Texas Comptroller of Public Accounts STAR System
Date: May 16, 2006
To: All Audit Personnel
From: David Rock, Audit HQ
Subject: Revenue Agency Report Procedures
Exception to Limitations
Tax Code Section 111.206, Exception to Limitation: Determination Resulting
from Administrative Proceeding, provides an exception to the four-year statute
of limitations when certain situations exist. Effective September 1, 1997, a
corporation which has been audited by the Internal Revenue Service (or other
competent authority, such as U.S. Tax Court, U.S. District Court, U.S. Court of
Appeals or U.S. Supreme Court) must file an amended franchise tax report within
120 days after the Revenue Agent's Report (RAR) is final, if the RAR results in
changes to the franchise tax reported. An RAR is final when all administrative
appeals with the Internal Revenue Service have been exhausted or waived. See
Rule 3.544(d) for information concerning administrative appeals. Generally,
the date we will use as the “final” date is the date the Form 870, Waiver of
Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance
of Over assessment, is signed. If there are official IRS documents provided
with a later date, then we will use the latest date available. Additionally,
STAR document 200205031T addresses the definition of an administrative
proceeding for the purposes of Tax Code Section111.206. It concludes that the
definition applies to all subject matter covered by Tax Code Section 171.212
and includes a change to a corporation’s earned surplus as the result of an
audit or other adjustment by the IRS or another competent authority. Internal
Revenue Code Sec. 7430(c)(5) defines an administrative proceeding as any
procedure or other action before the IRS. IRS Appeals Policy Statement P-8-1
states that the appeals office is the only level of appeal within the IRS, and
generally is the principal administrative function that exercises settlement
authority to resolve tax disputes for cases that are not docketed in the U.S.
If the taxpayer has been through the IRS appeals process and reached a
settlement with an appeals official, the taxpayer should have been issued a
document outlining the terms of the agreement. The signature date on this
document should serve as the date of the administrative proceeding that meets
the definition for Tax Code Section 111.206.
Prior to September 1, 1997, the only event that fell within the definition of
an “administrative proceeding” was a final determination resulting from an
administrative proceeding of a local, state, or federal regulatory agency; or a
judicial proceeding arising from an administrative proceeding of a local,
state, or federal regulatory agency. Effective September 1, 1997, subsection
111.206(f) was added, which expanded the definition of "Federal regulatory
agency" to include the United States Internal Revenue Service, and
“administrative proceeding” to include an IRS audit. However, this expansion
was only applicable to periods that were within statute of limitations on
September 1, 1997. Therefore, unless there was another tolling event that
would affect limitations, report periods audited by the IRS for 1992 and
earlier do not fall under this exception. 1993 would fall under this exception
only if the taxpayer had a valid extension to file to November 15, 1993. See
AP 100 for additional information regarding extensions. Of course, if the
taxpayer had a final determination resulting from an administrative or judicial
proceeding of a local, state, or federal regulatory agency, the exception to
limitations would apply, regardless of the report period at issue.
Section 111.206 does not apply to error corrections. Therefore, if amended
Texas returns are filed to correct an error, and to report RAR adjustments, and
the period is beyond the normal four-year statute of limitations, the only
items that can be adjusted for are the RAR adjustments (see exception in next
section). Error corrections cannot piggy-back on amended reports filed in
connection with and RAR when those reports would have normally been lost to
statute. Additionally, if the reports filed include both periods within
statute and beyond statute, taking Section 111.206 into consideration, we
cannot net the difference. See Hearing 38,299, STAR document 200003331P.
Example: Taxpayer files amended Texas returns covering 1993-1995 report years.
Amendments are filed to report RAR adjustments. 1993 results in a credit,
1994 through 1995 result in additional tax due. The 1993 report expired May
17, 1997 (no extension). Taxpayer pays the net of all amendments. In this
case, the 1993 does not fall under the exception provided in 111.206, so the
credit in 1993 cannot be used to offset any liability reported in 1994 and
Payments out-of-statute cannot be refunded. If the taxpayer files amended
Texas reports that are out-of-statute and pays any additional tax due to those
filings, we are under no obligation to refund those out-of-statute payments
because the tax was not collected unlawfully or erroneously. See Hearings
40,318 - 40,321 (STAR document 200204220H).
Example: Taxpayer files amended Texas returns covering 1993-1995 report years.
Amendments are filed to report RAR adjustments. 1993 results in additional
tax due and taxpayer makes a payment covering the tax. 1994 through 1995
result in credits. 1993 is out of statute because the taxpayer did not have a
valid extension to file for that period. 1994 through 1995 are covered by the
exception in 111.206. In this case, the 1993 payment cannot be refunded
because the liability that created the underpayment is valid. Statute only
comes into play when we assess a liability or give a refund. If the taxpayer
pays a valid liability, we will not refund the payment. However, we cannot
assess any additional tax if the taxpayer happens to underpay the liability,
nor can we assess any penalty and interest amounts that are over and above the
amount of the payment. But we can assess penalty and interest on the
additional tax paid on the out-of-statute periods if the taxpayer paid in
excess of the out-of-statute tax due, but only up to the total amount of the
Amendments must be based on a final adjustment to a federal tax return.
Hearing 41,114 (STAR document 200206360H), states that an amended franchise tax
return must be based on a valid amended federal return, and if it is not, even
though the period is within our statute of limitations, it should be rejected.
In this hearing, the taxpayer filed an amended 1997 report which was based on
federal taxable income figures that were not reported to the IRS. The amended
federal return was not filed because it fell outside of the three-year federal
statute of limitations. Therefore, even though the 1997 was still within
limitations for the State of Texas, it was not based on an amended federal
return that was filed with the IRS, and therefore, denied.
Section 111.206 only affects report periods that fall outside the normal
four-year statute of limitations. The one-year limitation discussed below only
applies to periods that would normally be out of statute. Therefore, if the
taxpayer requests a refund past the one-year deadline, but the periods involved
are still within the four-year statute of limitations, the request must still
be addressed. However, if the refund is requested past the one-year deadline
and the periods involved fall beyond the four-year statute of limitations, then
the request should be denied because the exception provided in Section 111.206
has expired. The same holds true for additional liabilities. Once the
taxpayer files the required reports, or once we discover that there was an IRS
audit, we have only one year to issue a deficiency determination on periods
that fall outside of the normal four-year statute of limitations.
* If the determination of the IRS audit or other administrative proceeding
results in a tax liability, the Comptroller may assess and collect, or bring
suit to collect the tax within one year after the later of the day the taxpayer
was required to notify the Comptroller of the determination or within one year
of the day the Comptroller actually received that notification.
* If the final determination results in the overpayment of tax to the state,
the taxpayer may file a refund claim for the amount of the overpayment before
the first anniversary of the date the determination becomes final.
* If the comptroller assesses tax by issuing a deficiency determination, the
taxpayer may file a claim for refund for an amount of tax that has been found
due in a deficiency determination before the 180th day after the deficiency
determination becomes final, but the claim is limited to the items and the tax
payment period for which the determination was issued.
Additional information regarding Section 111.206 and the 1997 law change can be
found in the January 2002 Tax Policy News and STAR 200109582L (November 2001).
Strayhorn v Willow Creek Resources Inc.
This court decision affected the time counted in administrative proceedings for
those refunds claimed prior to June 20, 2003. When computing the amount of
time that statute is tolled due to an administrative proceeding for refunds
claimed prior to June 20, 2003, include the time a refund was pending
verification in the field. The time that will be added starts on the date the
refund was filed (postmarked or hand-delivered) and ends when the refund is
paid or becomes administratively final, whichever is later. See STAR document
200508202L for application of this decision and STAR document 200508240L for a
copy of the memo explaining the decision.
Tax Code Section 171.212(a) stipulates that a corporation must file an amended
report if the corporation's net taxable earned surplus is changed as the result
of an audit or other adjustment by the Internal Revenue Service or another
competent authority, or the corporation files an amended federal income tax
return or other return that changes the corporation's net taxable earned
surplus. The federal taxable income as shown on a final RAR is considered to
be the correct amount to be used for the computation of earned surplus.
According to Sections 171.212(b) and (c), a corporation shall file the amended
report not later than the 120th day after the date the revenue agent's report
or other adjustment is final, or not later than the 120th day after the date
the corporation files the amended federal income tax return or other return. A
revenue agent's report or other adjustment is final on the date on which all
administrative appeals with the Internal Revenue Service or other competent
authority have been exhausted or waived. A corporation is considered to have
filed an amended federal income tax return if the corporation is a member of an
affiliated group during a period in which an amended consolidated federal
income tax return is filed.
If the taxpayer fails to comply with these filing requirements, the corporation
is liable for a penalty of 10 percent of the tax that should have been reported
and that had not previously been reported to the comptroller. This penalty is
in addition to any other penalty provided by law. Failure to file an amended
return in which a refund would result will not cause a 10 percent penalty to be
During an audit examination, auditors should inquire about and investigate all
IRS audits that have transpired since the last audit examination. Texas Tax
Code Section 171.211 authorizes the Comptroller to investigate or examine a
corporation's books and records to determine their franchise tax liability.
Rule 3.544(e) provides that the Comptroller "may examine financial statements,
working papers, registers, memoranda, contracts, corporate minutes, and any
other business papers used in connection with its accounting system." An
auditor may adjust a taxpayer's net taxable earned surplus if those documents
support the adjustment. Therefore, it is important to request to examine any
and all filings with the IRS and any other documents that may have a direct
effect on the computation of earned surplus.
* The taxpayer’s responses to the following questions must be documented in the
entrance conference section of the audit plan:
* Has the taxpayer been audited by the Internal Revenue Service (IRS) or has an
IRS audit been conducted on affiliates or related entities (members of the
affiliated group that filed a consolidated federal return)?
* Has earned surplus been adjusted by the IRS or other competent authority as
this would also be treated as an RAR?
* Has the taxpayer amended any federal IRS returns?
* Have RARs been issued not only for reports in the current audit period but
for any years outside of the audit period?
If the audit has been in progress for more than one year, or if the corporate
structure or audit contact has changed, the questions should be readdressed.
Consider both Sections 171.212 and 111.206 when handling amended franchise tax
reports based on IRS audits. Section 111.206 applies specifically to the
limitation period and Section 171.212 applies to the filing penalty. The
return should be examined for timeliness and for the actual reported amounts
for each category on the return.
If an amended federal return was filed or an IRS audit was conducted, the final
dates for each should be noted in the audit plan and the Audit Adjustment
Report (AAR). (An amended federal return final date is the postmark date or
hand delivery date of the amended returns to the IRS.) This date will
determine whether or not the additional 10 percent penalty will apply. The RAR
final date is also reflected on the XIHIST screen when returns are processed
through either Revenue Accounting or Account Maintenance divisions. The Field
Adjusted Report assignment also requires entry of a final RAR date.
Other IRS documents/forms are used by taxpayers to amend their reported federal
data. An example of this is the Form 1139, which is used to carry back a net
operating loss, capital loss, or certain unused tax credits. The IRS allows
the use of either Form 1139 or Form 1120X. The filing of Form 1139 with the IRS
usually results in a faster refund than the filing of a Form 1120X. Generally,
the IRS must act on an application within 90 days of its filing. In contrast,
the IRS has six months to act upon the filing of a Form 1120X. If the IRS
fails to act within the six months, the taxpayer may then file a suit for
Penalty may be waived on amendments due to RARs but this is not an automatic
waiver. The auditor should address penalty waiver every time an audit is
amended. Normally, the penalty waiver recommendation on the amendment follows
the recommendation of the original audit, but if the original audit did not
make any adjustments to a particular period that is now being amended, the
auditor must provide a waiver recommendation for that period. If the RAR is
being processed through a Field Verified Adjusted Report (FVAR) assignment, the
auditor should use the FVAR Penalty Waiver worksheet. However, if an amended
return resulting in additional tax is entered directly to the tax system, the
system will automatically assess penalty and interest and the taxpayer must
submit a written request for waiver to the Advanced Collections Processing
Section of the Revenue Accounting Division.
If the taxpayer plans to file a suit in U.S. District Court (or another court)
to contest any issues in the RAR, the company should file a claim for refund
with the Comptroller (at the time any amended returns are filed) for franchise
taxes which may change as a result of the court case. They should state in the
claim for refund that they are requesting a hearing if the refund claim is
denied. If this is the only issue, the auditor should deny the claim.
The claim for refund may be a letter or other written correspondence indicating
the amount of tax to be refunded and the reason for the refund. The taxpayer
should indicate in the refund letter that an administrative hearing on the
matter should be postponed pending the resolution of the matter in U.S.
District Court or whatever Court is pending.
If you have any questions, please contact the Franchise Tax subject matter
experts in Audit Headquarters.
As STAR is the Comptroller's research system for Texas tax policy issues,
only tax-specific audit policy memos (AP Memo) are included here. AP memos
not on STAR can be found on Window on State Government on the
Audit Memos web page.
ACCESSION NUMBER: 200605431L
DOCUMENT TYPE: L
TAX TYPE: FRANCHISE