In recent years Tax Executives Institute, Inc. (TEI), has met with various state organizations and revenue departments to encourage standardizing the rules for reporting federal audit adjustments. These efforts have been fruitful but have even greater potential for success with the passage of the Bipartisan Budget Act of 2015 (BBA), which adopts a new federal centralized partnership audit regime. The BBA, which is scheduled to become effective for taxable years beginning after December 31, drastically changes the way partnerships and their partners will be audited and assessed by the Internal Revenue Service (IRS). Because the BBA necessitates amendments to state laws governing the reporting of federal audit adjustments to states, it provides a unique opportunity to achieve greater uniformity for such state legislation.
States Diverge Widely on Reporting of Federal Audit Adjustments
Nearly all states require taxpayers to report changes resulting from federal income tax audits to their state revenue department. Reporting ensures that states can collect the revenues to which they are entitled.
States diverge substantially, however, on the time to report the changes, the specific events or actions triggering the reporting requirement, and the form or format required to report the federal adjustments. For example, states allow between thirty and 180 days from the date of a final adjustment to report federal income tax changes. (1) What constitutes a final determination also varies widely among states, with some states requiring reporting as each issue in the federal audit is settled or agreed to (even if other issues in the federal audit continue to be contested) and others requiring reporting only once all issues have been resolved. (2) States also allow different methods to report such adjustments, with some states requiring amended state tax returns, others allowing a stream-lined report or written notice, and still others waiving the reporting requirement if they have received notice of the adjustment from the IRS or another state. (3)
These diverse reporting requirements create needless confusion and complexity for multistate taxpayers. Indeed, multistate taxpayers must develop convoluted matrices to track each state's specific requirements and are often must prioritize reporting federal changes based on the due date, size of the adjustment, and the state's method of reporting. Taxpayers often have to file supplemental amended returns to correct errors on the returns reporting such adjustments because these returns were filed under short deadlines. The burden of complying with different state rules to report the same information in different formats is thus costly and wasteful for taxpayers and inefficient for states and taxpayers alike.
TEI's State and Local Tax Committee authored a policy statement on the Reporting of Federal Adjustments in 2015, and updated it in 2017, to provide recommended guidelines and procedures for state statutes for reporting federal audit adjustments. (4) In summary, TEI recommends that:
* taxpayers should be provided at least 180 days to report federal income tax adjustments to state tax authorities;
* the 180-day period should start from the date of a final determination, which shall be deemed to occur when all adjustments made by the IRS became final and all appeal rights under the Internal Revenue Code (IRC) are exhausted or waived for the taxpayer's taxable year. With respect to entities filing unitary or other types of combined or consolidated returns, the final determination would be based upon the last occurrence of such events for all members of the group;
* states should allow taxpayers to report federal adjustments to the state using a form similar to Federal Form 1120X, which is used to report federal income tax changes (5);
* such streamlined reports should be the taxpayer's means to report additional state tax due, report a claim for a refund or credit of state tax, and make other adjustments (including net operating losses) arising due to changes in the taxpayer's federal taxable income;
* states should provide taxpayers with the option to notify the state that the adjustments to the taxpayer's federal taxable income result in a de minimis state tax liability or refund in lieu of filing a report of their federal adjustments;
* prior to the final determination date, taxpayers should be permitted to make estimated payments of state tax that the taxpayer anticipates will be owed as a result of a pending IRS audit. Such payments should be creditable against any tax liability ultimately found to be due to the state and would limit the accrual of interest. Taxpayers should be able to obtain a refund on amounts the taxpayer overpaid; and
* adjustments made after the expiration of...