A common issue arising in FTB audits—personal and corporate—is whether to grant a waiver of the statute of limitations at the request of a field auditor. The general rule is that the FTB has four years from the original due date or the date the return was filed to audit that return and issue any Notice of Proposed Assessment (NPA) (RTC sections 19057, 19066).
However, keep in mind the FTB statute of limitations independently remains open for six months after the expiration of a federal IRS statute waiver signed by the taxpayer (RTC 19065).
FTB’s Manual of Audit Procedures (MAP) makes clear to auditors that “waivers are not an acceptable substitute for prompt, timely audits” (MAP Section 4.1; MAP 4 SOL & WAIVERS; ftb.ca.gov/tax-pros/procedures/manual-of-audit-procedures/chapter-4.pdf).
Further, FTB’s Audit Procedure regulation states that a taxpayer should have the “expectation” that a “resolution of the audit will be achieved within a two-year period” commencing with the date of the auditor’s initial contact (FTB Regulation 19032 (a)(2)). Further pressure results from FTB field auditors being instructed to complete cases and submit them for review by the Technical Resources Section at least six months before the statute of limitations expires (MAP Section 4.1).
Even with these clear directives regarding the timing and completion of audits, in the author’s experience, it is a rare FTB audit these days in which an auditor does not request at least one, and often multiple, wavers of the typical four-year statute. What are the considerations in deciding whether to grant or deny an auditor’s request for a statute waiver in a pending audit? The central question is: Is it in the client’s interest, or against the client’s interest, to sign the statute waiver requested by the auditor?
Here are some considerations for making that decision.
What are the likely consequences of not signing the requested waiver? Absent the waiver, the statute of limitations for FTB to issue any NPA will lapse for that tax year. Does this mean the auditor will essentially “throw together” and issue a timely NPA simply to protect potential revenue, even when not justified based on the current status of the audit? Does this mean the auditor will conclude that based upon the status of the audit, they do not have reasonable grounds to issue an NPA and will close the audit without assessing? Will the audit continue anyway for other years where there is still open statute, e.g., a three-year audit cycle?
There are no easy answers to these questions, which are entirely situational, based on the current status of the audit; the representative’s working relationship with the auditor and/or audit supervisor; the amount of the potential proposed assessment; and the client’s risk tolerance.
What, if anything, does the client receive in exchange for signing the requested waiver? For instance, can an agreement be reached that this will be the only waiver request? Can an agreement be reached regarding the number of additional Information Document Requests (IDRs) forthcoming in the (now extended) audit? Can an agreement be reached regarding when the client will receive any potential audit closing letter or Audit Issue Presentation Sheets (AIPS), which details the rationale for any NPA?
Consider negotiating (or attempting to negotiate) the length of the waiver. The FTB typically requests a statute waiver of one year (and if they want more, you likely can expect to see multiple requests). What about only granting a waiver through the end of the calendar year, which often turns out to be a period of about three months? What about only agreeing to grant a waiver of six months? If the auditor is unwilling to negotiate, then you are back to the situation above involving the likely consequences of not signing the requested waiver.
Press the auditor, and get it in writing, for their reasons for the need for the requested waiver—or any waiver. Remember, the FTB always has four years to audit, so why is any additional time needed? Two common responses from an auditor are (1) overall caseload and (2) more time is needed for the audit to be submitted and reviewed (i.e., the six-guideline above). But those are broad and general responses, so seek detail as to why audit goals in this specific case have not been achieved within the time limits discussed above in the statutes and the FTB’s own Audit Regulation.
Has the taxpayer in any way been responsible for a lack of audit progress? In fairness to the auditors, if a taxpayer is taking six months to respond to every IDR, the audit is going to move at an unnecessarily slow pace through no fault of the FTB. Similarly, has the taxpayer been unresponsive? If so, what is the potential to receive the 25 percent penalty in RTC Section 19133 for failure to furnishing information if the audit is closed too quickly?
The time value of money. The current rate for personal income tax underpayments and overpayments is 3 percent. The current corporation underpayment rate is also 3 percent, and the current corporation overpayment rate is zero. In all fairness, that is cheap money and may be a reason for delaying an audit. But, the FTB’s interest dates for personal income tax and corporate underpayments automatically reset every six months, so watch for changes.
The FTB’s interest rates in the past have been as high as 18 percent (in 1982). Also, don’t forget that even if the FTB issues an NPA, no payment is required while a timely Protest of that NPA is pending (although interest continues to accrue).
Confirmation bias is your enemy. Confirmation bias is the tendency of an individual to favor and process information that confirms or strengthens their existing beliefs. If you sense an auditor already has decided the case against you, there is no reason to give them additional time to further strengthen their case while interest continues to accrue. It is probably time to have the NPA issued, file a Protest and pick up the case at Protest with a different, fresh and hopefully less-biased audience—but, see time value of money, above.
Finally, while audits often can be contentious, unpleasant and seem personal, it does not have to be that way. FTB auditors are tax professionals and deserve to be treated as professionals. There are many legitimate situations where an auditor will need an extension of the statute and will work with a taxpayer to achieve that end. In many cases, it is also in the interest of the taxpayer to extend the statute in some manner. On the other hand, you do not want to grant a one-year statute waiver only to find the auditor then turns to another case in their inventory with a shorter statute, only to return to your case nine months into the waiver period—often to seek another waiver.
Eric J. Coffill is senior counsel at Eversheds Sutherland LLP and a member of the CalCPA Committee on Taxation. You can reach him at email@example.com.