Common Errors Found on California Combined Returns
Question B-3: Is there a change in the members listed in Schedule R-7 from the prior year?
Question B-4: Enter the number of members (including parent or key corporation) listed in the Schedule R-7, Part I, subject to income or franchise tax.
During the 2007 filing season, we received many returns that did not respond to the above questions or provided the wrong information. For example, if an entity has not been assessed the franchise tax or the income tax as reported on Section A, Part I of the Schedule R-7, that entity should not be considered in the response to Question B-4.
Another area where common errors occur is on the Schedule R-7. Boxes A, B, and C of Section A, Part I are not being checked. Boxes A and B on the Schedule R-7 should be checked based on the following:
- If the electing member is incorporated, organized, qualified, or registered with the California Secretary of State to do business here, this member has a California filing requirement since they are subject to the franchise tax. This electing member would check Box A.
- If the electing member has any property, payroll, or sales in California, this member has a California filing requirement since they are doing business here and are subject to the franchise tax. This electing member would check Box B.
- If the electing member derives income from sources within California, but is not doing business here, this member has a California filing requirement since they have California source income and are subject to the income tax. This electing member would also check Box B.
In addition, assigned California corporation numbers are not being provided.
Quite often, tax preparers and taxpayers list information in Section A, Part I of the Schedule R-7 with information from the federal consolidated return. A common error is that entities that are not California taxpayers are identified as such. Section A, Part I of the Schedule R-7 should only include entities that are required to file a return in California. If an entity does not have a California return filing requirement, the entity should be identified in Part 2 of the Schedule R-7.
Another area of concern involves the key corporation. Disclosing the key corporation’s California corporation number is critical when identifying affiliates on the Schedule R-7.
The key corporation must file the single group return for all of the California taxpayers of the combined reporting group. Preferably, the parent corporation of the California taxpayers should be designated as the key corporation, but only if it is qualified or incorporated in California, or if it is doing business in California, or if it has California source income. If the parent corporation is not taxable in California, the key corporation should be the taxpayer with the largest property factor numerator in California. All payments (including electronic fund transfers) must indicate the key corporation’s California corporate number.
A properly completed California Schedule R-7 eliminates processing delays and reduces erroneous assessments. For more help, please consult FTB Pub 1061, Guidelines for Corporations Filing a Combined Report.