpayer to include the income and factors of other affiliated entities engaged in the same unitary business in calculating its apportioned share of the unitary business's income. Because the application of these unitary business concepts, the composition of a combined reporting group may vary from the composition of a federal consolidated return group. The unitary theory has little application to the analysis and reporting of federal adjustments. As with the other return filing methods, the federal adjustments must be analyzed on entity by entity basis to determine if final and the impact, if any, on state taxable income. The fundamental question remains the same, do final adjustments for one member of the unitary group trigger a reporting requirement for the entire group.
To add further complexities for determining the triggering event, states for various policy reasons, may exclude otherwise unitary members from the unitary business group, ex. a unitary entity that is required to use a special industry formula may be excluded from the group. States may also decide, for reasons of policy or administrative ease, to exclude entities in the group which operate as flow-through entities. A number of states provide that pass-through entities, including, but not limited to, partnerships, limited liability companies not taxed as corporations, and S corporations, are not members of the combined group. However, the combined group's share of the pass-through entity's income and apportionment factors is required to be included in the combined group's income and apportionment factors. Adjustments made at the federal level to the taxable income of these entities must be reported to the states. The timing of the finalization of the federal audit of the pass-through entity may not coincide with that of the consolidated federal group. These policy decisions further complicate the state reporting requirements.
3. Consolidated Return Method
States define the term, "consolidated return," differently. Some state use the term to refer to a filing method similar to the federal consolidated return regime. Other states use consolidated return" to describe the manner in which a return is prepared, i.e., using a version of the separate return method. The term is sometimes used to refer to what has been described above as the combined return method.
States which permit a group of affiliated taxpayers to file using the federal consolidated return method typically follow the federal rules to calculate the group's apportionable tax base ("consolidated taxable income"), to which the group's combined apportionment factor is applied. The requirements for inclusion in the consolidated group may mirror the requirements set out in the Internal Revenue Code or may involve a state's own statutory ownership tests, which generally require at least 50 percent direct or indirect ownership. For example, in Virginia, a single consolidated return may be filed for a group of affiliated corporations, where "affiliated" means "two or more corporations subject to Virginia income taxes whose relationship to each other is such that (i) one corporation owns at least 80 percent of the voting stock of the other or others or (ii) at least 80 percent of the voting stock of two or more corporations is owned by the same interests." To the extent a consolidated return is mandatory or elective the fundamental question remains the same: does the triggering event, e.g. final determination, relate to each separate corporate entity or to all of the entities included in the consolidated return? 
The issues that result from the interaction of the federal audit and appeals procedures and state tax reporting requirements certainly confirm that "timing is everything." The failure to timely report federal changes and comply with the reporting requirements may result in unlimited statutory periods, penalties and possible lost refunds. Thus, it is key that a taxpayer understand both the complexities that impact the timing of filing the reports as well as the consequences for the failure to meet the requirements.
It is clear that the adoption of uniform definitions and reporting requirements would go a long way to resolving not only the timing the issues faced by taxpayers but also other issues such as format of the reports and adjustments that may be made. The triggering event for reporting is a final determination of a federal change. Thus, an initial step would be to adopt a uniform and clear definition of what constitutes a final determination. That definition should address the term in the context of combined and consolidated returns. The draft Model Uniform Statute for Reporting RARs which was submitted to the Multistate Tax Commission's Uniform Committee is a positive start to addressing and resolving some of the complexities of reporting federal changes.