Tax Amnesty is Underway
The Franchise Tax Board (FTB) announced in its January/February Tax News publication the beginning of California’s 2005 tax amnesty program. As the FTB states, the amnesty program “…offers a window of opportunity for business entities and individuals to pay their past-due income or franchise taxes and interest, and they will not have to pay most penalties and fees or fear prosecution.” The tax amnesty program ends March 31, 2005. If taxpayers choose to take advantage of this limited time program, they can correct tax records and save money, according to the FTB. Most penalties and fees applicable to taxable years beginning before January 1, 2003 will be waived. The State Board of Equalization (BOE) has announced a similar program for taxpayers who failed to pay the required sales or use taxes on time.
Last year, the Legislature approved a tax amnesty program as part of the annual budget agreement (SB1100, Chapter 225, Statutes of 2004). The tax amnesty program applies to income tax, which is administered by the FTB, and sales and use taxes, which are administered by the BOE.
Eligibility for the Tax Amnesty Program
Amnesty is available for all taxable years through 2002 for individuals or businesses that did not file the required California tax returns, underreported income on a previously filed return, claimed excessive deductions, or did not pay income, franchise, sales, or use tax on time.
Taxpayers who are currently under criminal investigation or who are being prosecuted for tax related matters are not eligible for the program. In addition, transactions that were eligible for relief under California’s Voluntary Compliance Initiative are not eligible for relief in this amnesty program.
Applying for the Tax Amnesty Program
The period to obtain, complete, and return a signed amnesty application is from February 1, 2005 through March 31, 2005, although the tax agencies will accept applications postmarked April 1, 2005, since March 31, 2005, is a state holiday.
Taxpayers must submit all missing income tax returns or all amended returns for years where income was underreported by May 31, 2005. All outstanding tax liabilities and interest for amnesty years must be paid by May 31, 2005, or, a taxpayer must establish an installment payment agreement that will be fully paid by June 30, 2006.
Taxpayers may contact the Taxpayers’ Right Advocate at the FTB at 1.800.883.5910 or the BOE at 1.888.324.2798. General amnesty information, amnesty applications, and tax forms for the applicable tax years may be obtained at the FTB website at www.ftb.ca.gov/amnesty/index.html or from the BOE at www.boe.ca.gov/sutax/taxamnesty.htm.
Benefits of Complying with Amnesty
For taxpayers that come forward under amnesty, the State will waive penalties (but not interest) on taxes that were due in 2002 or earlier. The State also will waive its right to file criminal actions against qualified amnesty participants . Taxpayers who fail to take advantage of amnesty face severe consequences, which include the doubling of accuracy related penalties from 20% to 40% and the application of a “hammer” provision, which requires the FTB or the BOE to add a penalty equal to 50% of the interest owed by the taxpayer.
Concerns with the Tax Amnesty Program
The California Taxpayers Association (Cal-Tax) in a paper titled, Tax Amnesty or Tax Trap – The Untold Consequences of California’s Tax Amnesty Program articulated concerns with the tax amnesty program. Some concerns cited by Cal-Tax include:
No Exceptions for Federal Adjustments – Any federal adjustment for a tax year prior to 2003 will trigger the 50% interest “hammer” penalty. For example, the following situation will result in the 50% interest “hammer” being applied: On December 2, 2005, a taxpayer receives a final federal adjustment for tax year 2002 and voluntarily submits it to the FTB on January 1, 2006. Then, on December 31, 2008, the FTB issues a proposed assessment reflecting the federal adjustment. The 50% interest “hammer” penalty would apply because the FTB does not have the ability to waive the “hammer” penalty and the submission of information for tax year 2002 occurs outside the February 1, 2005 to March 31, 2005 timeframe established in the new amnesty program sections of the Revenue and Taxation Code.
• Indiscriminate Assessments – The new post-amnesty penalties apply to all deficiencies for pre-2003 taxable years and reporting periods that are assessed after March 31, 2005, regardless of motive or legal authority. For example, On April 17, 2005, an elderly individual taxpayer receives a proposed assessment because the IRS or the FTB assert that she erroneously claimed head of household filing status on her 2001 tax return. She decides to pay the assessment instead of fighting the FTB. The 50% “hammer” penalty applies.
• Reliance on the Law at the Time is no Exception – For tax years prior to 2003, taxpayers were entitled to a dividends received deduction (DRD), limited to dividends paid from income subject to tax in California and their ownership percentage in the payor entity. In 2003, the limitation on the deductibility of those dividends was ruled unconstitutional. The FTB has taken the position that there is no longer any DRD at all while taxpayers have argued that the Court did not strike down the statute, only its unconstitutional application. The amnesty program will impose the 50% interest “hammer” penalty on deficiencies associated with this ongoing dispute, despite the uncertainty of the law and despite the fact that the law at the time the tax return was filed permitted the DRD to be taken.
• Penalties Despite No Net Taxes Owed – The FTB will impose the interest penalty on an amnesty-eligible liability even when a taxpayer has an overpayment from another amnesty-eligible year that results in a net refund, unless the taxpayer happened to file a claim for refund before March 31, 2005. For example, the FTB audits a taxpayer for tax years 2000 and 2001 and in May of 2005 issues a proposed overpayment of $100,000 for 2000 and a proposed assessment of $10,000 for 2001. The net tax affect is a $90,000 refund. The 50% interest “hammer” penalty will apply to the 2001 liability even though no interest is imposed on that year under the normal interest netting rules and no additional tax or interest amounts are due to the FTB.
Interested parties including Cal-Tax and the Chamber of Commerce have been working with the Administration, the BOE, the FTB, and lawmakers to craft solutions to their concerns. Two critical areas have been discussed: (1) provide statutory authority for the FTB to waive the 50% interest “hammer” penalty when it is determined that the taxpayer acted in “good faith” or was unaware of the liability and, therefore, was unable to apply for amnesty during the amnesty application period; and (2) require the FTB to allow “netting” of tax overpayments and tax liabilities where applicable, which would correct the problem of penalties being applied when the taxpayer is owed a refund.
It is unclear at this time if any of the concerns raised about the amnesty program will be addressed. However, unless the Legislature takes action to correct the unforeseen problems identified above, taxpayers who have acted in good faith by participating in the amnesty program or who believe they have no reason to participate in the amnesty program will be “hammered” by post-amnesty penalties.
For more information on this report or other Revenue & Taxation issues, contact Robert Becker, Senate Republican Office of Policy at 916/323-9221.