Tax gap operations: FTB's procedure may be new to many CPAs.

California's Franchise Tax Board has a procedure that is new to many. A client received an inquiry requesting a 2005 Form 540. Included in the verbiage was something to the effect of: "You paid $35,000 in home mortgage expense, we believe that you must have had income that exceeded the filing requirement."

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It turned out that his income was below the 2005 filing requirement because he'd made a pile of money in 2004, from the exercise and sale of stock options, invested the proceeds in California and municipal bonds and didn't work in 2005. So, he had no taxable income for 2005. (Maybe he should look into paying off the mortgage if he has that kind of money.)

This probably is ancillary to the use of Form 1098 mortgage interest payment records by both the IRS and FTB in their "lifestyle" analyses to measure possible under-reporting of income, even when a return has been filed, when the income reported on the tax return doesn't seem to support the mortgage interest being paid.

State Board of Equalization and Use-tax Collections

The SBE routinely looks for any documentation indicating a sale value of more than $400. A usual source is customs declarations from the U.S. government, which are filed when someone re-enters the United States after a trip abroad. They receive similar reports from e-Bay, as one Tax Talk participant told of a client who got a use-tax bill for a $7,195 watch purchased on e-Bay.

FTB Changes FAQs for Interest Abatement

Qualified individuals and business entities should take a look at the FTB's updated website, which contains information on everything from erroneous refunds, circumstances for abatement denied requests.

View the updates at www.ftb.ca.gov/ individuals/faq/interestabatement.html.

Prior-year Balance Due from Refunds to Taxpayers

A CPA's client still owed about $1,900 in taxes to the IRS for 2005. His 2006 taxes were filed showing substantial refunds from both the IRS and the FTB.

He got a statement from the FTB stating that it had "intercepted" the refund on behalf of the IRS and would forward the amount to IRS.

There is nothing specific that has to be done at the time. Sooner or later, once the payment by FTB has been posted, the account will show an overpayment and the IRS will refund the excess automatically if no other taxes are owed to the IRS.

Good Advice From a Board of Equalization Auditor

While working with the audit regarding use tax for an out-of-state company making sales in California, the auditor said that the best way to handle issues going forward is to request a ruling in writing. The BOE apparently stands behind its rulings in the event a subsequent audit determines that something should have been taxed.

A request for "written advice" is defined in California-BOE Regs. 18 CCR Sec. 1705(b), but it gives no particular format for such requests, other than it requires the name of the person for whom the advice is being requested.

Two of the participants who have been through this exercise submitted letters in the following format. This is an amalgamation of two different letters:

1. Specific person for whom the advice is requested. Some CPAs choose to request the ruling in their own name and, if approved, ask that the client's name be substituted for the CPA's name. The SBE is reportedly willing to do this.

2. Specific advice requested.

3. Facts on which the requested advice is based, including fully describing the activities of the client in this state.

4. Law on which requested advice is based.

5. Whether or not an audit of the client has been completed within the past six months. If so, the letter goes back to the auditor who did the audit for comment.

The elapsed time varies. One respondent reported three or so months, another said that it was done via e-mail and was both easy and fast.

Problems with Tax Agencies Ignoring Powers of Attorney

For many years, one of the main complaints filed by CalCPA members at the IRS liaison meetings has been that so many of their auditors ignore powers of attorney and go around the duly designated representative. Apparently, the FTB and SBE have picked up the same bad habit, according to a recent posting.

If enough people complain, though, perhaps there might be some real response, instead of the usual verbal messaging, followed by no action.

In one such incident, after the close of an audit, where the SBE auditor agreed that no penalty would be assessed, the SBE auditor phoned the 82-year-old taxpayer and told her she was being assessed a negligence penalty. There was no communication with the CPA.

When the CPA got wind of it, he complained to the auditor's supervisor, who said that there was no requirement for the auditor to communicate with the CPA--even though there was a power of attorney on file. However, the supervisor agreed to remove the penalty.

Thanks to the following CPAs for their contributions to these discussions: Jim Counts, Edward Estrin, Bob Petersen, Cathy Stierhoff, Bill Sturgeon, Melody Thornton and Ralph Weintraub.

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Leonard W. Williams, CPA is a Sunnyvale-based sole practitioner. A member of CalCPA's Committee on Taxation, the AICPA Tax Division and a former Peninsula Chapter president, you can reach him at williams@/wwilliamscpa.com.

By Leonard W. Williams, CPA