FTB Audit Issues - Continued
We continue our series of articles from last month's issues for both individual and business entity taxpayers. This month, we focus on common issues that impact pass-through entities. Some of the most common tax audit issues currently affecting pass through entities and related flow through to owners are:
Disposition of Real Estate
We continue to identify IRC Section 1031 and 1033 issues with respect to deferred gain, transactions that are incorrectly excluding cancellation of debt (COD) income via short sales or deeds in lieu and nonresident taxpayers failing to report California-source income.
Final Year of Limited Liability Companies (LLC) or Partnerships
Common audit issues in the final year of an LLC or Partnerships are verifications of proper gains or losses, reconciliation of negative capital accounts, distributions of installment notes, and COD income.
A trust will be subject to taxation if the fiduciary is a resident of California or a beneficiary whose interest in such trust is noncontingent is a resident of California. When trust apportionment of income is within and without California, we look at how the income is sourced to California and the residency status of the trustee.
Other State Tax Credits
When auditing other state tax credits for trusts, we always request verification of taxes paid to the other states. Trusts pay tax on all of the income (from all sources) received during the calendar year. Resident trusts get a tax credit for taxes paid to any other state. California calculates the tax on all income as if the trust was a resident and then allocates the tax based on trust apportionment rules.
We continue to audit shareholder’s basis to determine the correct flow through income, losses, deductions, and credits. We use the correct basis to determine taxability of distributions, debt repayments, and dispositions.
When determining whether or not an S corporation is subject to built-in-gains, we examine items subject to built-in gains, whether or not the correct recognition period was reported during the audit process, and the correct basis of the disposed asset.