We’re all about sharing these days, aren’t we? So, did you share with the state tax authorities the outcome of your IRS audit?
While telling the Franchise Tax Board that you owe more taxes to the feds may seem like inviting trouble, you gain by doing so.
You set those taxes owed to California up for discharge in bankruptcy.
And that’s a nice card to have up your sleeve.
Taxes discharged in bankruptcy
A central requirement to wipe out tax liability in bankruptcy is the filing of a return. Bankruptcy Code 523(a).
Taxes that are unassessed but still legally assessable when you file your bankruptcy case don’t get discharged.
If you owe more taxes as a result of an IRS audit, bankruptcy law treats any resulting increase in your state tax liability as one for which you haven’t filed a return. That is, unless you have made a report or filed an amended tax return with the state.
No return or report, no discharge of the state tax increase.
Tax exposure under California law
California law requires that you share the results of a tax audit that increases your taxes to the Franchise Tax Board.
Edited for clarity, Revenue & Taxation Code 18622 provides:
(a) If any item required to be shown on a federal tax return, including any gross income, deduction, penalty, credit, or tax for any year of any taxpayer is changed or corrected by the Commissioner of Internal Revenue …, that taxpayer shall report each change or correction…, within six months after the date of each final federal determination of the change or correction or renegotiation, or as required by the Franchise Tax Board, and shall concede the accuracy of the determination or state wherein it is erroneous. For any individual …changes or corrections need not be reported unless they increase the amount of tax payable …for any year.
(b) Any taxpayer filing an amended return with the Commissioner of Internal Revenue shall also file within six months thereafter an amended return with the Franchise Tax Board… For any individual …, an amended return need not be filed unless the change therein would increase the amount of tax payable…
So, if changes to elements of your return by reason of an IRS audit would result in you owing more state tax, you have to report that change to the FTB. If you are required to file an amended federal return, you have six months to file an amended state tax return if you owe more state tax as a result of the audit.
Reporting requirement in other states
California isn’t alone in requiring you to share the audit bad news with the state. The AICPA organization of CPA’s put out this summary of tax audit reporting requirements nationwide.