California FTB Audits: What Triggers an Investigation and How to Protect Your Business in 2025

Most California business owners are terrified of a Franchise Tax Board (FTB) audit—but the real audit triggers aren’t what you think. Forget ancient urban legends: the FTB isn’t searching for innocent mistakes; they’re hunting for patterns that suggest noncompliance, underreporting, or systematic neglect. And in 2025, those patterns are easier than ever for the state—and the IRS—to spot. Yet what the average entrepreneur misses is that most California FTB audits start with five predictable (and avoidable) triggers. Avoid these, and you dramatically lower the chance your business gets the dreaded audit letter.

Fast Tax Fact: FTB Audit Triggers for 2025

For tax year 2025, the FTB is targeting returns with large year-over-year changes, 1099/employee misclassification, consistent late filings, outlier deductions compared to industry averages, and business activities flagged by federal audits or whistleblower tips. Most FTB audits are triggered by specific data, not random selection—and nearly all can be avoided with preventative strategy and documentation.

1. Year-Over-Year Income Swings—The #1 Audit Trigger

The FTB’s audit algorithms scrape every CA return for big revenue swings. Reported a $320,000 profit last year and suddenly $37,000 this year? That’s a neon-red flag. The FTB expects explanation—including proof. Let’s say Michael, a Los Angeles S Corp owner, had consistent sales of $250K/year, but dropped to $42K in 2025 while keeping payroll steady. Unless Michael can document a major event (COVID, disaster, exit of a big client), expect an FTB audit letter requesting proof—plus a reconciliation of every banking transaction.

💡 Pro Tip: If revenue drops or expenses spike, proactively add a clear explanation statement on your return (CA Form 568 for LLCs or Form 100 for corporations) and attach backup records (see FTB documentation).

What If I Can’t Document My Loss?

The FTB can add back unsubstantiated loss, trigger state tax, penalties, and even refer your file to the IRS for double jeopardy. Always document.

2. Employee vs. Contractor Classification—The Misunderstood Minefield

In 2025, AB 5 is still haunting CA employers. If you’re paying workers as 1099 contractors but they “look like” employees (work regular hours, use your equipment, have no other clients), the risk isn’t just misclassification penalties—it’s a guaranteed audit. For example, Sarah’s marketing firm paid her design team $110K as 1099s, even as the same team clocked in daily, worked onsite, and had company email addresses. CA flagged her 2024 filing, initiated an AB 5 compliance audit, and hit her with $25K in back taxes and penalties.

🔴 Red Flag Alert: The FTB uses the ABC Test to evaluate worker status. If you fail any part, you’re flagged.

Can I Switch 1099s to W-2 Mid-Year?

Yes—but you must correct prior classifications, possibly file amended returns, and pay any owed payroll taxes. Don’t let fear delay corrective action; it’s cheaper to fix internally than face state penalties.

For a deeper breakdown of legal compliance, see our California Tax Notice & Audit Defense Guide.

3. Underreported CA Income vs. Federal—The Silent Trigger

“Filing federal only” is one of California’s top audit starters. If you skip your CA LLC, S Corp, or C Corp return but file a federal 1120S/1065/1040, California’s FTB will auto-match and open an audit. If your CA gross receipts differ from what’s reported to the IRS, expect a notice.

• Example: Hector, an Alameda LLC owner, reported $180K net profits to the IRS but excluded $40K in CA income during state filing. The FTB opened an audit, matched QuickBooks deposits, and added $40K back—with interest and a 20% penalty.

What Forms Are Matched?

All federal K-1, 1099, W-2, and Schedule C income is cross-referenced. Omitting California-specific income guarantees an audit, especially with multistate businesses.

4. Non-Compliance With Franchise Tax Obligations

Starting in 2025, California is increasing franchise tax enforcement for LLCs and S Corps. Missing the $800 minimum annual franchise tax (Form 3522), late filings, or sending incomplete payment immediately flags your entity. For instance, Darlene’s S Corp missed her Form 3522 payment by 12 days, triggering a $250 late penalty and an FTB warning letter. She’d received warnings but ignored them. After three years, FTB suspended her entity’s status, froze her account, and voided her e-commerce seller permits—blocking sales statewide.

💡 Pro Tip: Set recurring reminders to process your annual $800 FTB payment well before the due date (April 15 for S Corps/LLCs), and double-check bank records for payment confirmation.

How Strict Is the Franchise Tax Board on Deadlines?

Very. There are few late payment waivers. For current rules, check the FTB’s official payment portal.

5. IRS Referral Audits—Double Jeopardy for the Careless

If you are audited by the IRS, assume that data is instantly shared with the FTB. CA opens “mirror audits” against any flagged entities, typically reviewing up to three prior years. They focus on large business deductions ($15K+), aggressive travel/meal write-offs, or prior audit findings.

🔴 Red Flag Alert: If you lose an IRS audit and agree to changes, you are legally required to amend your CA return and pay any additional tax—failure triggers FTB audit automatically. Our tax resolution team specializes in these corrections.

How Far Back Can the FTB Audit?

FTB can audit up to four years from the original return date, but unlimited if fraud is suspected.

📌 KDA Case Study: S Corp Owner Avoids Double Audit Nightmare

Persona: S Corp owner, digital marketing agency, $850K/year revenue.
Problem: Facing IRS audit for excessive travel deductions ($38K/year); possible CA referral.
What KDA Did: Reviewed all travel records, found $7,200 lacked proper receipts. Preemptively amended both IRS and FTB returns with documentation, saving $31K in disallowed deductions and nearly $9K in cumulative penalties.
Savings: KDA charged $4,600 for defense prep, saving client $40,000+ in taxes and penalties. ROI = 8.7x in first year.

Staying Off the FTB Radar: Preventative Record-Keeping

Audit risk drops to near-zero if your books are “boring”—no unexplained spikes, late filings, or missing income. Especially for LLCs and S Corps in California, the secret is systems. Implement:

• Automatic recurring reminders for all FTB deadlines (Forms 3522, 568, 100).
• Separate business checking—no co-mingled personal funds.
• Digitized receipts and supporting docs for all deductions over $2,500.
• Using a payroll service for W-2s and contractor payments.
• Monthly closes (not annual catch-ups) to spot errors before filing.

💡 Pro Tip: The FTB loves consistency. Make sure your gross receipts, payroll, and deductions don’t “yo-yo” year to year. Learn about clean bookkeeping in our California Business Owner’s Guide to Bookkeeping Compliance.

Common Mistake that Triggers an Audit: Relying on Tax Software Alone

Tax software cannot spot many FTB audit triggers. If you use TurboTax, H&R Block, or other off-the-shelf programs, you risk misclassification, overlooked required forms, and “silent return errors” that a human professional would catch. Do not rely on software alone for compliance if your business earns over $200K or has W-2s/1099s.

What Happens If the FTB Audits My CA LLC or S Corp?

You’ll receive an initial notice (FTB Form 4953, 5830, or 5820B). The FTB will request specific documentation: bank statements, payroll records, contracts, and substantiation for every deduction over $2,500. The audit is typically desk-based but can escalate to in-person review if records are incomplete.

If you ignore, delay, or fail to provide substantiation, your deductions are disallowed, and the board can assess back taxes, penalties (up to 25% of tax owed), and interest. Severe or repeated neglect can result in business suspension or criminal referral.

FAQs About FTB Audit Triggers in 2025

How long do I have to respond to an FTB audit notice?

The FTB generally allows 30 days to respond. If you need more time, request an extension immediately—never miss the stated deadline.

Can I appeal an FTB audit decision?

Yes, but you must file a protest within 60 days of your notice date using the correct FTB appeal forms.

Are S Corps and LLCs both targeted equally?

Yes—California audits both structures, especially those with gross receipts over $150K or wage/payroll complexity.

💡 Mic Drop Insight

The FTB isn’t looking for mistakes—they’re looking for carelessness. Build systems, document everything, and the audit risk vanishes. The IRS isn’t hiding these write-offs—you just weren’t taught how to find them.

This information is current as of 7/22/2025. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.

Book Your 2025 California FTB Audit Shield Session

Don’t let an FTB or IRS audit upend your business. Book a confidential, 1-on-1 audit shield strategy session with a KDA expert, and receive a customized compliance blueprint. Get audit-proof and protect every dollar you’ve earned. Click here to book your audit shield session now.

• 1. “Year-over-year swings in CA profits get flagged automatically—don’t risk your livelihood.”
• 2. “If you pay workers as independent contractors but treat them like employees, you’re basically inviting an FTB audit.”
• 3. “You’ll never win an FTB audit by relying on tax software alone—get a real strategy before it’s too late.”