In the world of U.S. income taxation, there is a tendency to say ‘state follows federal’ as an automatic response to questions involving the state tax impact of federal-level changes. On Dec. 30, 2020, the California Franchise Tax Board (FTB) issued Notice 2020-04, reminding taxpayers that ‘state follows federal’ is a broad over-generalization that should never be applied in the absence of due consideration of state-level procedure and substantive review of outright exceptions and other federal-to-state differences.
FTB Notice 2020-04 supersedes Notice 2000-8, as corrected by Notice 2001-02. New Notice 2020-04 provides guidance to taxpayers on how to file an election to change an accounting period or method with the FTB. The new notice substantially follows the previous notice, with procedural clarifications to conform the notice to the state’s return instructions. Unchanged is the guidance that, as long as California has conformed to the underlying federal law, any change in accounting period or method approved by the IRS for federal purposes will apply for California purposes.
Per Notice 2000-8, as corrected by Notice 2001-02, in circumstances where California has conformed to the underlying federal law related to the change, automatic conformity was a matter of course without any specified state-level procedural requirements. To supplement the now superseded notice, California’s form instructions added a requirement to attach a copy of the approved federal forms 3115 or 1128 to the taxpayer’s return. In order to reconcile the instructions and the notice, Notice 2020-04 includes the language from the form instructions, requiring a taxpayer to attach a copy of the approved federal election to their original tax return for the year of the change. Under the guidance and California’s approach to the Doctrine of Elections, it is unlikely that the state will accept a change reported on an amended return.
In addition, Notice 2020-04 provides guidance where (1) California does not conform to the federal law and a taxpayer cannot rely on a federally-approved change, (2) the taxpayer requests a change different from the federal change or (3) the taxpayer, in the absence of a federal change, requests a change for California purposes only. In these circumstances, a taxpayer must complete a California pro forma form 3115 or 1128 using California-specific tax information, and applying reconciling guidance. Taxpayers must file the pro forma change request either before or with their original California return for the year of change. Where a California-specific change would be eligible for federal automatic consent if filed at the federal level, the FTB will also grant automatic consent.
Why should taxpayers take notice?
Why should taxpayers be concerned about a notice providing minor procedural clarifications to a 20 year old notice that was arguably already modified by the state’s return instructions? The short of it is that taxpayer-favorable provisions in 2020’s Coronavirus Aid, Relief, and Economic Security Act (CARES Act) have resulted in a wave of form 3115 filings at the federal level. The states are aware of the increase in these filings, and they are watching for state-level ineligible changes. Taxpayers filing federal methods changes should carefully review their state-level procedural obligations, whether those changes are allowed at the state level, and the state impact of conformity.