Understanding California Franchise Tax Board Controversy Timelines and Delays

In June of this year, the California Franchise Tax Board (FTB) reported that it had more than 10,000 open cases in its controversy and alternative apportionment petition inventory, covering tax years as far back as 1991. The largest backlog involved 2,763 open audits, followed by 574 open refund claims and 273 open docketed protests. It is no surprise that taxpayers continue to complain about the time it takes for the FTB to conclude controversies, including audits, refund claims, protests, appeals, and petitions for alternative apportionment.

California has grappled with the slow resolution of controversy cases for more than 30 years. When it passed the Taxpayers’ Bill of Rights in 1988, the California Legislature included Revenue and Taxation Code § 21010, which required the FTB to work with the State Board of Equalization, the State Bar of California, the California Society of Certified Public Accountants, the FTB Taxpayers’ Rights Advocate, and other interested taxpayer-oriented groups to develop a plan to reduce the time required to resolve refund claims, protests, and appeals. Pursuant to § 21010, the FTB established a maximum of 24 months in which to evaluate the merits of a protest or refund claim, conduct a hearing if requested by the taxpayer, and issue a Notice of Action. The FTB memorialized this rule in its Manual of Audit Procedures § 15.5.

Fifteen years later, in 2003, the FTB adopted 18 Cal. Code Regs. § 19032, setting an expectation that audits would be resolved within two years of the FTB’s initial audit contact with taxpayers. There were few exceptions to this two-year rule, but also no consequences for failing to meet the deadline.

Throughout the 2010s, FTB delays continued to be the number one complaint of taxpayers. In 2015—after testimony by the California Taxpayers Association (CalTax) at the FTB’s 2024 annual Taxpayers’ Bill of Rights hearing—the Board signaled its focus on cases in the Audit Division and Legal Division that were more than 36 months old. The Board also committed to taking proactive measures with technical reviewers to have auditors and FTB attorneys collaborate more closely.

The Office of Tax Appeals, created by the legislature in 2017, alleviated part of the FTB’s backlog issue, largely decreasing the FTB’s backlog of appeals cases. However, starting at the same time, the FTB has dealt with increased alternative apportionment petitions following a voter-approved mandatory shift to single sales factor apportionment in 2013.

Because of confidentiality concerns, the FTB will not publicly release the full revenue impact of its controversy backlog. There are no public reports that track the FTB’s controversy backlog or the potential revenue associated with the cases. Some taxpayer groups have urged more transparency in this area, requesting reports on the type of case, tax years involved, amount of revenue involved, and status of each case. The FTB responded to at least one public request for the total revenue impact of its backlog by communicating that it would require a payment in advance of more than $2,300 to digitally extract the numbers. With a projected state budget deficit of $55 billion for the 2024–25 fiscal year, identifying potential revenue sources within existing state programs is more important than ever—something hard pressed to do without the necessary information.

While transparency about the FTB’s backlog would help the public and policymakers understand why certain cases take longer than others, taxpayers at the very least want to know that the information is available to the FTB internally to enable the agency to set priorities and ensure efficient operations. Part of these efforts must focus on ensuring quick resolution of refund claims. Taxpayers are entitled to interest on refund claims, but the state tends to pay very low or no interest on corporate tax overpayments. In fact, the FTB’s interest rate on corporate overpayments was 0% from July 1, 2009, through June 30, 2017, and 0% again from January 1, 2021, through December 31, 2022.

On the flip side, during those same periods, the FTB’s interest rate on corporate underpayments averaged 3.83% in 2021 and 3% in 2022. Interest adds up quickly and can be exorbitant when a taxpayer has a 5- to 10-year-old (or older) proposed assessment. It is also difficult, but not impossible, to get interest abated, especially where the FTB exercised its discretion arbitrarily, capriciously, or without sound basis in fact or law, or where “failure to abate interest would be widely perceived as grossly unfair” (Lee v. Commissioner (1999), 113 T.C. 145, 150). The “mere passage of time does not establish error or delay that can be the basis of an abatement of interest” (Lee v. Commissioner, supra).

The imposition of California’s Large Corporate Underpayment Penalty, affectionately known as the “LCUP,” exacerbated the impact of disparate interest rates, as it applies a 20% strict liability penalty to applicable underpayments per Cal Rev & Tax Code § 19138. The threat of the LCUP drives many taxpayers to take conservative filing positions on material and controversial issues on original returns, then file refund claims, relegating them to a lower interest rate and allowing the FTB to audit the entire tax return to look for audit offsets without worry of understatement interest. 

The FTB has not been dormant in addressing the challenges of its backlog. It seems committed to completing audits within two years of initial contact with taxpayers. Most low-complexity audits are completed within that timeframe, while high-complexity cases are expected to take much longer. Several factors have been identified as causing delays:

• The taxpayer files a refund claim near the end of an audit;
• The refund claim includes complex issues that require a length process to fully develop;
• The auditor is informed of a pending federal audit determination;
• The auditor goes on maternity or paternity leave and FTB management does not reassign the audit; and
• An issue under audit was also at issue in a prior audit and is pending at protest, appeal, or litigation.

The FTB also has noted that staff are working on alternative efficiency strategies, such as sending out educational letters to promote self-compliance rather than initiating an audit.

Taxpayers sometimes share the blame for delays, as overworked tax departments frequently require extensions on audit requests. Tax departments and FTB audit teams frequently work together and make timing concessions to fulfill the documentation needs of the audit team. While collegial on timing, the necessary scope of the audit or extent of the documentation required to substantiate positions often are more contentious. Policies that encourage a full audit of a tax year before granting claims on isolated issues create diminished efficiencies. Further, because of the age of some cases, records have been destroyed under the company’s record retention rules (FTB records are sometimes destroyed for this reason), or the records are in storage and must be physically retrieved. There may also have been staff turnover or an acquisition.

Audits may also be delayed by the filing of alternative apportionment petitions or an alternative apportionment variation request by an auditor or taxpayer. Most such petitions and assertions arise during an audit and are addressed in the final determination. While the three-member Board has a mechanism to hear alternative apportionment petitions itself pursuant to 18 Cal. Code Regs. § 25137(d), this option accounts for few of the requests made. When they are, the Board generally is able to resolve such petitions within 12 months.

The FTB says that it remains committed to minimizing and reducing the number of protests older than two years. Over the past four fiscal years, these efforts have seen success, with a significant drop in the number of protests more than two years old. FTB management also has encouraged taxpayers to bring their timing concerns to FTB audit supervisors and managers and to share their experiences in the Audit Customer Experience Survey after completion of an audit or protest.

The timely, efficient resolution of controversies requires the cooperation of both taxpayers and state officials. Transparency of FTB operations must be a consideration in this discussion. The FTB, at the direction of its three-member Board, should release a public report accounting for its aging controversy inventory. The legislature recognized the importance of public participation to remove delays in the 1988 Taxpayers’ Bill of Rights, and it remains true more than three decades later. A public report would empower taxpayers and voters to provide valuable input to the FTB and state legislators to ensure all parties have the knowledge and resources needed to make taxes less burdensome for everyone.

Gina Rodriquez
Principal
Ryan
279.600.3261
gina.rodriquez@ryan.com