The Federal Partnership Audit Rules and California Taxes

California modified its tax laws to address the federal partnership audit rules. California added state reporting and payment requirements for adjustments under the federal rules. The state requirements went into effect on September 23, 2018.

California Deadline to Report Partnership Audit Changes

Partnerships must report changes in their federal returns under the partnership audit rules. They must report the changes to the Franchise Tax Board (FTB) within six months after the final federal determination.

Federal Election Required for Adjustments to Flow to Partners

Beginning with the 2018 tax year, partnerships must pay the taxes arising from federal audit adjustments. Historically, federal partnership audit adjustments have flowed through to the individual partners.

Although partnerships are now liable for post-audit taxes, they may elect to shift the tax obligation to their partners. This federal election will apply for California tax purposes, with two exceptions.

California Unitary Partners Separately Report Adjustments

If a partnership is part of a unitary group, the unitary partners must separately report and pay their California share of the partnership adjustments. California will treat them as having filed an amended federal return. They must then file an amended California return.

State Election to Shift Tax Obligation Back to Partnership

A partnership can file a request to make a California election different from its federal election. The FTB must grant this request if the partnership:

  • establishes that the election will not impede the FTB’s tax collection ability; and
  • properly computes the amount of tax due.

Imposition of California Tax on Partnerships

The California tax imputed to a partnership depends on the types of partners in the partnership. Calculation of the tax takes into account whether the partners are:

  • corporations;
  • individuals or fiduciaries;
  • tiered partners; or
  • tax-exempt entities.

Tax applies at the highest rate applicable for each type of partner. It applies after apportionment and allocation or sourcing of income to California. Partnerships may exclude from the calculation:

  • a tax-exempt partner’s share of adjustments that is not unrelated business taxable income; and
  • a partner’s share of adjustments previously reported on an amended return and for which the partner has already paid any additional state tax due.

Tiered and Indirect Partners

Tiered and indirect partners are subject to the same requirements as audited partnerships and direct partners relating to:

  • elections;
  • reporting; and
  • payment.

They must make reports and payments within 90 days after the deadline for partnerships to furnish statements.

Publicly Traded Partnerships

The FTB will assume publicly-traded partnerships have elected to pass adjustments to their partners, unless they request otherwise. They need only report their direct partners’ distributive shares of the adjustments to the FTB.

By Carolyn Kwock, J.D.

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All stories by: CCHTaxGroup