Misreporting on Joint 2020 CA Tax Return

[separate899]

My former spouse received approximately $1.055M in cash proceeds from the sale of startup stock in 2020 (acquired by a public company). On the federal return, the gain was treated as eligible for QSBS exclusion.

However, I’ve since learned that California does not conform to the QSBS exclusion, and the $1.055M should have been taxed almost fully as its cost basis was  negligible (less than $250). 

We filed Married Filing Jointly at the time. We are now divorced, and under our marital settlement agreement that income is his separate property and he is responsible for any associated tax liability and audits of prior returns.

My questions:

1. Based on your experience, if the QSBS exclusion was applied to the California return, is that likely an error that should be corrected?

2. What is the recommended process if one former spouse will not cooperate in amending a joint return?

3. In situations like this, is it appropriate to consider an IRS or FTB referral for potential misreporting? How likely will the FTB pursue this referral? 

Thank you for any guidance.

[MonikaK1]

Yes, California did not conform to the Qualified Small Business Stock exclusion for 2024 and 2025. There may be changes in the future. California Instructions for Schedule D (2024) state, for Line 1:

• Qualified Small Business Stock – California does not conform to the qualified small business stock deferral and gain exclusion under IRC Sections 1045 and 1202. Enter the entire gain realized in column (e).

The California Franchise Tax Board receives the Federal return along with the California return. The FTB regularly audits returns for which it may appear that income on the Federal return was understated or omitted on the California return. 

Because California has a four-year statute of limitations for assessment, their audit notices may go out more than three years after the return was filed, and would include penalties and interest from the due date of the return. Therefore, it is advisable to have the error corrected as soon as possible rather than waiting for an audit notice.

Taxpayers who file a joint return are jointly and severally liable for the tax on that return. There are some exceptions. See this IRS webpage for information about separation of liability relief on the Federal return. 

California also has similar provisions. See this California webpage about Form FTB 714.

You may wish to seek legal counsel as far as other options you mentioned, which are beyond the scope of our Community advice.