California Franchise Tax Board Hot Audit Issues Part III

By Mayer Nazarian and Geoffrey A. Weg

Recently, the California Franchise Tax Board announced the most common tax audit issues affecting Individuals, Pass-Through Entities and Corporations.  In the previous couple weeks we highlighted the first two taxpayer groups.

In this last installment, we will discuss the top issues for Corporate Taxpayers.

1. Sales Factor and Gross Receipts - Items included in the sales factor denominator that do not meet the definition of "gross receipts" or result in distortion.  (The sales factor denominator is the total sales everywhere during the taxable year.  Only sales derived from business activities are considered in the sales factor -- nonbusiness sales are excluded.)

2. Abusive Tax Shelters - Abusive tax shelters involving the creation of entities or deductions without economic substance or a business purpose that attempt to avoid state or federal tax.

3. Credits - Credits such as the Enterprise Zone and the Research and Development Credit not properly reported.

4. Cost of Performance and Sourcing of Intangible Sales - Utilization of market rules for assigning sales from intangibles and services when electing a single sales factor for apportioning business income to California.

Please contact our Tax and Wealth Planning attorneys for consultation or assistance in the identification, clarification or resolution of these issues. 
Contact Mayer Nazarian
Contact Geoffrey Weg

California Franchise Tax Board Hot Audit Issues Part II

By Mayer Nazarian and Geoffrey A. Weg

As discussed in our previous post, the California Franchise Tax Board recently announced the most common tax audit issues affecting Individuals, Pass-Through Entities and Corporations.  Last week we highlighted personal income taxpayers.

 

This week, we will review the top issues for Pass-Through Entity Taxpayers.

 

1. Disposition of Real Estate - IRC Section 1031 and 1033 issues: specifically with respect to deferred gain, incorrect treatment of cancellation of debt (COD) income within short sales or deeds in lieu, and failure to report California-source income by nonresident taxpayers . 

 

2. Final Year of Limited Liability Companies (LLC) or Partnerships - In the final year of an LLC or Partnerships, verification of proper gains or losses, reconciliation of negative capital accounts, distributions of installment notes, and COD income.

 

3. Apportioning Trust Income - When trust income is from sources within and without California, the apportionment of income to California and the residency status of the trustee must be appropriate. (A trust will be subject to taxation in California if the fiduciary or a noncontingent beneficiary is a resident of California.)

 

4. Other State Tax Credits - Verification of taxes paid to the other states is another audit priority.

 

5. Shareholders Basis - Review of shareholder's basis to determine correct flow through income, losses, deductions, credits, as well as taxability of distributions, debt repayments, and dispositions.

 

6. Built-in Gains - The recognition period and the basis of the disposed asset must be properly reported.  (If an S corporation that was formerly a C corporation sells an appreciated asset (such as real estate) and the appreciation occurred during the time the corporation was a C corporation, the S corporation will probably pay C corporation taxes on the appreciation--even though the corporation is now an S corporation. This Built In Gain (BIG) tax rate is 35% on the appreciated property, but is only realized if the BIG asset is sold within 5 years (starting from the first day of the first tax year of conversion to S-Corp status.))

Please contact our Tax and Wealth Planning attorneys for consultation or assistance in the identification, clarification or resolution of these issues. 

 

Contact Mayer Nazarian

Contact Geoffrey Weg 

California Franchise Tax Board Hot Audit Issues Part I

By Mayer Nazarian and Geoffrey A. Weg
 

Mayer Nazarian

Geoffrey A. Weg

Recently, the California Franchise Tax Board announced the most common tax audit issues affecting Individuals, Pass-Through Entities and Corporations. 

Over the next few weeks we will briefly highlight these areas.

 

This week, we will discuss the top issues for Personal Income Taxpayers.

 

1. Like-Kind-Exchange Transactions - Sale of Property Through an IRC 1031 Exchange with incorrect treatment of boot, identification of property, and/or "drop and swap transactions.”

 

2. Securities Transactions - Overstated stock basis, unreported option premium income, and regulated futures contracts. 

 

3. Rental Real Estate Losses - The treatment of the real estate activity as passive or nonpassive may vary for Federal versus State tax purposes, therefore, the classification selected by the taxpayer must be appropriate. (Generally, losses from passive activities, including rental real estate, may be deducted only up to the amount of income from passive activities. Any excess loss is carried forward to the following year or years until the interest in the activity is disposed in a fully taxable transaction. In some cases, a taxpayer may classify rental activities as nonpassive for federal purposes. However, for California purposes rental activities are generally considered passive, with a few exceptions.) 

 

4. Residency - Residency status for state tax purposes is based upon the taxpayer's specific situation which includes consideration of where the taxpayer has the closest connections and whether or not he/she receives substantial benefits and protection from the state. 

Please contact our Tax and Wealth Planning attorneys for consultation or assistance in the identification, clarification or resolution of these issues. 

Part two will be published next week.

Contact Mayer Nazarian
Contact Geoffrey A. Weg