California Unitary Group of Corporations; Intercompany Distributions; Deferred Gain Tracking

New Form 3726 - Deadline Extended to 10/15/09

Ron Cohen, CPA, MST By Ron Cohen, CPA, MST
Greenstein, Rogoff, Olsen & Co., LLP

Unitary Groups must do more tracking in some cases. The Franchise Tax Board wants to make sure deferred intercompany gains don’t get lost over the years (and therefore, never taxed), so they are forcing taxpayers to provide annual details in the corporate tax return.

“If the taxpayer fails to disclose its DISA balance (see below) on its annual tax return, the staff of the Franchise Tax Board may, in its discretion, require the amounts in the undisclosed DISA accounts to be taken into account (meaning, trigger the taxable gain) in part or in whole in any year of such failure."

Franchise Tax Board Notice 2009-01 on the issue:

The Franchise Tax Board (FTB) announced that the deadline for filing Form 3726 (DISA and Capital Gain Information) to satisfy the requirements of Cal. Code Regs. § 25106.5-1(j)(7) has been extended to October 15, 2009.

FTB Form 3726 – DISA and Capital Gain Information:

From the form instructions:

“Cal. Code Regs., tit. 18 section 25106.5-1 provides detailed rules relating to the treatment of intercompany transactions between members of a combined reporting group. These regulations apply to intercompany transactions that occur on or after January 1, 2001. In general, the regulations adopt the treatment of intercompany transactions for federal consolidated return purposes. (Treas. Reg., Section 1.1502 13.) R&TC Section 25106 allows for the elimination of dividend distributions between members of the combined report. Distributions are dividends to the extent that they are paid out of earnings and profits (E&P). Once the current year E&P and accumulated E&P have been depleted, additional distributions will reduce the shareholder’s basis in the stock. Distributions in excess of current year E&P, accumulated E&P, and the shareholder’s basis in the stock, are then treated as a capital gain.

Cal. Code Regs., tit. 18 section 25106.5-1(f)(1)(B) provides that for transactions occurring on or after January 1, 2001, the capital gain may be deferred, but must be tracked in a Deferred Intercompany Stock Account (DISA). Under Cal. Code Regs., tit. 18 section 25106.5-1(b)(8), the balance of each DISA must be disclosed annually on the taxpayer’s return. The capital gain is deferred until either the distributor or recipient is no longer included in the combined report, or the occurrence of any other triggering event. See Cal. Code Regs., tit. 18 section 25106.5-1(f)(1)(B), for more information. If there is a partial stock sale of the distributor outside of the combined reporting group and the distributor remains in the combined report after the stock sale, then a portion of the DISA balance will be taxable to the extent of the stock sale.”

Prior Years!!!!

“For years 2001 through 2007, taxpayers who have not yet fulfilled their disclosure obligation on the original return can fulfill their disclosure obligation by submitting a Form 3726 disclosing their DISA balances for each of those prior years. An amended return does not need to be filed. However, taxpayers should file an amended return if they discover that a prior triggering event has occurred that would have required taking into income the relevant DISA amount. If taxpayers satisfy their disclosure obligations as indicated in this notice, the previously undisclosed balances will not be included in income due to the prior nondisclosures.”

Consequences for Failure to Disclose
If the prior DISA balances for years 2001 through 2007 are not reported as income due to the occurrence of a triggering event described in CCR section 25106.5-1, subsection (f)(1)(B), or disclosed as required, then pursuant to CCR section 25106.5-1, subsection (j)(7), the undisclosed balances may be accelerated by the FTB and required to be taken into income. This could result in additional tax liability and the imposition of various penalties, including the accuracy-related penalty under CRTC section 19164 and the large corporate underpayment penalty under CRTC section 19138.”

I am always available for questions or comments at (510) 797 8661 x237 and we are ready to help your company comply with these rules.

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