California FTB Audit Defense: How State Tax Audits Differ from IRS Audits

California taxpayers often focus their concern on the IRS, but the California Franchise Tax Board (FTB) conducts aggressive audits that can result in equally devastating assessments. In fact, FTB penalty notices surged 32% in 2025 alone, driven by enhanced data-matching technology that cross-references IRS filings, business registrations, and other state agency records. Understanding how California state audits differ from federal examinations—and how to defend against them—is essential for every California taxpayer.

At the Law Office of Pietro Canestrelli, we represent California taxpayers before both the IRS and the FTB. As a California Board Certified Tax Specialist and former IRS agent, Pietro Canestrelli brings unique expertise to state tax audits—understanding both the technical differences between federal and California tax law and the procedural distinctions that affect audit defense strategy. This guide explains what makes FTB audits different and how to protect yourself.

Understanding the California Franchise Tax Board

The FTB is California’s primary tax collection agency for personal income tax and corporation tax. Unlike the IRS, which only handles federal taxes, the FTB operates solely within California but has extensive powers within the state.

FTB Authority and Resources

The FTB has access to:

IRS data sharing: The FTB receives copies of federal returns and matches them against California filings
Secretary of State records: Business entity filings, formation documents, and annual statements
EDD records: Employment and wage data from California employers
CDTFA data: Sales tax information that can reveal unreported business activity
Real property records: County assessor data on property ownership and values
Third-party information: 1099s, W-2s, K-1s, and other information returns

This comprehensive data access makes it increasingly difficult for discrepancies between federal and state returns to go unnoticed.

Key Differences Between FTB and IRS Audits

Different Tax Laws Apply

While California tax law largely conforms to federal law, significant differences exist:

No capital gains preference: California taxes capital gains as ordinary income at rates up to 13.3%
Different depreciation rules: California doesn’t conform to all federal depreciation provisions
No Section 199A deduction: California doesn’t allow the federal qualified business income deduction
Different NOL rules: Net operating loss carryforward and carryback rules differ
Residency-based taxation: California taxes residents on worldwide income, with complex rules for partial-year residents and nonresidents

These differences mean issues that pass IRS scrutiny may trigger FTB problems—and vice versa.

Residency Audits: A California Specialty

One audit type unique to California is the residency audit. When taxpayers claim to have left California for a lower-tax state, the FTB may investigate whether they truly established domicile elsewhere. Residency audits examine:

Where you spend your time (day counts matter)
Location of your primary residence
Where your spouse and children live
Where you’re registered to vote
Where your vehicles are registered
Where you have professional licenses
Location of your doctors, dentists, and accountants
Where you have social ties and club memberships

The stakes are high: if the FTB determines you remained a California resident, you’ll owe California tax on all income during the disputed period—plus penalties and interest.

Shorter Statute of Limitations

California’s standard statute of limitations is four years from the filing date (compared to three years for the IRS). However, exceptions extend this period:

Six years if you understate income by more than 25%
Eight years for partnership and S corporation items
No limit for fraud or failure to file

Different Penalty Structures

California imposes penalties similar to federal penalties, but amounts and triggers can differ:

Late filing penalty: 5% per month, up to 25% (same as federal)
Late payment penalty: 5% plus 0.5% per month (slightly different from federal)
Accuracy penalty: 20% for negligence or substantial understatement
Demand penalty: 25% if you fail to file after receiving a demand notice (unique to California)

Common FTB Audit Triggers

Understanding what triggers FTB audits helps you avoid problems:

Federal-State Mismatches

When your California return doesn’t reconcile with your federal return, the FTB notices. Common triggers include:

California AGI significantly different from federal AGI without explanation
Deductions claimed on federal return not appearing on California return (or vice versa)
Business income reported differently between returns

High Income

High-income taxpayers face disproportionate audit risk. California’s top 1% of earners pay over 50% of personal income tax revenue, making them natural audit targets.

Out-of-State Income for Residents

California residents must report worldwide income, including income earned in other states. The FTB cross-references information from other states to identify unreported income.

Stock Option and RSU Income

California’s rules for taxing stock compensation are complex, especially when employees move to or from California. The FTB frequently audits stock option exercises and RSU vesting to ensure proper California sourcing. See our guide on stock market tax strategies.

Business-Related Issues

Pass-through entity tax elections
Apportionment of multistate business income
Independent contractor misclassification (coordinated with EDD audits)

The FTB Audit Process

California audits follow a structured process:

Initial Contact

The FTB typically initiates audits by mail. You’ll receive a notice identifying the tax year under examination and the items of concern. Unlike the IRS, the FTB doesn’t always conduct in-person audits—many are handled entirely by correspondence.

Information Requests

The FTB will request documentation supporting your return positions. Respond thoroughly and on time—failure to respond can result in the FTB making assessments based on their assumptions.

Proposed Adjustment

After reviewing your information, the FTB issues a Notice of Proposed Assessment (NPA) if they believe additional tax is owed. This notice explains the proposed changes and your appeal rights.

Protest Rights

You have 60 days to protest a proposed assessment. This is a critical deadline—missing it can significantly limit your options. The protest goes to the FTB’s Settlement Bureau for review.

Appeals

If the protest doesn’t resolve the dispute, you can appeal to the Office of Tax Appeals (OTA), California’s independent tax appeals body. The OTA replaced the State Board of Equalization for most tax appeals in 2018.

For a detailed explanation of the appeals process, see our guide to tax appeals.

Defending Against FTB Audits

Respond Promptly

FTB deadlines are strict. Missing a response deadline can result in automatic assessments, loss of appeal rights, or additional penalties. Never ignore FTB correspondence.

Provide Complete Documentation

Support every item under examination with documentation. The burden of proof is generally on the taxpayer in California tax disputes.

Address California-Specific Issues

Remember that California law may differ from federal law. Don’t assume that because the IRS accepted a position, the FTB will too.

Consider Representation

FTB auditors can be aggressive, and the stakes are high given California’s top tax rate of 13.3%. Professional representation often produces significantly better outcomes than self-representation.

Residency Audit Defense Strategies

If you’re facing a residency audit, documentation is everything:

Travel records: Keep calendars, flight records, and hotel receipts showing your location
Utility bills: Bills from your new state showing regular usage support your claim of residence there
Lease or mortgage documents: Prove you have a permanent residence in the new state
Change of address notifications: Document when you notified banks, creditors, and government agencies
New state integration: Voter registration, vehicle registration, driver’s license, professional licenses
Social ties: Evidence of involvement in your new community

The FTB looks at totality of circumstances. A few trips back to California won’t necessarily establish residency, but patterns of behavior matter enormously.

FTB Collection Powers

If an audit results in an assessment and you don’t pay, the FTB has extensive collection powers:

Bank levies: The FTB can seize bank accounts without court approval
Wage garnishment: Up to 25% of disposable earnings
State tax liens: Filed against real and personal property
Offset programs: The FTB can intercept state tax refunds, lottery winnings, and other state payments
Suspension of professional licenses: The FTB can notify licensing boards of outstanding tax debts

These powers make resolving FTB disputes promptly essential. Learn more about California tax negotiation strategies.

Coordinating FTB and IRS Issues

California and federal audits sometimes overlap. When they do:

Information provided to one agency may be shared with the other
Resolving the federal issue first may simplify the state case
California has specific rules for amending state returns after federal changes
A consistent position across both audits is generally advisable

Our team handles both IRS and FTB matters, ensuring coordinated defense strategy across agencies.

When to Contact a California Tax Attorney

While minor FTB inquiries can sometimes be handled independently, consider professional representation if:

The potential assessment exceeds $10,000
Residency is at issue
Business income or complex investments are involved
You have corresponding IRS issues
The FTB is proposing fraud penalties
You’ve missed response deadlines

Learn about when you need a tax attorney versus other representation options.

Get Expert California FTB Audit Defense

The California Franchise Tax Board is increasingly aggressive in audit enforcement, and California’s high tax rates mean significant exposure for taxpayers who lose audits. At the Law Office of Pietro Canestrelli, we defend California taxpayers against both IRS and FTB examinations.

As a California Board Certified Tax Specialist, Pietro Canestrelli has the specialized expertise required for effective state tax defense. Combined with former IRS agent experience, this background provides unique insight into how tax agencies conduct audits and what strategies produce the best results.

Facing an FTB audit or have concerns about your California tax compliance? Contact our team for a consultation. We’ll evaluate your situation and develop a defense strategy to protect your interests.

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