Can a foreign-owned group that finds years of unfiled California returns still elect water's edge?

The timing rule, and why a late original return cannot carry the election

For taxable years beginning on or after January 1, 2003, the water's edge election "shall be made on an original, timely filed return for the year of the election," and it is valid if the tax is computed consistently with a water's edge election and a written notification is filed with the return on the prescribed form; the Franchise Tax Board may accept other objective evidence that an election was intended in lieu of the form (RTC section 25113(a)). The FTB's 2025 Form 100W booklet states the same rule for every unitary taxpayer in the combined report and directs that Form 100-WE be attached to the timely filed original return for the year of the election (2025 Form 100W booklet, General Information T).

Two words carry the weight. "Original" is defined by regulation as the last return filed on or before the due date, extensions included, regardless of the form on which it is filed, and the FTB's manual adds the consequence for the non-filer: a return filed after the extended due date may be the original return if no other return was filed, but it is not a timely filed one (FTB Water's-Edge Manual, section 3.1(b)(5)). The manual also states that California tax law does not allow a taxpayer to elect water's edge through an amended return (section 3.1(d)(2)). The delinquent returns the group now prepares are original returns. They are not timely, and the election is the one choice on the return that depends on timeliness rather than originality.

The objective evidence sentence in section 25113(a) substitutes for the election form, not for the calendar. The regulation's rule that a timely supplemental or corrected filing can serve as the original return rescues a group that filed on time and imperfectly; it does nothing for a group that did not file at all. The library's article on what makes a water's edge election valid when the return and the election disagree covers those cures in detail. Each of them operates inside the filing window, and for every delinquent year the window has closed. No statute, regulation, or FTB notice located for this article gives the FTB authority to accept an election made after it.

The deemed election rules presuppose an election someone made on time

The deemed election provisions are not a back door for a group that never filed. A taxpayer that did not elect on its own timely filed original return is deemed to have elected only where an electing parent, holding more than 50 percent of its voting power, included its income and factors in the combined report on the parent's timely filed original return, or where its income and factors appear in the combined report on another electing taxpayer's timely filed original return and the election notification was signed by an officer or agent with authority to bind it (RTC section 25113(b)(2)(A), (B), (b)(3)). Both routes require a timely return by someone. In a group where no member filed, there is no electing parent, no timely combined report, and no notification.

The rules for members that become taxpayers later are built the same way. A member of the combined reporting group that is not itself subject to tax in the year the election is made, but later becomes subject to tax, is deemed to have elected with the other taxpayer members (section 25113(b)(4)). A unitary corporation incorporated outside the United States that is not subject to tax in the year the valid election is made, and later becomes subject to tax solely because of the doing business thresholds of RTC section 23101(b) in a taxable year beginning on or after January 1, 2021, is likewise deemed to have elected (section 25113(b)(5), as amended by Stats. 2020, ch. 297). That rule codified relief the FTB first gave administratively in FTB Notice 2016-02 (September 9, 2016) and extended in FTB Notices 2017-04 (October 16, 2017) and 2019-02 (June 26, 2019). Each notice required that a group of taxpayers had already made a valid water's edge election, that the foreign affiliate could not join it because it was not then a taxpayer, that the unitary relationship stayed continuous, and that the affiliate became a taxpayer solely because of section 23101(b). Nothing in the notices, and nothing in their statutory successor, reaches a group that never elected.

For the group in the question, the result is a sequence rather than a rescue. For the delinquent years, no election exists and none can be deemed. For the first year that can carry an election, every member that is a taxpayer in that year must make it, directly or through the paths in section 25113(b)(2), because an election is effective only if made by every member of the self-assessed combined reporting group that is subject to tax (section 25113(b)). That includes the foreign parent if it is itself a taxpayer in that year: section 25113(b)(5) covers only an affiliate that was not a taxpayer when the election was made. Affiliates that cross the thresholds in later years are then picked up by the statutory deemed election.

What the delinquent years look like without the election

The water's edge election operates "notwithstanding Section 25101" (RTC section 25110(a)), so without it the unfiled years are reported on the worldwide combined report: the business income of every unitary member, wherever incorporated, is combined and apportioned, and each California taxpayer's income is its share of that worldwide combined income. The election would have narrowed the report to the corporations section 25110 describes, chiefly corporations incorporated in the United States and any corporation, other than a bank, whose average United States property, payroll, and sales factors is 20 percent or more, with partial inclusion of other foreign corporations to the extent of their United States source income and of controlled foreign corporations in the ratio of Subpart F income to earnings and profits (section 25110(a)(1), (a)(2)(A)). The library's article on when a foreign corporation is excluded from a water's edge combined report covers that composition. For a foreign parent with substantial non-United States income, the difference between the two reports is often the whole economic question.

Two further features of the delinquent years matter. First, the foreign parent is frequently a taxpayer in its own right. A corporation is doing business in California if its California sales exceed the lesser of an indexed amount or 25 percent of its total sales, with parallel tests for property and payroll (RTC section 23101(b), (c)); for taxable year 2025, the most recent year the FTB has published, the sales amount is $757,070 and the property and payroll amounts are $75,707 each (2025 Form 100W booklet, General Information A). A foreign parent above those lines files its own return and, in the delinquent years, files it on the worldwide basis. Second, a year for which no return was filed does not close. If a taxpayer fails to file, the FTB "at any time" may require a return, estimate income from any available information, and propose to assess tax, interest, and penalties (RTC section 19087(a)). The four-year period for a notice of proposed assessment runs from the date the return is filed (RTC section 19057(a)), so the late return starts the clock that the missing return never did.

The voluntary disclosure agreement changes the penalties, not the calendar

The voluntary disclosure program is the usual route for a group in this position. A qualified entity is one that, counting predecessors, has never filed a California return, has never been the subject of an FTB inquiry about its liability, and comes forward before any unilateral contact from the FTB; an entity organized under California law, qualified or registered with the Secretary of State, or maintaining and staffing a permanent facility in California does not qualify (RTC section 19192(a)(1), (a)(2)). Under the agreement, the FTB waives its authority to assess tax, additions, fees, or penalties for taxable years ending before six years from the signing date (RTC section 19191(d)(1)(A)) and may waive, for the six years covered, the failure to file penalty of section 19131, the failure to pay penalty of section 19132, the estimated tax addition of section 19136, and the other penalties listed in section 19191(d)(1)(B). The entity discloses all material facts and, within 30 days of the signing date, files the required returns and pays the tax, interest, and penalties not waived (section 19191(d)(2)(A)(ii)). The FTB may extend that time to 120 days from the signing date or to the latest extended due date of the return for a taxable year for which relief is granted, whichever is later (section 19191(d)(3)). Applications may be made anonymously (section 19191(b)(2)), on Form FTB 4925.

Nothing in sections 19191 or 19192, the FTB's voluntary compliance page, or the current Form FTB 4925 (REV 10-2025) addresses when a water's edge election made on returns filed under an agreement is valid; the form lists Form 100W among the returns an applicant may need and stops there. The analysis therefore runs on the statutes. The returns filed under the agreement for the earlier covered years are original returns filed after their extended due dates. The agreement does not purport to deem them timely, and section 25113 contains no provision allowing the FTB to agree that they are.

What the agreement's filing deadline does, on the article's reading, is leave room for one more year on the water's edge side of the line. Section 19191(d)(3) measures the extended filing period against the latest extended due date of the return, the same date that marks timeliness under section 25113(a). The most recent covered year, if its extended due date has not passed when its return is filed, can be filed on Form 100W with Form 100-WE attached and a water's edge computation; that return is both original and timely, and the election is valid for that year on the statute's own terms. The earlier covered years cannot carry it. A group that wants the election as early as possible therefore times the signing date, and the filing of the most recent year's return, so that the return lands inside its own window.

The understatement penalty and an aggressive late return

The waiver list in section 19191(d)(1)(B) does not include the large corporate understatement penalty of RTC section 19138. That penalty applies when a corporation's understatement exceeds the greater of $1,000,000 or 20 percent of the tax shown on an original return, or on an amended return filed by the original or extended due date, measured for a combined group on the members' aggregate tax; the penalty is 20 percent of the understatement (section 19138(a), (b)). Its exceptions are limited to a later change in law, an FTB-imposed alternative apportionment under section 25137, certain federal accounting method changes, and reliance on a Chief Counsel ruling, and a refund is allowed only on the ground that the penalty was not properly computed (section 19138(e), (f), (g)). The library's article on whether the penalty can be waived covers its mechanics.

Section 19138 measures the understatement against "an original return" and contains no exclusion for a delinquent one. On that reading, a late worldwide return that self-assesses the correct tax produces no understatement, whatever the failure to file and failure to pay penalties on the same year may be. A late return that claims a water's edge election the statute does not allow, and reports the smaller water's edge tax, produces an understatement equal to the difference, and in a group large enough for the question to matter, that difference can pass $1,000,000 in a single year. The resulting penalty is outside the agreement's waiver list and has no reasonable cause exception in the statute. A group weighing an election position on its late returns is weighing the worldwide tax plus a 20 percent penalty against the worldwide tax alone, on a question the statute answers in its first sentence.

The 84-month commitment once the election is made

When the first timely year arrives and the election is made, the group is in the position of any electing group. The election remains in effect until terminated (RTC section 25113(c)(12)); it may be terminated without FTB consent only after 84 months, on an original, timely filed return by every member of the water's edge group (section 25113(c)(9)); earlier termination requires FTB consent (section 25113(c)(10)); and after a termination another election is barred for taxable years beginning within the following 84 months unless the FTB waives the bar for good cause (section 25113(c)(11)). The 84-month figure began as the initial term of the pre-2003 water's edge contract, a regime that section 25111 now limits to taxable years beginning before January 1, 2003, carrying earlier elections into section 25113 with their original commencement dates (RTC section 25111(a), (f); FTB Notice 2004-2, May 3, 2004). The library's article on what happens to the election when the group reorganizes covers the larger-taxpayer rule and the newcomers that join during the commitment period.

The practical point for a group emerging from a delinquency is that the first available election is a seven-year projection, made at a moment when attention is on the years behind it. A foreign parent whose profitability turns during that period, the scenario in which worldwide reporting would have been better, does not reopen the question without FTB consent.

Practice notes

The sequence for a foreign-owned group that discovers an unfiled California history has four steps, and the order matters. The first is the taxpayer inventory: each entity in the unitary group is tested year by year under RTC section 23101, the foreign parent included, because the delinquent returns and the eventual election are both made entity by entity, and the parent's own status decides whether it must make the election itself. The second is eligibility and timing for a voluntary disclosure agreement: the section 19192 criteria are confirmed for each applicant before any return is filed, since a filed return ends eligibility, and Form FTB 4925 gives separate directions where more than one corporation in a single unitary combined reporting group wishes to apply. The signing date is planned so that the most recent year's return can be filed by its own extended due date. The library's article on whether an extension disqualifies a taxpayer from the program explains why an extension, which is not a return, does not close that gate. The third is the delinquent returns themselves: they are computed on the worldwide basis and self-assess the full tax, because a correct self-assessment is the dependable protection against a penalty the agreement cannot waive. The fourth is the election package for the first timely year: Form 100W, a Form 100-WE election covering every member that is a taxpayer in that year, and a computation that is water's edge throughout, reviewed before the extended due date, with the 84-month projection documented alongside it. G&G State Tax Group provides water's edge election planning and voluntary disclosure representation for foreign-owned groups alongside its state and local tax practice.