The Two Sources of Income Tax Audits in California

There are two sources of income tax audits in California: those initiated by the State of California Franchise Tax Board (FTB) and those based on audits conducted by another agency, such as the IRS. This second form of audit, often referred to as a "Piggy-Back Audit," is one of the most hazardous and unexpected challenges faced by California taxpayers.

• Income tax audits are usually the result of bell-curve analysis and targeted group analysis, or referral by another tax agency, such as the IRS.
• Tax agencies within California communicate with one another and the IRS. Information is shared inter-agency, and most tax agencies now use Artificial Intelligence (AI) to identify and target audits.
• California taxpayers are more likely to be audited by the FTB or the Employment Development Department (EDD) than they are the IRS. However, an IRS audit usually results in a referral to the FTB and a piggy-back audit by that agency.

The vital thing to know is this: If the IRS audits you, you can expect a California FTB or other state agency audit to follow immediately. The IRS communicates directly with California tax agencies, and vice versa. When changes are made to a California tax form, the IRS is notified by the California Franchise Tax Board (FTB), the Board of Equalization (BOE), or the Employment Development Department (EDD). When you complete an IRS audit, the IRS notifies the FTB, EDD, and other state agencies appropriately based upon changes to your business or personal tax return(s).

Most taxpayers in California are unaware of the two sources of income tax audits in California and the risk of a second “piggy-back” audit once the first is completed. This is why it is so essential to work with an experienced California tax attorney. It will be crucial for the tax attorney in any California audit to consider the implications of decisions made in the present audit on future analysis by other agencies, such as the IRS. An IRS audit creates the same types of risks and considerations, as any changes at the federal level will affect previously filed California income tax returns.

The fact is, based upon recent budget and staffing cuts at the IRS, California individual and business taxpayers are more likely to be audited by a California agency such as the FTB or the EDD. If you are notified by the FTB for an income tax audit or a business that the EDD has contacted for a misclassification audit or payroll tax audit, it is in your best interests to contact an experienced, proven California tax attorney near you. Ask for a free consultation to discuss any correspondence you have received from a tax agency and how best to work together to respond and manage the issue or audit.

There is usually no cost for the initial consultation, and you will learn more about the process surrounding your audit and the steps you should take to protect yourself. Ask about the protections of the attorney-client privilege when you work with a tax attorney, and how this important legal tool allows you to have candid conversations your tax attorney without concern that the information can be obtained by subpoena. Your tax preparer, bookkeeper, CPA, and online tax solution cannot provide these protections.