Identify areas of noncompliance Taxpayers’ Bill of Rights Annual Report to the Legislature
Sample Data from the Audit Process
We compiled and analyzed data from the audit process to identify areas of recurrent taxpayer noncompliance. The data, some of which is derived from statistical samples, includes:
- The statute or regulation violated by the taxpayer.
- The amount of tax involved.
- The industry or business engaged in by the taxpayer (sample data).
- The number of years covered in the audit period.
- Whether the taxpayer used professional tax preparation assistance (sample data).
- Whether the taxpayer filed individual or corporate tax returns.
We collected assessment information from the personal income tax NPA display file for assessments that became final in FY 2018/2019. When we used sample data, the volumes and dollar amounts represent the sample study numbers projected to the total universe of assessments. Refer to tables in Appendix 1 for details.
We collected data for the distribution of NPAs by issue and tax assessed. If a single notice included multiple issues, we categorized the notice under the issue that provided the majority of the tax change. We categorized the assessment as “other” when there was no distinct primary issue.
For corporation taxes, the largest dollar amount in proposed assessments resulted from one primary issue: allocation and apportionment audits, which involves corporations doing business within and outside California.
Allocation is the assignment of nonbusiness income to a particular state. Apportionment is the division of business income among states by the use of an apportionment formula. Within the apportionment formula, the sales factor is the most frequent audit issue for corporations. The higher rate of noncompliance associated with allocation and apportionment may be attributed to the complexity of the underlying issues. In addition, noncompliance may occur due to diverse interpretations of the tax laws.
Based on the primary business activity in California, the industry group assessed with the largest dollar amount of additional tax was the trade industry.
For personal income taxes, the largest dollar amount in proposed assessments resulted from FE assessments, which refers to taxpayers who have not filed their state income tax return after we notified them of their filing requirements. Most of the proposed assessments were issued to personal income taxpayers for failure to file a state income tax return.
We issue a separate NPA to the taxpayer for each tax year included in an audit adjustment. Typically, individuals have audit changes for just one tax year. Ninety-five percent of the individuals who received NPAs during FY 2018/2019 had audit changes for a single tax year.
An in-house accounting department or an accounting or legal firm prepares virtually all corporation tax returns. The data indicates that tax professionals file over 64 percent of all personal income tax returns. We consider corporation tax returns as professionally prepared. In the absence of a paid tax professional’s signature, we consider that taxpayers self-prepared their personal income tax returns.
We also compiled statistics for e-filing and payments. For these figures, refer to Appendix 1, Table 6. E-filing continues to increase, with a 3 percent increase from July 1, 2018, to June 30, 2019. As of June 30, 2019, we received 1.65 million e-filed business entity (BE) tax returns, a 6 percent increase.
Taxpayer Filing Errors
The California R&TC requires the Taxpayers’ Rights Advocate to identify the most common errors taxpayers make when they file their tax returns and evaluate how those errors may be avoided or corrected.
We compiled taxpayer error information on approximately 18.2 million current year tax returns processed between July 1, 2018, and June 30, 2019. During this time, FTB sent approximately 638,000 Notices of Tax Return Change (NTRCs) to taxpayers who filed tax returns with errors that resulted in a change. This figure equates to approximately 4 percent of tax returns, up 1 percent from last year. We explain the errors in the NTRCs and inform customers how they can resolve any discrepancies.
Just under half (44 percent) of the adjustments we made were on paper-filed tax returns, even though only 11 percent of total current year tax returns were paper-filed. Adjustments on electronically filed tax returns (89 percent of total current year tax returns) accounted for the remaining 56 percent.
The two most common taxpayer errors, for all filing methods, are wage withholding and estimate payment discrepancies. Together, these two errors account for 39 percent of all taxpayer errors identified during the processing of tax returns.
Of all NTRCs sent, 17 percent contained a wage withholding adjustment. Taxpayers claimed a wage withholding amount that could not be verified based on the withholding information provided by the taxpayer and/or based on amounts reported to EDD by the taxpayer’s employer.
The other most common taxpayer error identified during processing is claiming the incorrect estimate payment amount. This error accounted for another 22 percent of NTRCs sent to taxpayers that resulted in an adjustment and notice from FTB. This error is also one of the most common reasons personal income tax (PIT) and business entity (BE) taxpayers and/or their representatives call during our peak pre-filing season.
In an effort to help taxpayers claim the correct amount of estimate payments, FTB piloted a project this past filing season aimed at the BE community providing a letter detailing their 2018 annual estimate payments and credit information. Phase 2 of the pilot will include providing BE taxpayers with a letter detailing their 2019 annual estimate payments and credit information. Findings from this pilot will help determine the feasibility of future efforts in this regard.
Tables in Appendix 2 display the number of adjustments by tax return type and filing method, and include a definition of what typically caused each adjustment.