Multistate Audit Procedures Manual

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CALIFORNIA FRANCHISE TAX BOARD Internal Procedures Manual Page 1 of 27Multistate Audit Procedures Manual 14000 BANKRUPTCY MAPM 14010 Bankruptcy Unit MAPM 14020 Identifying A Taxpayer In Bankruptcy MAPM 14030 Bankruptcy Types MAPM 14040 Important Dates & Periods MAPM 14050 Prior Bankruptcy Law MAPM 14060 Current Bankruptcy Law MAPM 14070 Prompt Audit Requests MAPM 14080 Statute Of Limitations MAPM 14090 Petition Number MAPM 14100 Audit Bankruptcy Procedures MAPM 14110 Application Of Franchise Tax MAPM 14120 Penalties MAPM 14130 Tax Notice Procedures-Prior Bankruptcy Law MAPM 14140 Tax Notice Procedures-Current Bankruptcy Law MAPM 14150 Post NPA - Out Of State Protest Cases MAPM 14160 Tax Notice Worksheet (NPA, NOA NOD) MAPM 14170 Bankruptcy Correspondence - Protested NPAs, Other Non-Final NPAs MAPM 14180 Bankruptcy Correspondence - Final NPAs MAPM 14190 Combined Report Procedures The information provided in the Franchise Tax Board's internal procedure manuals does not reflect changes in law, regulations, notices, decisions, or administrative procedures that may have been adopted since the manual was last updated. CALIFORNIA FRANCHISE TAX BOARD Internal Procedures Manual Page 2 of 27Multistate Audit Procedures Manual 14010 BANKRUPTCY UNIT Auditors may contact the Bankruptcy unit with questions regarding pending audits on bankrupt debtors or to obtain advice from the Bankruptcy unit staff about case information about ...

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CALIFORNIA FRANCHISE TAX BOARD Internal Procedures Manual Multistate Audit Procedures Manual 14000 BANKRUPTCY MAPM 14010 MAPM 14020 MAPM 14030 MAPM 14040 MAPM 14050 MAPM 14060 MAPM 14070 MAPM 14080 MAPM 14090 MAPM 14100 MAPM 14110 MAPM 14120 MAPM 14130 MAPM 14140 MAPM 14150 MAPM 14160 MAPM 14170 MAPM 14180 MAPM 14190

Bankruptcy Unit Identifying A Taxpayer In Bankruptcy Bankruptcy Types Important Dates & Periods Prior Bankruptcy Law Current Bankruptcy Law Prompt Audit Requests Statute Of Limitations Petition Number Audit Bankruptcy Procedures Application Of Franchise Tax Penalties Tax Notice Procedures-Prior Bankruptcy Law Tax Notice Procedures-Current Bankruptcy Law Post NPA - Out Of State Protest Cases Tax Notice Worksheet (NPA, NOA NOD) Bankruptcy Correspondence - Protested NPAs, Other Non-Final NPAs Bankruptcy Correspondence - Final NPAs Combined Report Procedures

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CALIFORNIA FRANCHISE TAX BOARD Internal Procedures Manual Multistate Audit Procedures Manual 14010 BANKRUPTCY UNIT Auditors may contact the Bankruptcy unit with questions regarding pending audits on bankrupt debtors or to obtain advice from the Bankruptcy unit staff about case information about pending assessments and other issues. The Bankruptcy Unit in the Special Procedures Section of the Special Programs Bureau coordinates all bankruptcy actions. The unit files claims with the Bankruptcy Court, advises other units on bankruptcy procedures, provides training, and coordinates activities between our employees, the Attorney General's Office, and taxpayers on bankruptcy matters. The Bankruptcy Unit is responsible for the collection of amounts owing from taxpayers that have filed for bankruptcy protection. This section contains answers to questions such as: •the taxpayer has filed for bankruptcy?When can an auditor issue an NPA, if •Should an NPA be issued on federal audits that are not final and/or agreed? •Can the auditor issue an O/A (refund)? •What effect does the issuance of an NPA or refund have on the bankruptcy or FTB's ability to collect? •If a taxpayer tells us they are bankrupt but does not provide any details and bankruptcy information is not located, how should staff proceed with the audit? • should the auditor proceed? Should you HowHow much authority does a trustee have? request a power of attorney from the trustee? A number of terms have specific and significant meaning that must be understood when working with a taxpayer in bankruptcy. A brief definition is included below, however, it is very important that you read all of the information contained in this section in order to understand which actions are prohibited to FTB. When a bankruptcy petition is filed on a corporation, an automatic stay is imposed AutSotamyatic immediately. It prohibits creditors, or potential creditors, from making demands on the corporation in bankruptcy. Last date when FTB can file a claim with the Bar Datebankruptcy court for taxes due on income earned prior to thepetitiondate. Confirmation The date the Chapter 11plan is approved by the Datebankruptcy court. Petition DateThe date a Petition for Bankruptcy is filed with the

CALIFORNIA FRANCHISE TAX BOARD Internal Procedures Manual Multistate Audit Procedures Manual

court.

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CALIFORNIA FRANCHISE TAX BOARD Internal Procedures Manual Multistate Audit Procedures Manual 14020 IDENTIFYING A TAXPAYER IN BANKRUPTCY The Bankruptcy Unit will monitor all Chapter 7 and Chapter 11 accounts. The Bankruptcy Unit receives petition information from the California courts and uses this information to place certain codes on the taxpayer's account. If the corporation files for bankruptcy in a court outside of California, the FTB will be notified only if it is listed as a creditor. Once the Bankruptcy Unit receives information that a corporation is in bankruptcy, it will prepare form FTB 6631, Corporation Bankruptcy Claim Worksheet. This form lists the bankruptcy information and the bar date if one is set. This form is placed in the corporation folder. When entering bankruptcy codes on corporation system files, the Bankruptcy Unit may not be aware an audit is in progress. Therefore, when working any audit case, keep in mind the potential for bankruptcy. How often the system should be checked is a matter of judgment. Particular weight should be given to the amount of revenue involved and any other information the auditor has regarding a taxpayer's financial condition. BUSINESS ENTITY TAX SYSTEM BETSNPA case detail screen will show a "HOLD" status, and assigned to 199 BKY,- * * , the for prior 10/22/94 Bankruptcy Law only. * * will provide the Bankruptcy information, chapter filed (7 or 11) and petition date. * * may contain notes regarding the Bankruptcy. IDENTIFICATION DURING AUDIT PROCESS If a taxpayer does not inform the auditor of their intention to file for bankruptcy, the following are some indicators that can help to identify a potential bankruptcy situation: •Negative cash flow or cash flow problems •Change from profit to loss on tax returns •High debt to equity ratio •Large adverse litigation judgements •Significant drop in the price of stock •Substantial under-funding of pension plan •Major management shakeups •Foreclosure proceedings •Retention of bankruptcy counsel •Representative complaining of nonpayment •Negative reports or publicity

CALIFORNIA FRANCHISE TAX BOARD Internal Procedures Manual Multistate Audit Procedures Manual •Hiring of a "turnaround specialist"

NOTE:((* * *)) = Indicates confidential and/or proprietary information that has been deleted.

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CALIFORNIA FRANCHISE TAX BOARD Internal Procedures Manual Multistate Audit Procedures Manual 14030 BANKRUPTCY TYPES CHAPTER 7 LIQUIDATION In Chapter 7 liquidations, an estate is created, and a trustee is assigned by the court to collect and liquidate all non-exempt assets. A bar date is established usually 90 days after the first meeting of creditors. Once the estate is liquidated, the trustee distributes the estate's proceeds to creditors according to priority. A discharge order is not entered because the entity ceases to exist. CHAPTER 11 REORGANIZATION In Chapter 11 reorganizations, the debtor is given protection from creditors to develop a reorganization plan to repay debts. The debtor attempts to workout agreements with creditors to remain in business. It allows for 100% payment of some creditors' claims but less than full payment for others. All claims are paid according to a reorganization plan that is approved by a majority of the creditors. The court determines the bar date. AUDITS AND BANKRUPTCY Audits involving taxpayers that have filed for bankruptcy protection require special handling. There are two principal issues of concern when a taxpayer files a bankruptcy petition: 1. The state's interest must be protected by filing claims prior to the bar date. 2. The taxpayer's rights must be protected with regard to the "Automatic Stay." When a corporation files a petition for bankruptcy, additional dates come into play that will bar the assessment of additional tax regardless of whether we have a waiver signed. Therefore, once an auditor becomes aware that a corporation has filed a petition for bankruptcy, a decision must be made to either survey all open years, or to expedite the audit of all open years.

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CALIFORNIA FRANCHISE TAX BOARD Internal Procedures Manual Multistate Audit Procedures Manual 14040 IMPORTANT DATES & PERIODS PETITION DATE The petition date is the date a Petition for Bankruptcy is filed with the court. BAR DATE The bar date is the last date in which FTB can file a claim with the bankruptcy court for taxes due on income earned prior to the petition date. (Pre-petition years plus the short income period ending on the petition date). If a timely claim is not filed, then the department may be barred from collecting past taxes including pending assessments. For audit purposes, the bar date is of great concern since it may be considered as the statute of limitations date. THE BAR DATE RULES FOR CORPORATIONS 1. The bar date is the last day for creditors to file claims against a debtor in a bankruptcy case. For audit purposes the bar date becomes our statute date. The bar date does not extend the audit time limit and does not extend the SOL under the California Revenue and Taxation Code. (SeeMAPM 14080on SOLs for bankruptcy cases.) The Bankruptcy Unit must be informed well in advance of the bar date of any pending assessment to allow sufficient time for filing claims in bankruptcy court for taxes owed. 2. For a Chapter 7 bankruptcy case which began prior to October 22, 1994, there is no bar date for priority claims (e.g., taxes owed) following court cases for the period prior to the Chapter 7 petition date. Refer to the following court case: Pacific Atlantic Trading Co., U.S. Court of Appeals for the Ninth Circuit, August 18, 1994. However, the auditor should call the Bankruptcy Unit for advice before assessing tax on "NO ASSET" Chapter 7 cases. The bankruptcy case could change from a "NO ASSET" case to an "ASSET" case. Once a Chapter 7 corporation liquidates, the debt is not collectible even though the debt is not discharged by the Bankruptcy Court. 3. Normally the Chapter 11 bar date becomes null and void if a bankruptcy case is converted from Chapter 11 to Chapter 7. If the SOL period has not expired, we may assess tax on the pre-chapter period while the Chapter 7 case is still open, assuming it is an “ASSET case.

CALIFORNIA FRANCHISE TAX BOARD Internal Procedures Manual Page 8 of 27 Multistate Audit Procedures Manual 4. If the Bankruptcy Unit receives notification that a Chapter 11 case has converted to a “NO ASSET Chapter 7case, they will suspend the taxpayer and do an in-house discharge of all account balances. 5. If a Chapter 7 or Chapter 11 bankruptcy case is dismissed by the Bankruptcy Court, the bar date is null and void for that case. The department may then treat the taxpayer as any other taxpayer. CONFIRMATION DATE The confirmation date is the date the Chapter 11 plan is approved by the bankruptcy court. AUTOMATIC STAY When a bankruptcy petition is filed on a corporation, an automatic stay is imposed immediately. The automatic stay prohibits creditors, or potential creditors, from making demands on the corporation in bankruptcy. The automatic stay can prevent further collection action and also prohibit the department from demanding audit information for the duration of the bankruptcy proceedings. An auditor must be careful not to violate the automatic stay when requesting audit information. The auditor may request information but cannot impose penalties for non-response. If the taxpayer does not provide the information, the auditor should inform the taxpayer in writing of our intention to issue an assessment. Issue the assessment following the procedures inMAPM 14100automatic stay has different limitations on . The FTB's actions depending on the date the bankrupt corporation filed the bankruptcy petition as follows: WHEN THE BANKRUPTCY PETITION IS FILED PRIOR TO OCTOBER 22, 1994: 1. The automatic stay prohibits the department from taking the following actions: Issuing Demand Letters Levying the Taxpayer's Account Billing the Taxpayer Issuing Notices of Action, Notices of Revision, Notices of Determination Placing Liens on Assets Issuing Jeopardy Assessments (unless given permission by the taxpayer) Finalizing NPAs Issuing Subpoenas 2. With the taxpayer's permission, auditors may continue the following:

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CALIFORNIA FRANCHISE TAX BOARD Internal Procedures Manual Multistate Audit Procedures Manual •Making Audit Inquiries (no demands) •Placing Telephone calls •Issuing Information Document Requests 3. NPAs may be issued while the taxpayer is in automatic stay, but flag the NPA with bankruptcy code 199 BKY immediately to ensure it does not go final. (SeeMAPM 14100, Item 2) The importance of contacting the Bankruptcy Unit cannot be overemphasized. WHEN THE BANKRUPTCY PETITION IS FILED ON OR AFTER OCTOBER 22, 1994: 1. The automatic stay prohibits the department from taking the following actions: •Issuing Demand letters •Levying the Taxpayer's Account •Placing Liens on Assets •Issuing Jeopardy Assessments (unless given permission by the taxpayer) •Issuing Subpoenas •Sending Bills Threatening Involuntary Collection Action •Taking Involuntary Collection Action 2. With the taxpayer's permission, auditors may continue the following: Making Audit Inquiries (no demands) • •Placing Telephone Calls Any Audit Information Requests • 3. Auditors may do the following: •NPAs may be issued while the taxpayer is in automatic stay and NPAs can go final. •Issue NPAs, NORs or NODs. •Issue standard bills that do not threaten involuntary collection actions. •Demand the filing of income tax returns. •Perform normal audit activity including issuing IDRs (but not demands for information).

CALIFORNIA FRANCHISE TAX BOARD Internal Procedures Manual Multistate Audit Procedures Manual

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14050 PRIOR BANKRUPTCY LAW For those corporations whose bankruptcy petitions were filed prior to October 22, 1994, a tax notice could not be finalized while the taxpayer was in bankruptcy. Refer to the following court case: Schwartz vs. United States, U.S. Court of Appeals for the Ninth Circuit, January 22, 1992. Under these conditions, finalization of a tax notice (NPA, NOA, and NOD) would be a violation of the automatic stay provisions of the bankruptcy law. Therefore, check with the Bankruptcy Unit's advisor for those cases subject to prior law before issuing NPAs to see if the 199 BKY hold procedure should be used. (SeeMAPM 14100) Also check with the Bankruptcy Unit for those cases subject to prior law before issuing finalized notices (NOAs and NODs) or allowing an NPA to go final.

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CALIFORNIA FRANCHISE TAX BOARD Internal Procedures Manual Multistate Audit Procedures Manual 14060 CURRENT BANKRUPTCY LAW The Bankruptcy Reform Act of 1994 is applicable for those corporations filing bankruptcy petitionson or afterOctober 22, 1994. Changes made to the Bankruptcy Code by the Act are as follows: 1. Section 362(b)(9) of the Bankruptcy Code expanded the exception to the automatic stay provisions for governmental units. The new provision allows governmental units to issue a finalized notice of tax deficiency, make a demand for tax returns, assess any tax and issue a notice for payment of tax assessed. 2. Section 502(b) of the Bankruptcy Code provides that a claim of a governmental unit is considered timely filed if it is filed before 180 days after the date of the order for relief (petition date) or such later time as the Federal Rules of Bankruptcy Procedure may provide. (For audit purposes no more than 120 days from the petition date will be used to complete the audit. This allows the Bankruptcy Unit 60 days to file a claim with the Bankruptcy Court.)