California Tax Disputes FAQ

California Franchise Tax Board (FTB) audits operate independently from IRS audits, though they often parallel or follow federal examinations due to information sharing agreements. The FTB has independent examination authority under California Revenue and Taxation Code Section 19504, its own procedures outlined in Section 19033, and applies California substantive tax law which differs from federal law in significant respects. While both agencies examine similar issues—income reporting, deduction substantiation, and credit eligibility—they apply different legal standards, conformity rules, and administrative procedures.

Key procedural differences include statutes of limitations: California's standard period is four years from the return's filing date under Revenue and Taxation Code Section 19057, compared to the IRS's three years under IRC Section 6501(a). For substantial understatements exceeding $1 million, California extends the statute to eight years under Section 19059, while federal law extends to six years only for understatements exceeding 25% of gross income. California lacks a fraud exception extending the statute indefinitely, instead imposing a 50% fraud penalty under Section 19164 within the eight-year period.

Substantively, California must follow federal determinations for items that are the same under both systems pursuant to Revenue and Taxation Code Section 18622, but California has numerous conformity exceptions. These include: different treatment of business expense deductions, varying capital gains exclusion rules (particularly for qualified small business stock under IRC Section 1202, which California doesn't conform to), different passive activity loss limitations, and distinct tax credit programs. The FTB conducts independent analysis of these non-conforming items even when the IRS has made determinations. Understanding these differences is crucial for California taxpayers, as favorable federal audit results don't necessarily translate to California tax benefits, and vice versa.

The California protest process under Revenue and Taxation Code Section 19041 provides an administrative appeal opportunity before assessments become final. After the FTB completes an audit or examination, it issues a Notice of Proposed Assessment (NPA) detailing the proposed tax, penalty, and interest adjustments. You have 60 days from the date of the NPA to file a written protest with the FTB's Appeals Bureau. This 60-day deadline is strictly enforced, and missing it waives your right to administrative appeal, leaving only the more limited refund claim procedure or Office of Tax Appeals review after payment.

The written protest must contain specific elements to be valid: a statement of the grounds for disagreement with specific references to the items you're protesting; a statement of facts supporting your position with sufficient detail to allow meaningful review; the law or authority supporting your position including citations to statutes, regulations, or case law; and a declaration under penalty of perjury that the statements are true and correct. The protest should be thorough and well-documented, as it frames the issues for Appeals Bureau consideration. You may include supporting documents such as receipts, contracts, expert reports, or legal memoranda.

Once filed, the FTB's Appeals Bureau—an independent division separate from the audit function—reviews your protest. The bureau may request additional information, schedule conferences to discuss the issues, and work toward settlement. Unlike court proceedings, the protest process is informal and designed to encourage resolution without litigation. The Appeals Bureau has authority to consider hazards of litigation and settle cases based on the relative strengths of each party's position. After reviewing your protest and supporting materials, the bureau issues a written determination either affirming, modifying, or withdrawing the proposed assessment. If you disagree with the Appeals Bureau decision, you can file a claim for refund and appeal to the Office of Tax Appeals, or pay the assessment and appeal directly to the OTA.

Yes, California's Office of Tax Appeals (OTA) provides independent administrative review of FTB determinations under Revenue and Taxation Code Sections 15672 and 19045.5. The OTA was created in 2017 as an independent agency, taking over the tax appeals function previously handled by the State Board of Equalization. The OTA hears appeals involving personal income tax, corporate tax, sales and use tax, and various other California taxes. It operates independently from the tax agencies, providing impartial review of disputed assessments.

You can appeal to the OTA in two situations: (1) within 30 days of receiving a Notice of Action after the FTB denies your protest or issues a final determination, or (2) within 30 days of the FTB's denial of a claim for refund filed after paying a disputed assessment. The 30-day deadline is jurisdictional—missing it deprives the OTA of authority to hear your appeal. The appeal must be filed on the prescribed form with a filing fee ($45 for taxpayers, higher for businesses), and should specify the errors you allege in the FTB's determination.

OTA proceedings are formal administrative hearings conducted by Administrative Law Judges (ALJs). Discovery is limited compared to court litigation, but parties can subpoena witnesses and documents. Hearings follow California Government Code administrative hearing procedures, with rules of evidence similar to court trials. The taxpayer bears the burden of proving the FTB's determination is wrong, except for certain fraud penalties where the FTB must prove fraud by clear and convincing evidence. After the hearing, the ALJ issues a written opinion that becomes the OTA's final decision. You can appeal adverse OTA decisions to California Superior Court within 30 days under Revenue and Taxation Code Section 19048, though court review is limited to whether the OTA's decision is supported by substantial evidence. Filing an OTA appeal stays collection of the disputed amount pending final resolution, protecting you from levies and other enforcement actions during the appeal.

The California FTB can assess various penalties for noncompliance with state tax obligations, many mirroring federal penalties but with California-specific amounts and procedures. The failure to file penalty under Revenue and Taxation Code Section 19131 is 5% of the tax due for each month or partial month the return is late, up to a maximum of 25% of the unpaid tax. This penalty applies when you fail to file by the due date (including extensions). The failure to pay penalty under Section 19132 is 5% of the unpaid tax, assessed when you file a return but don't pay the full amount due by the deadline.

Accuracy-related penalties under Revenue and Taxation Code Section 19164 impose 20% of the underpayment for: negligence or disregard of rules and regulations; substantial understatement of income tax (generally, understatements exceeding the greater of $5,000 or 10% of the correct tax); or substantial valuation misstatements. The fraud penalty under Section 19164 is 50% of the underpayment attributable to fraud, requiring the FTB to prove fraud by clear and convincing evidence showing intentional wrongdoing and intent to evade tax.

The late filing of information returns carries penalties under Section 19131, with amounts varying by the type of return and delay period. The demand penalty under Section 19133 adds 25% if you fail to file after the FTB issues a written demand. Estimated tax penalties under Section 19136 apply when you underpay quarterly estimated taxes, calculated based on the underpayment amount and period. Importantly, California law allows penalty abatement for reasonable cause under Section 19132 when you demonstrate that failure to comply resulted from circumstances beyond your control despite ordinary business care and prudence. First-time penalty abatement policies similar to federal programs may also apply for taxpayers with clean compliance histories.

California assesses interest on tax deficiencies under Revenue and Taxation Code Section 19101, which establishes a floating interest rate that changes periodically based on federal rates. Interest begins accruing on the original due date of the return (typically April 15 for calendar year filers) and compounds daily until the tax is fully paid. Unlike federal interest under IRC Section 6601, which uses the federal short-term rate plus 3%, California's interest rate is set by statute as the federal underpayment rate established under IRC Section 6621 for the calendar quarter, adjusted as specified in California law.

The current interest rate is announced by the FTB and published on its website, changing quarterly to reflect federal rate adjustments. For example, when the federal underpayment rate is 8%, California's rate for individuals is typically the same or very close, though the exact computation may vary slightly based on statutory formulas in Section 19521. Interest is mandatory and cannot be abated for reasonable cause—it accrues automatically on any unpaid tax regardless of the reasons for nonpayment. This distinguishes interest from penalties, which the FTB can abate under Section 19132 for reasonable cause.

Interest calculations can significantly increase tax liabilities, especially for older tax years. If you owe tax from multiple years, interest compounds on each year's liability separately from that year's original due date. The FTB provides online calculators and tables to help estimate interest, though exact calculations can be complex given the daily compounding and quarterly rate changes. When negotiating settlements or installment agreements, understanding interest calculation is crucial because interest continues accruing on unpaid balances until fully satisfied, potentially adding 40-50% or more to the original tax debt over several years.

California law imposes strict reporting requirements and severe penalties for failure to report federal tax changes. Under Revenue and Taxation Code Section 18622, if the IRS makes any change to your federal return that affects your California tax liability, you must report those changes to the FTB within six months of the final federal determination. This includes IRS audit adjustments, amended returns you filed, federal refund claims, and any other federal changes increasing or decreasing your federal tax liability. The reporting requirement applies whether the federal change increases or decreases your California liability.

You must report federal changes by filing California Form 540-X (Amended Individual Income Tax Return) or Form 100-X (Amended Corporation Franchise or Income Tax Return) within the six-month deadline, attaching copies of the federal Revenue Agent's Report, federal amended return, or other documentation showing the federal changes. The amended return should reflect the federal adjustments and any California-specific modifications. If the federal changes don't affect your California liability (due to conformity exceptions), you should still report the changes and explain why no California adjustment is necessary.

Failure to timely report federal changes triggers a 25% penalty under Revenue and Taxation Code Section 18622(a) on the additional California tax resulting from the federal adjustments. This penalty is in addition to regular interest under Section 19101 and any other applicable penalties under Section 19164. The 25% penalty is substantial and strictly enforced, making timely reporting essential even when you believe the federal changes shouldn't affect California tax. Moreover, the FTB may discover federal changes through IRS information sharing even if you don't report them, resulting in assessments with penalties and interest calculated from the original due date. The four-year statute under Section 19057 doesn't begin running on federal-change issues until you report them or the FTB discovers them, potentially leaving these issues open indefinitely.

Yes, the California FTB has extensive levy authority similar to IRS collection powers. Under Revenue and Taxation Code Section 18817, the FTB can issue wage and earnings withholding orders to your employer, requiring withholding of wages until the tax debt is satisfied. The FTB uses Form FTB 2905 (Earnings Withholding Order for Taxes) to implement wage garnishments. Unlike most creditors who must obtain court judgments before garnishing wages, the FTB can levy wages administratively without going to court, similar to the IRS's authority under IRC Section 6331.

The amount withheld from wages follows California's withholding tables and exemption amounts, generally leaving you with minimum living allowances based on filing status, number of dependents, and earnings levels as specified in Code of Civil Procedure Section 706.050 and Revenue and Taxation Code Section 18807. These exemptions are typically more generous than federal levy exemptions, but still result in substantial wage garnishment. For example, the FTB usually cannot take more than 25% of disposable earnings, or the amount by which weekly disposable earnings exceed 40 times the state minimum hourly wage, whichever is less, though these calculations vary based on circumstances.

The FTB can also levy bank accounts under Revenue and Taxation Code Section 706.070, serving financial institutions with a notice of levy that freezes and remits account balances. Bank levies are one-time seizures of the balance on the levy date, unlike wage levies which continue until released. Before levying, the FTB must send a Notice of State Tax Liability and a Collection Notice (FTB Form 2797), providing notice of the debt and opportunity to pay or arrange payment plans. However, once these notices are sent and the statutory waiting period expires, the FTB can levy without further notice. You can release levies by paying in full, arranging installment agreements, or demonstrating that the levy creates economic hardship. You also have appeal rights to contest the underlying liability through protest and Office of Tax Appeals procedures.

California's statute of limitations for assessing additional tax is generally four years from the return's filing date under Revenue and Taxation Code Section 19057. This means the FTB must propose assessments within four years, or they're barred from assessing additional tax for that year. The four-year period runs from the actual filing date if you filed late, or from the due date if you never filed a return. This provides one additional year compared to the federal three-year statute under IRC Section 6501(a), giving the FTB more time to examine returns and propose adjustments.

The statute extends to eight years under Revenue and Taxation Code Section 19059 when you omit from gross income an amount exceeding $1 million. This substantial understatement extension applies to both individual and business returns and represents a significant expansion beyond the federal six-year extension under IRC Section 6501(e), which applies to omissions exceeding 25% of gross income. California's $1 million threshold is a fixed dollar amount rather than a percentage, making it more predictable but potentially capturing smaller percentage omissions for high-income taxpayers.

Importantly, California does not have an unlimited statute for fraudulent returns like the federal rule under IRC Section 6501(c)(1). Instead, California's maximum statute for fraud cases is eight years under Section 19059, though the FTB can assess a 50% fraud penalty under Section 19164 within this period. The statute is suspended during periods when you're outside California for six months or more continuously under Section 19058, and for periods while a protest or Office of Tax Appeals proceeding is pending. If you never file a required return, there is no statute of limitations—the FTB can assess at any time under Section 19057. Understanding these limitation periods is crucial for evaluating settlement strategies, recordkeeping obligations, and potential assessment risks.

California's tax conformity with federal law is complex and selective, requiring careful analysis for each tax issue. Under Revenue and Taxation Code Section 17024.5, California generally conforms to the Internal Revenue Code as it existed on a specific date, updated periodically by the Legislature. As of 2024, California conforms to the IRC as of January 1, 2015, for most provisions, though the conformity date varies by specific code section. This means federal tax law changes enacted after California's conformity date don't automatically apply for California purposes unless the Legislature specifically adopts them.

California has numerous non-conformity provisions where state law intentionally differs from federal law. Major non-conformity areas include: depreciation and expense deductions (California doesn't conform to federal bonus depreciation or IRC Section 179 expense limits); qualified small business stock gain exclusion (California doesn't allow the federal 50-100% exclusion under IRC Section 1202); passive activity loss limitations (California has its own rules under Revenue and Taxation Code Section 17561); net operating loss deductions (California has different carryback/carryforward rules and suspension periods); and various tax credits that exist at the federal level but not California, or vice versa.

Under Revenue and Taxation Code Section 18622, California must follow federal determinations for items that are the same under federal and California law—the "res judicata" provision. This means if the IRS determines that a particular income item should be included in gross income, and California law treats that income the same way as federal law, the FTB must accept the federal determination and cannot re-litigate that issue. However, for non-conformity items, the FTB conducts independent analysis even when the IRS has made determinations. This creates complexity in parallel federal and state audits, requiring detailed analysis of which adjustments California must follow versus which it can independently evaluate. When preparing California returns or defending audits, you must identify conformity versus non-conformity issues and apply the appropriate law to each item.

During an FTB audit, you should provide comprehensive documentation supporting the items under examination while being careful not to volunteer information beyond the audit scope. Under Revenue and Taxation Code Section 19504, the FTB has authority to examine books, records, and other data relevant to determining correct tax liability. You should respond to specific Information Document Requests (IDRs) by providing exactly what's requested—neither more nor less. Over-producing documents can expand the audit scope, while under-producing can result in adverse determinations based on inadequate substantiation.

Essential documentation varies by audit issue but typically includes: bank statements showing deposits and withdrawals for income verification; receipts, invoices, and canceled checks for claimed deductions; business expense logs with dates, amounts, payees, and business purposes; mileage logs for vehicle expense deductions showing dates, destinations, business purposes, and miles; home office documentation including square footage measurements, photos, utility bills, and allocation worksheets; Form 1099s, W-2s, and other information returns matching reported income; contracts and closing statements for real estate transactions; purchase and sale confirmations for investment transactions establishing basis and holding periods; and corporate minutes, partnership agreements, and operating agreements for entity-related issues.

For California-specific issues, provide documentation showing the application of California conformity exceptions, such as: separate depreciation schedules using California rules; California-specific passive activity loss calculations; documentation of California-source versus non-California-source income for nonresidents; and explanation of differences between federal and California treatment of specific items. Organize documents logically, provide summary schedules linking documentation to return line items, and include written explanations for complex issues. If you lack complete documentation, provide what you have along with credible reconstructions based on available evidence, banking records, or industry standards. The FTB may accept reasonable estimates when exact documentation is unavailable due to circumstances beyond your control, though the burden of proof remains on you to establish entitlement to claimed deductions and credits.

Yes, California law provides several bases for penalty abatement, and you should always explore relief options before accepting assessed penalties. Under Revenue and Taxation Code Section 19132, the FTB has authority to abate penalties when you establish reasonable cause for failure to comply with tax obligations. Reasonable cause exists when you demonstrate that failure resulted from circumstances beyond your control despite exercising ordinary business care and prudence. Acceptable reasonable cause includes: serious illness or death of the taxpayer or immediate family member; unavoidable absence; destruction of records by fire, casualty, or natural disaster; erroneous written advice from the FTB; inability to obtain records despite reasonable efforts; or other circumstances establishing that you acted reasonably under the circumstances.

California also has a first-time penalty abatement (FTA) program similar to the IRS policy, though not formally codified in statute. Under FTB administrative policy, taxpayers with clean compliance histories may qualify for penalty relief for failure-to-file and failure-to-pay penalties. Generally, you qualify for FTA if you: haven't had penalties assessed for the three preceding tax years; filed all required returns or filed extensions; and paid or arranged to pay any tax due. FTA typically doesn't apply to accuracy-related penalties under Section 19164, which require reasonable cause and good faith showing.

To request penalty abatement, submit a written request to the FTB explaining the specific circumstances that prevented timely compliance, how those circumstances were beyond your control, what steps you took to comply despite the circumstances, and when/how you remedied the noncompliance. Include supporting documentation such as medical records, death certificates, correspondence with third parties, or other evidence corroborating your explanation. For FTA requests, cite your clean compliance history and request abatement under the FTB's first-time penalty abatement administrative policy. If the FTB denies your abatement request, you can appeal through the normal protest and Office of Tax Appeals procedures, or request supervisory review of the denial. Penalty abatement requests should be made in writing and retained in your records, as oral requests may not be adequately documented.

California taxpayers have comprehensive rights during FTB audits codified in the California Taxpayer Bill of Rights under Revenue and Taxation Code Section 21003. These rights include: the right to be treated professionally, fairly, and courteously by FTB employees; the right to privacy and confidentiality regarding tax information; the right to know why the FTB is requesting information, how it will be used, and what happens if you don't provide it; the right to representation by an attorney, CPA, or enrolled agent; the right to protest FTB determinations and appeal to the Office of Tax Appeals; the right to be informed of audit results and the basis for FTB determinations; and the right to relief from penalties when you demonstrate reasonable cause.

Specific procedural rights during examinations include the right to know what information the FTB has in its files regarding your case (you can request this through Public Records Act requests or informal inquiries); the right to refuse extending the statute of limitations, though refusal may prompt the FTB to make determinations based on available information; the right to request that examinations be conducted at reasonable times and places; and the right to have representation present at all meetings with FTB personnel. Under Revenue and Taxation Code Section 19504, the FTB must provide reasonable notice before examining you, and you can propose alternative examination dates and locations when the FTB's proposed schedule creates hardship.

You also have the right to complete an examination within a reasonable time frame and to speak with a supervisor if you're dissatisfied with the examiner's conduct or the examination's progress. The FTB cannot initiate collection actions for disputed amounts while a timely protest or Office of Tax Appeals appeal is pending under Section 19042, which stays collection during administrative appeals. If the FTB violates your rights or engages in improper collection practices, you may have remedies under Section 19717 (taxpayer assistance orders) or through complaints to the Taxpayer Rights Advocate's Office established within the FTB. Understanding and asserting these rights is crucial for protecting yourself during examinations and ensuring fair treatment throughout the audit and appeals process.