On July 17, 2009, the California Franchise Tax Board (the FTB) issued FTB Notice 2009-05 (Notice 2009-05), which extends the deadline for reporting Deferred Intercompany Stock Account (DISA) balances until October 17, 2009. Failure to report DISA balances could result in accelerated gain recognition.
I. Deferred Intercompany Stock Accounts
A DISA is an item of deferred gain that is created by non-dividend distributions (i.e., those distributions that exceed earnings and profits and basis).
Sutherland Observation: California’s treatment of DISAs has important relevance for any taxpayer that is engaged in, or will be engaging in, any type of restructuring for California tax purposes. DISAs cannot be eliminated. As a result, DISAs must be carefully tracked to ensure they are not triggered during restructuring transactions.
Since 2001, California taxpayers have been required by regulation to report DISA balances on their annual return.1 The FTB, in its sole discretion, has the authority to accelerate DISA balances—resulting in gain recognition—if a taxpayer fails to report the outstanding DISA balance on its annual return.2
Many California taxpayers failed to comply with this requirement, and thus the FTB issued two notices addressing the annual filing requirement and providing taxpayers that failed to report DISA balances between 2001 and 2007 the opportunity to file a single disclosure. There has been some confusion surrounding the DISA reporting requirements and the FTB’s notices issued on this subject.
II. California FTB Notice 2009-01
On February 20, 2009, the FTB issued FTB Notice 2009-01 (Notice 2009-01), which reminded taxpayers of the California reporting requirements related to DISAs and provided that all DISA balances must be reported on a California Form 3726 before May 31, 2009. Based on Notice 2009-01, there was some concern that if a taxpayer did not disclose DISA balances by May 31, 2009, the FTB would require that taxpayers recognize undisclosed DISA balances—meaning that May 31, 2009, was a “triggering date.”
However, the May 31, 2009, reporting date was not a “deadline” or a “triggering date” for reporting DISA balances. In fact, the significance to the May 31, 2009, date was that taxpayers were permitted a simplified filing method – taxpayers filing before May 31, 2009, were permitted to file only Form 3726 (which provides for the reporting of DISA balances) without being required to file an amended California franchise tax return. Taxpayers reporting after May 31 were required to file an amended return and Form 3726 (or similar schedule).
III. DISA Latest: California FTB Notice 2009-05
In Notice 2009-05, the FTB re-clarified the reporting of DISA balances and extended the deadline for filing Form 3726 until October 15, 2009, without having to file an amended California franchise tax return.
Sutherland Observation: It is unlikely that the FTB will further extend the deadline for reporting DISA balances. Taxpayers with unreported DISA balances should endeavor to meet the October 15, 2009, deadline. Moreover, California taxpayers should put in place a process for tracking and reporting DISA balances. California’s fiscal condition has garnered much attention in the press. While DISA reporting has not been a common California audit issue, it is unclear as to whether that treatment will change.