California provides accounting method guidance

The California Franchise Tax Board (FTB) released Notice 2020-04 on Dec. 30, 2020, to update and revise its guidance on how taxpayers may change their accounting period or method for California personal or corporation income tax purposes.¹

Background

For federal income tax purposes, Form 3115, Application for Change in Accounting Method, allows taxpayers to change their method of accounting, generally with adjustments. For example, taxpayers must file Form 3115 when they wish to correct their method of accounting and receive audit protection for that method, or affirmatively change their method of accounting, which may serve to reduce (or increase) federal taxable income. In addition, taxpayers may file Form 1128, Application to Adopt, Change, or Retain a Tax Year, to request a change in their federal income tax year either through an automatic approval or ruling request.

In Notice 2000-8, the FTB outlined California’s policy with respect to state changes in accounting method. This Notice set forth guidance applicable to California’s conformity to federal method changes, along with state-specific method changes. Notice 2020-04 clarifies the conditions under which a California method change can be obtained.

Deemed California consent

Cal. Rev. and Tax. Code Secs. 17024.5(e)(1) and 23051.5(e)(1) generally provide that a taxpayer is deemed to have made a proper election for California personal or corporation income tax purposes if the taxpayer makes a proper election for federal income tax purposes, provided that California has confirmed to the underlying law which is being applied. Generally, a taxpayer must attach a copy of the approved federal election to its original California return for the taxable year in which the change is in effect.

Different California elections

If a taxpayer: (i) cannot rely on a federally-approved request to change an accounting period or method; (ii) wishes to obtain a treatment different from the federal change or election; or (iii) wishes to change for California personal or corporation income tax purposes only, a Form 3115 or a Form 1128 must be filed with the FTB, using the appropriate California tax information.²

In the case of combined reporting groups, the taxpayer members of the group may either determine their total separate net income from California sources from the unitary combined reporting group’s activities,³ or elect to file a group return under Cal. Code Regs. tit. 18, Sec. 25106.5-11, in which case the key corporation then acts as agent for the electing taxpayer members of the combined reporting group.⁴

Automatic California consent

Notice 2020-04 provides that, for purposes of California personal or corporation income tax only, taxpayers will be granted automatic consent for their changes in accounting period or method, provided that: (i) the underlying change would also be eligible for automatic consent for federal income tax purposes; and (ii) California has conformed to the underlying federal provisions. Taxpayers that wish to request the automatic California consent must file Form 3115 with the FTB with the original California tax return for the taxable year in which the election is to take effect. Notice 2000-8 had been silent on the circumstances under which an automatic California consent could be received.

Procedural guidance

Taxpayers that wish to file Form 3115 or Form 1128 with the FTB must include a cover letter that clearly indicates that a “Change in Accounting Method” or a “Change in Accounting Period” is being requested, along with the taxpayer’s name and California Corporation Number. For Form 3115, taxpayers should attach their Form 3115 to their California return, and a California-specific pro forma Form 3115 showing the adjustments to the impact of the accounting method change to reflect. The form(s) and cover letter should be mailed to:

In the alternative, the request may be faxed to (916) 855-5557.

For elections that require FTB consent, the request is due at least 60 days prior to the taxpayer’s return due date, including extensions. For elections that do not require FTB consent, Form 3115 should be filed any time prior to, or along with, the filing of an original California tax return on which the election is being requested to be effective.

Commentary

Notice 2020-04 describes how taxpayers may make certain accounting method changes for California personal or corporation income tax purposes that could result in the mixing and matching of different accounting methods for California, federal, and possibly other state income tax regimes. California taxpayers that have recently changed (or are considering changing) their federal accounting methods may wish to consider whether similar accounting method changes are applicable in California, or whether decoupling from federal tax treatment is warranted or even required. Understanding the effects and consequences of making a method change is not always as straightforward and simple as it may seem.

Under Notice 2020-04, when a California taxpayer submits a request to change an accounting period or method for federal income tax purposes, and the IRS approves such a request, the change will automatically apply for California purposes to the extent that California conforms to the underlying federal provisions, unless the taxpayer affirmatively makes a California-only election to depart from the federal treatment. With these principles in mind, California taxpayers should closely consider the state’s general IRC conformity date of Jan. 1, 2015, under which California has only conformed to a few limited provisions of the Tax Cuts and Jobs Act of 2017 (“TCJA”), and the Coronavirus Aid, Relief, and Economic Security Act of 2020 (“CARES Act”). Due to California’s 2015 general IRC conformity date, taxpayers should not merely assume that federal accounting period or method changes made as a result of the TCJA or CARES Act will automatically apply for California purposes.

Another consideration is California’s legislative declaration that it follows the “doctrine of election” in Senate Bill 1015 (“S.B. 1015”), enacted on June 27, 2012. Under S.B. 1015, the doctrine of election “provides that an election affecting the computation of tax must be made on an original timely filed return for the taxable period for which the election is to apply and once made is binding.”⁵ This language may place additional importance on the treatment selected on a taxpayer’s original return, and may potentially limit the ability to effect a change on an amended return should it later come to light that a different accounting period or method would be advantageous for California purposes.

1 FTB Notice 2020-04, California Franchise Tax Board, Dec. 30, 2020. The Notice expands upon FTB Notice 2000-8, as corrected by Notice 2001-02.
2 In contrast to the federal government, California does not charge a user fee for submitting a Form 3115 or a Form 1128.
3 CAL. CODE REGS. tit. 18, § 25106.5-3(a).
4 CAL. CODE REGS. tit. 18, § 25106.5(b)(14).
5 S.B. 1015, § 4, Laws 2012.

Contacts: