How did California apply an IRS Form 906 closing agreement and compliance fee for errors on Forms 1099-B issued to fund shareholders?

Plain-English summary

California Chief Counsel Ruling 2001-1278 accepted a California-adjusted portion of a federal Form 906 compliance fee as a state information-return penalty under section 19183.

The taxpayer had voluntarily disclosed errors on Forms 1099-B issued to fund shareholders, corrected its reporting procedures, and entered a closing agreement with the IRS.

FTB followed the federal agreement only to the extent California conformed to the penalties for incorrect information returns and payee statements. California did not generally conform to the federal compliance-fee authority itself.

The reporting errors

The taxpayer improperly combined all of a shareholder's fund redemptions for a year on one Form 1099-B. In limited cases, that could cause the shareholder to mischaracterize the income.

It also understated reportable gross proceeds on some partial fund redemptions.

The taxpayer voluntarily reported the errors to the IRS and represented that the faulty procedures had been corrected.

The federal agreement and California proposal

The IRS Form 906 closing agreement required a compliance fee calculated from two components: an account-based amount using actual figures for some periods and an estimated amount for partial redemptions in another period.

The taxpayer proposed a California penalty derived from the federal computation and adjusted for fund shareholders with addresses outside California.

California's regulations required information returns only for payees whose last known addresses were in California.

Why FTB used the federal agreement

FTB generally followed federal settlements and closing agreements when their provisions were applicable under California law.

A Form 906 closing agreement was a final federal determination for matters it covered.

California incorporated the federal penalties for failure to file correct information returns and failure to furnish correct payee statements through section 19183. It did not incorporate the broader federal authority for compliance or user fees.

FTB therefore treated the agreed California amount as a state penalty, not as wholesale adoption of the federal fee regime.

Holding

FTB accepted the proposed California-adjusted amount as an appropriate self-assessment under section 19183.

Because the penalty amounts were the same for the filing and payee-statement violations and the federal agreement did not apportion them, FTB did not require a split between the two subdivisions.

FTB would issue a notice of proposed deficiency assessment. No interest would accrue if the taxpayer paid within 15 days of notice and demand.

Payment would satisfy the taxpayer's California liability arising from the described errors for the covered years. The taxpayer did not have to file corrected Forms 1099-B with FTB or issue corrected payee statements for those errors.

What this means for you

Information-reporting teams

Keep recipient-address data, original and corrected reporting logic, voluntary-disclosure records, federal closing agreements, and the state allocation method.

Investment funds and brokers

Federal settlement does not automatically dictate California treatment. Identify the state provisions that conform to each federal penalty or fee component.

Tax professionals

Distinguish a conforming information-return penalty from a nonconforming federal compliance fee, and track the short payment deadline that controls penalty interest.

Common questions

Q: Did California simply adopt the federal compliance fee?

A: No. FTB used the federal agreement only to the extent California conformed to sections 6721 and 6722 penalties.

Q: Why was the federal amount adjusted?

A: California information-return rules focused on payees with California addresses.

Q: Did FTB require the penalty to be divided between two violations?

A: No. The amounts were the same and the federal agreement did not apportion them.

Q: When did interest begin?

A: No interest accrued if the assessable penalty was paid within 15 days of notice and demand.

Q: Were corrected Forms 1099-B required?

A: No, for the specific errors and years covered by the ruling and payment.

Citations and references

• Cal. Rev. & Tax. Code §§ 18622, 18631 et seq., 19060, 19101(c)(2)(A), and 19183
• Cal. Code Regs., tit. 18, §§ 18631-18681(a)(1) and 19059(e)(1)
• I.R.C. §§ 6721 and 6722
• Montgomery Ward & Co. v. Franchise Tax Board, 6 Cal. App. 3d 149 (1970)
• Appeal of Von Housen Motors (Cal. St. Bd. of Equal., Mar. 3, 1982)
• Appeal of Jack and Arla Meyer, 96-SBE-012 (May 15, 1996)
• Rev. Proc. 2001-8, 2001-1 I.R.B. 239

Source

• Landing page: Chief Counsel Ruling index
• Official ruling: Chief Counsel Ruling 2001-1278

Original ruling text

STATE OF CALIFORNIA
KATHLEEN CONNELL
FRANCHISE TAX BOARD
Chair
Legal Branch
CLAUDE PARRISH
PO Box 2229
Member
Sacramento, CA 95812-2229
(916) 845-3307 Fax (916) 845-3191
B. TIMOTHY GAGE
Member

October 31, 2001
Chief Counsel Ruling
2001-1278

Re: ****

Dear **:

You have requested a Chief Counsel Ruling on the application of a federal closing agreement executed on behalf of the Commissioner of Internal Revenue on **, in which the taxpayer agreed to pay a compliance fee to the Internal Revenue Service (IRS) with respect to certain errors on Forms 1099-B issued for tax years ending *******.

According to the facts presented in the closing agreement and at our meeting on
**, the taxpayer made certain errors on Form 1099-B information returns furnished to Fund shareholders (payees). ***, the taxpayer improperly aggregated and reported to a Fund shareholder on a single Form 1099-B for the particular year all Fund redemptions occurring during that year. This error, in certain limited instances, may have caused the shareholder to mischaracterize the nature of the income. ****, the taxpayer understated reportable gross proceeds on certain partial Fund redemptions on Forms 1099-B. The taxpayer voluntarily reported these errors to the IRS and represents that these erroneous reporting procedures have been corrected.

From the information you have provided, the federal compliance fee was computed based on the sum of two components: A *** per account penalty computed using actual figures for the **, and a second set of figures for *, roughly estimating partial redemptions and computing what amounts to an estimated fee. The total amount of the federal compliance fee, including both components, was ****.

You propose that the California penalty amount resulting from the ***, adjusted for the percentage of fund shareholders with addresses outside of

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California, would be *****. You also propose that this amount be assessed on a Notice of Proposed Assessment based on the federal closing agreement.

Applicable Law

Revenue and Taxation Code (RTC) section 18622 requires a report of federal changes, including penalties. RTC section 19060(b) allows a Notice of Proposed Deficiency Assessment to be issued within four years from the date the taxpayer reports a federal change to FTB, where such notification is more than six months after the final federal determination.

RTC section 19183(a) incorporates Internal Revenue Code (IRC) section 6721 (failure to file correct information returns). RTC section 19183(b) incorporates IRC section 6722 (failure to furnish correct payee statements). RTC section 19183(f) provides that the penalty may be imposed and paid on notice and demand by FTB.

RTC sections 18631 et seq. require the filing of California information returns. RTC section 18631 incorporates various IRC sections, and requires that a copy of the federal information return may be required to be filed with FTB as well.

18 Cal. Code Regs. sections 18631-18681(a)(1) require information returns only with respect to payees whose last known address is within California.

18 Cal. Code Regs. section 19059(e)(1) specifies a closing agreement as a final federal determination.

RTC section 19101(c)(2)(A) provides that interest on any assessable penalty is imposed only if the assessable penalty is not paid within 15 days of notice and demand, and then from the date of notice and demand.

Discussion

The Franchise Tax Board (FTB) will generally follow the provisions of a federal settlement or closing agreement to the extent applicable to California law. Montgomery Ward v. FTB (1970) 6 Cal.App.3d 149; Appeal of Von Housen Motors, Cal. St. Bd. of Equal., March 3, 1982. Specifically, the provisions of a federal Form 906 closing agreement are considered to be the final federal determination of any matter included therein. Appeal of Jack and Arla Meyer, 96- SBE-012, May 15, 1996. Here, California law conforms to the penalty provisions

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of IRC 6721 and 6722, but does not conform to the general federal compliance or user fee authority 1 .

Holding

Based on the information you have provided, we agree that the sum of
** represents an appropriate self-assessment of the California penalty against the taxpayer for tax years ending *****
*****, resulting from the provisions of the Form 906 closing agreement. For California purposes, this is treated as a penalty under RTC section 19183. As the penalty amounts are the same under both subdivisions (a) and (b) of RTC section 19183, and no apportionment is made in the federal closing agreement, it is not necessary to distinguish or apportion the penalty between the failure to file correct information returns to FTB under subdivision (a) and the failure to furnish correct payee statements to customers under subdivision (b).

This amount will be assessed on a Notice of Proposed Deficiency Assessment pursuant to RTC section 19060, and so no interest will accrue on the penalty if it is paid within 15 days from the date of the notice under RTC section 19101(c)(2).

The taxpayer's payment of the ** penalty will satisfy the taxpayer's liability for tax years ending *******, under RTC section 19183, if any, and any predecessor statutes, arising from the reporting errors described above. The taxpayer shall not be required to file information returns (Forms 1099-B) with the FTB and shall not be required to issue payee statements (Form 1099-B) to the payee to correct errors on the Forms 1099-B noted above.

Please be advised that the tax consequences expressed in this Chief Counsel Ruling are applicable only to the named taxpayers and are based upon and limited to the facts you have submitted. In the event of a change in relevant legislation, or judicial or administrative case law, a change in federal interpretation of federal law in cases where our opinion is based upon such an interpretation, or a change in the material facts or circumstances relating to your request upon which this opinion is based, this opinion may no longer be applicable. It is your responsibility to be aware of these changes should they occur. This letter is a legal ruling by the Franchise Tax Board Chief Counsel within the meaning of Revenue and Taxation Code section 21012(a)(1).

1
See Rev. Proc. 2001-8, 2001-1 I.R.B. 239, for a detailed list of legislative acts authorizing federal user fees.

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Please attach a copy of this letter and your request to the appropriate return(s) (if any) when filed or any notices or inquires which might be issued.

Very truly yours,

Bruce R. Langston
Tax Counsel