No one wants to be audited by the Internal Revenue Service (IRS).  However, if the IRS examines your tax return and makes any changes to it, then California taxpayers have an extra obligation to notify the California Franchise Tax Board (FTB) of these changes.  Under California law, a taxpayer must notify the FTB of an IRS adjustment within six months after the date of the IRS change.  See California Revenue & Taxation Code § 18622.  A taxpayer must notify the FTB if there is any change to the taxpayer’s IRS return, even if the taxpayer does not think that their FTB tax liability will change.

If a taxpayer provides notice to the FTB within six months, then the FTB only has two years after such notice to propose any adjustments to the taxpayer’s FTB tax return.  If a taxpayer does not provide notice within six months, then the FTB has four years from when it receives “sufficiently-detailed” information about the adjustment.  For example, if a taxpayer never notifies the FTB, then the FTB could make changes to the taxpayer’s FTB return at any date in the future.

But what happens if the Taxpayer files for bankruptcy?  Is the debt they never reported to the FTB discharged during bankruptcy?

In In re Berkovich (Berkovich v. California Franchise Tax Board), the Ninth Circuit addressed this issue.  Most of the rules related to dischargeability of taxes in bankruptcy are related to how old the tax liabilities are—the more recent the tax debt, the more likely the debt would not be dischargeable in bankruptcy.  However, some rules in the bankruptcy code state that taxes can never be discharged (no matter how old).  One of those rules is in 11 U.S.C. § 523(a)(1), which states that taxes are not discharged for an individual if a taxpayer failed to file a ”return or equivalent notice.”

In Berkovich, there was no question that the taxpayer failed to properly notify the FTB of the change to their federal tax return within the six-month period.  The Ninth Circuit concluded that the taxpayer’s failure to provide this notice to the FTB made the taxes non-dischargeable.  Therefore, failure to file the required FTB notice means the state tax debt is not discharged in bankruptcy and can never be dischargeable in bankruptcy (no matter how long a taxpayer waits to file bankruptcy).

Are you under audit or examination by the IRS or FTB?  The former IRS attorneys at Holtz, Slavett & Drabkin, APLC regularly assist clients with IRS or FTB audits involving all types of taxes and issues.

Were you under IRS audit and now unsure about how to comply with the FTB notice requirements?  We can review your situation, assist you with fixing any potential tax problems before the FTB contacts you.  Please contact us at 310-550-6200.

Richard Gano is a Tax Attorney at Holtz, Slavett & Drabkin.  Before joining the firm, Richard was an IRS Attorney in the Office of Associate Chief Counsel (Income Tax & Accounting) in the IRS’s headquarters in Washington DC.  His practice focuses on both federal and state tax matters such as tax audits, litigation, and compliance.