Inside scoop from the FTB: Officials answer CalCPA members' taxing questions.

Among the many benefits of CalCPA membership are the annual liaison meetings that the Tax Committee holds with the Franchise Tax Board and IRS. Following are highlights from the FTB meeting.

Multiple-Year Tax Returns Filing

The FTB has implemented special handling procedures that allow multiple returns with interrelated issues to be processed together by its Information Validation Section.

The CPA should file all of the related returns in the same envelope. Attach a copy of a cover letter to each return, identifying the taxpayer, I.D. number, tax year, and total number of returns being submitted, along with any specific instructions.

The cover letter should be stapled below the entity information on each return. Although balance due, refund and prior vs. current year returns have different processing priorities and requirements, the attached cross-referenced cover letters will help FTB personnel identify the special processing need and finalize processing of the multiple returns concurrently.

Incapacitated Taxpayers

Who signs the individual return, and in what capacity, under the following scenario: The taxpayer has become incapacitated during the year, and as a result, no power of attorney has been executed. The taxpayer's adult child is the successor trustee of the taxpayer's irrevocable (sic) trust.

The FTB will follow the IRS procedure here: If the adult child is in charge of the taxpayer and his/her property, there is sufficient evidence of implied intent for the successor trustee to act on behalf of the taxpayer as an authorized agent.

The trustee should contact the IRS for permission by submitting IRS Form 2848, the Power of Attorney form. After permission has been granted, the trustee will sign his/her name in the signature block under the capacity of an authorized representative. If the IRS accepts the trustee as the taxpayer's representative, California will follow.

Stock Options and Nonresidents

A taxpayer earned and was granted stock options while performing services in California. The options were exercised subsequent to the taxpayer giving up his California residence. What is the status of the income from the exercise of these options as far as California is concerned?

According to the FTB, the income's status depends upon the type of options that were exercised.

* Nonqualified stock options: When a taxpayer exercises nonqualified stock options while a nonresident, the income is characterized as compensation for services with a source in the state where the taxpayer performed the services, in this case, California.

* Incentive stock options: No income is recognized when ISOs are exercised.

Capital gain income from a qualifying disposition of stock acquired through an ISO is sourced to the seller's state of residence at the time of the sale. So, a California nonresident who sells such stock is not subject to California tax even though the services that gave rise to the grant were performed in California.

If a taxpayer disposes of the stock in a disqualifying disposition, the income may be characterized as both wages and capital gain:

The wage income is equal to the difference between the fair market value of the shares on the date of exercise (or sale price, if lower) and the amount paid for the shares. When a California nonresident exercises ISOs and later disposes of the stock in a disqualifying disposition, the wage income has a source in the state where the taxpayer performed the services, in this case, California.

* The capital gain income is equal to the difference between the fair market value of the shares on the date of sale and the fair market value of the shares on the date of exercise. The increase in value is treated as capital gain income with a source in the taxpayer's new state of residence. If no increase in value occurs, no capital gain income is reported.

The alternative minimum tax adjustment is the amount the fair market value of the shares (in the year the stock was substantially vested) exceeded the Option price. No AMT adjustment is made if the shares were disposed in the same year of exercise. If the shares are disposed in a later year, the adjustment has a source in California in the same manner as income from the exercise of nonqualified stock options for regular tax purposes.

Nonresident Partner Withholding

A new California joint venture elected to be excluded from Subchapter K IRC Sec. 761(a). A California Form 565 was filed to make this election for California purposes. The owners and their California addresses were provided on the Form 565. The joint venture received a Partnership's Requirement to Withhold notice. Why?

According to the FTB, this is an informational letter only, automatically sent when a new Form 565 enters the system. If all of the partners are California residents, or the partnership does not have California source income, the notice can be ignored.

However, the requirements of California Revenue and Taxation Code Sec. 18662 still may apply. If California source income is paid to a nonresident joint venture, the joint venture is required to withhold.

Leonard W. Williams, CPA, is a Sunnyvale-based sole practitioner. He is a member of CalCPA's Committee on Taxation, AICPA Tax Division member and former Peninsula Chapter president.