ORDLOCK v. FRANCHISE TAX BOARD
Filed 6/8/06
IN THE SUPREME COURT OF CALIFORNIA
)
v. )
Defendant and Respondent. ) Super. Ct. No. BC278386
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California personal income tax law references its federal counterpart as the basis upon which to calculate a taxpayer's state taxable income and, ultimately, the state income tax owed for a specified tax period. California law does so by recognizing the amount reported as taxable income in the taxpayer's federal income tax return and then applying adjustments to that amount as required by state law. Accordingly, in the majority of cases, a determination in an audit by the Internal Revenue Service (IRS) that a California taxpayer's federal personal income tax liability is greater than reported in his or her federal income tax return also will effect an increase in the taxpayer's state personal income tax liability.
In general, when a California taxpayer owes additional state personal income tax for a particular tax year, and unless another provision of the Revenue and Taxation Code applies, section 19057 of that code requires that the California Franchise Tax Board (FTB) provide notice to the taxpayer of any deficiency assessment within four years of the date on which the taxpayer filed his or her state income tax return for the tax year in question. In the specific circumstance in which a California taxpayer receives a final IRS determination changing or correcting his or her federal personal income tax return for a particular tax year, Revenue and Taxation Code section 18622 requires that within six months, the taxpayer report to the FTB any federal adjustment that will increase the taxpayer's state tax payable for the same period.[1] When the taxpayer reports such an adjustment within six months, the FTB must provide notice of any related deficiency assessment within two years. (§ 19059.) When the taxpayer fails to report such an adjustment, the FTB may give notice of a deficiency assessment at any time. (§ 19060.)
In the present case, the IRS audited the federal income tax return of the taxpayers, plaintiffs Bayard M. Ordlock and Lois S. Ordlock, for a particular tax year and eventually determined -- more than four years after the date on which the taxpayers filed their federal and state income tax returns for that tax year -- that the taxpayers received greater taxable income than they reported and owed additional federal income taxes. Although the change in federal taxable income had the effect of increasing the taxpayers' state taxable income and income tax for the same period, they did not report the federal adjustments to the FTB pursuant to section 18622. Following their unsuccessful administrative appeal of the state's eventual deficiency assessment and their payment of the assessed taxes, the taxpayers filed a civil action seeking a refund. The appellate court agreed with the taxpayers that, because the four-year period prescribed by section 19057 for the FTB to provide notice of any deficiency assessment had expired prior to the final IRS determination of the taxpayers' additional federal tax liability, the taxpayers were not required to report the federal changes or pay the additional state taxes assessed.
We consider the correctness of the Court of Appeal's holding. As we shall explain, in affording the FTB a four-year period of limitations in which to notify a taxpayer of a state tax deficiency assessment, section 19057 by its terms does not establish an outermost time limit for notification by that agency in all circumstances. Instead, an alternative period of limitation applies when, after the taxpayer files his or her tax return, the IRS intervenes and finally determines that the taxpayer's federal taxable income and tax liability are greater than reported in his or her federal return for a particular tax year, with resulting increases in state taxable income and the amount of state income tax calculated thereon for the same period. In the event of such IRS intervention, section 19059 or section 19060 provides an alternative period during which the FTB may notify the taxpayer of a deficiency assessment, the duration of which depends upon when or whether the taxpayer reports to the FTB the final results of the federal authorities' examination of the taxpayer's return.
In the present case, the taxpayers failed entirely to report pursuant to section 18622 the federal changes that increased their state income tax liability. As a consequence, the FTB had an unlimited time in which to issue its notice of a deficiency assessment pursuant to section 19060. Accordingly, we reverse the judgment of the Court of Appeal.
I
The material facts are not in dispute. Having obtained an automatic extension, plaintiffs Bayard M. and Lois S. Ordlock in May 1984 timely filed, as married, filing jointly, their federal and state personal income tax returns for the 1983 tax year. Their federal income tax return reflected their having taken, as deductions, certain expenses related to three partnerships in which Mr. Ordlock held minority interests.
Thereafter, the IRS commenced partnership-level audits of the partnerships' federal tax returns for 1983 and subsequent tax years. Eventually, the IRS offered and plaintiffs accepted a settlement with regard to their interests in two of the partnerships reported on their 1983 federal income tax return. In 1994, the IRS issued a report of tax examination changes reflecting disallowances of deductions attributable to those partnership interests. In 1996, the IRS issued a report of tax examination disallowances of deductions related to the third partnership interest, as well as a final report reflecting an increase in plaintiffs' federal taxable income for the 1983 tax year. Although the increase in their federal taxable income also caused an increase in their state taxable income and the state taxes calculated thereon for 1983, plaintiffs did not notify defendant FTB of the interim or final IRS audit reports of income tax changes.
In May 1998, defendant mailed plaintiffs a notice of proposed assessment of additional state income tax for the 1983 tax year in the amount of $12,350, with accumulated interest in the amount of $35,215.62, based upon the increase in state taxable income resulting from the increase in federal taxable income determined in the IRS tax audit. Defendant's notice advised plaintiffs that pursuant to section 18622, they must report any federal changes resulting in increased state taxes payable â€
