California May Conform to Federal Partnership Audit Law

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By Laura Mahoney

The California Franchise Tax Board will pursue a bill in 2018 to make federal partnership-level audit elections binding for state tax purposes—but with room to adjust the proposal if the Multistate Tax Commission approves a final model state statute addressing the new federal partnership audit regime.

The three-member board voted 2-0 Dec. 7 to seek a lawmaker to introduce a bill when the Legislature reconvenes in January. The bill would conform California law to the 2015 Bipartisan Budget Act’s provisions that replace the current partner-by-partner audit system with a centralized audit approach that, in general, assesses and collects tax at the partnership level. The new audit regime takes effect Jan. 1.

State Controller Betty T. Yee (D) and Eraina Ortega, chief deputy director of policy at the Department of Finance, said they want to move ahead with a bill despite requests to wait a few months from taxpayer groups, including the California Taxpayers Association (CalTax) and Council On State Taxation (COST).

“It’s important for the board to memorialize a proposal following the federal changes,” Yee said. “We can amend the bill in this coming legislative year.”

Several tax-industry groups have been working with the MTC’s Partnership Work Group on a model uniform statute and regulation for states to adopt next year. COST proposed the original draft model along with other industry groups, including the Tax Executives Institute Inc., the Institute for Professionals in Taxation, the American Institute of CPAs, and a task force of the American Bar Association tax section’s State and Local Tax Committee. The groups are working on a revised version of the proposed model in response to MTC concerns.

Work in Progress

FTB member Diane Harkey (R), who serves as chair of the State Board of Equalization, abstained from the vote out of concern that the proposal is still a work in progress.

Therese Twomey, director of state fiscal policy at CalTax, asked the board to wait until at least late January to pursue a bill with specific conformity provisions—after the MTC possibly completes its draft model statute for states to adopt.

Arizona is the only state that has adopted the federal regime so far and has had problems with the rules, Twomey said. California should wait to avoid the problems Arizona has experienced, she said.

In an analysis of the proposal, the FTB staff said if California doesn’t follow the federal changes, partnerships will lose the benefit of more efficient audits, and the state will lose revenue because federal changes won’t be imputed and assessed at the partnership level for state purposes. Revenue losses would grow from $600,000 in the 2017-18 fiscal year to $22 million by the 2021-22 fiscal year, according to the analysis.

Other Bill Ideas

The FTB said it would also pursue the following legislative proposals during the 2018 session:

  •  allowing taxpayers to apply for a tentative refund for net operating loss carrybacks to conform to federal provisions, including an expedited tentative refund process, statute of limitations extensions, and interest computations;
  •  solidifying through state law the FTB’s guidance issued in 2016 and 2017 allowing multistate water’s edge groups to keep valid water’s edge elections if a member of the group becomes a California taxpayer solely because of changes to California’s rules for doing business in the state; and
  •  giving the FTB authority to dissolve business entities that are inactive but fail to complete the dissolution process, so that they don’t continue to accrue taxes, penalties, and fees.

The Legislature reconvenes for the second year of its two-year session Jan. 3.

To contact the reporter on this story: Laura Mahoney in Sacramento, Calif. at lmahoney@bloomberglaw.com

To contact the editor responsible for this story: Cheryl Saenz at csaenz@bloombergtax.com

For More Information

More information about the proposals is at http://src.bna.com/uOB.

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