BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
AB 697 - Calderon
Amended: June 1, 2009
Hearing: July 8, 2009 Fiscal: Yes
SUMMARY: Revises the operative date for the Corporation
Understatement Penalty (CUP) and adds a repeal
date.
EXISTING LAW
The CUP is a strict liability penalty that is assessed
against any corporation that has an understatement of tax
in excess of $1 million in any open taxable year beginning
on or after January 1, 2003. In the case of taxpayers that
are required or authorized to be included in a combined
report, the $1 million threshold would apply to the
aggregate amount of tax liability for all taxpayers that
are required or authorized to be included in the combined
report.
The penalty is calculated at 20 percent of the
understatement of tax. For purposes of this penalty,
understatement of tax means the difference between what is
shown on the original return (or amended return, if filed
on or before the extended due date of the original return)
and what is subsequently determined to be the correct
amount of tax owed. For any taxable year beginning before
January 1, 2008, amounts paid on or before May 31, 2009,
and reported on an amended return filed on or before May
31, 2009, are treated as the amount of tax shown on an
original return. Taxpayers may file an amended return for
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pre-2008 taxable years by May 31, 2009, self-assess and pay
any additional tax that might be due, thereby increasing
the amount of tax treated as paid with the original return
for those year(s).
The CUP provisions specify that the penalty is in
addition to any other applicable penalty and is a strict
liability penalty. A credit or refund for any amounts paid
to satisfy the penalty may be allowed only on the grounds
that the amount of the penalty was not properly computed by
FTB.
There is limited relief from the CUP in the following
circumstances:
The understatement of tax is attributable
to a change in law, a regulation, a legal ruling of
counsel, or a published federal or California court
decision that occurs after the earlier of either the
date the taxpayer files the return for the taxable
year for which the change is operative or the
extended due date for the return of the taxpayer for
the taxable year for which the change is operative.
The understatement of tax is attributable
to a taxpayer's reasonable reliance on written advice
of the Franchise Tax Board, but only if the written
advice was a legal ruling by the Chief Counsel
(within the meaning of the Taxpayer's Bill of
Rights).
Underpayment of Tax - R&TC 19132
The underpayment penalty is assessed if a corporation
fails to pay the amount of the tax due by the original
return due date. (Note that the automatic seven-month
extension of time to file a return is not an extension of
time to pay the tax due).
The underpayment penalty will not be assessed if ALL
of the following requirements are met:
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An extension of time to file has been granted.
At least 90 percent of the tax due is timely paid by
the original return due date.
The remainder of the tax due is paid by the extended
due date.
Underpayment of Estimated Tax - R&TC 19142
A penalty is imposed on an underpayment of tax if an
installment is not paid in the correct amount or in a
timely manner. The penalty is computed on the underpayment
of estimated tax from the date of the payment to the
earlier of the date of payment or the original due date of
the return. The underpayment of estimated tax is the
difference between the amount due for each installment of
the estimated tax and the amount actually paid or credited
on or before the due date of that installment.
The penalty for underpayment of estimated tax may not
be waived for reasonable cause. The penalty may be waived
if the underpayment of estimated tax is due to a change in
law that was chaptered during and operative the taxable
year of the underpayment. In addition, the underpayment of
estimated tax penalty may be waived if the installment of
estimated tax was made timely, and the payment meets the
prior year tax, annualized income, or seasonal income
exceptions.
Accuracy-Related Penalty - R&TC section 19164
The Accuracy-Related Penalty may be imposed on the
portion of any underpayment of tax that should be shown on
the return. The penalty is generally equal to 20 percent
of the portion of the underpayment (40 percent in the case
of amnesty-eligible years beginning before January 1,
2003, unless the taxpayer was under audit, in protest,
settlement, or appeal, or in judicial proceedings as of
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February 1, 2005) caused by one or more of the following:
Negligence or disregard of rules or regulations;
Substantial understatement of income tax;
Substantial valuation misstatement;
Substantial overstatement of pension liabilities;
or
Substantial estate or gift tax valuation
understatement.
The statute provides relief provisions or exceptions
for each of these situations. FTB will consider the relief
provisions for each situation prior to assessing the
penalty. A taxpayer may raise three common defenses
(relief provisions) to avoid assessment of the penalty.
The defenses are:
1. Substantial Authority - Substantial Authority
exists for the tax treatment of an item on the return
[Internal Revenue Code (IRC) section 6662(d)(2)(B)];
2. Adequate Disclosure - Adequate Disclosure of the
transaction has been made on the original return [IRC
Sec. 6662(d)(2)(B)]; and
3. Reasonable Cause - The taxpayer, in regards to the
underpayment, has shown Reasonable Cause and good
faith [IRC Sec. 6664(c)(1)].
Depending on the situation causing the understatement
meeting any one of these three defenses will preclude the
assessment of the accuracy-related penalty. In addition,
an existing FTB regulation provides that a taxpayer's good
faith determination of the components which are a part of
one or more unitary businesses and amounts that are
attributable to classifying an item as business or
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non-business income will not be included in computing the
amount of any understatement for purposes of the
accuracy-related penalty.
THIS BILL
This bill would revise the operative date for the CUP
in the following manner:
Current law: Operative for taxable years beginning on or
after January 1, 2003, for which the statute of
limitations on assessment has not expired.
Proposed: Operative for taxable years beginning on or
after January 1, 2003, and before January 1,
2008, for which the statute of limitations on
assessment has not expired.
In addition, this bill would repeal the CUP as of
December 1, 2010. Consequently, no penalty may be imposed
on or after December 1, 2010.
FISCAL EFFECT:
FTB estimates the following losses attributable to this
bill:
2008/09: -$580 million
2009/10: -$690 million
2010/11 -$500 million
Losses in subsequent years would decrease from about
$400 million in 2011/12 to about $175 million in 2015/16
and ultimately to about $100 million per year
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COMMENTS:
A.Purpose of the Bill
According to the author, the purpose of AB 697 is to
repeal the 20% corporate understatement penalty on a going
forward basis, for taxable years beginning on or after
January 1, 2008, and to eliminate a significant
administrative burden for both taxpayers and the Franchise
Tax Board. This strict liability penalty is unprecedented;
neither the federal government nor any other state imposes
a similar penalty on taxpayers.
B.All Branches of Government at Work
In California Taxpayer's Association v California
Franchise Tax Board, Case No. 34-2009-80000 168, the
Superior Court of California, Sacramento County, orally
denied the petition for writ of mandate, request for
injunctive relief, and request for an award of attorney's
fees filed by the California Taxpayer's Association finding
Revenue and Taxation Code Section 19138 (the CUP
provisions) constitutional and enforceable on its face.
C.Program Background
SBX1 28 (Senate Budget Committee, Stats. 2008, Ch.
X1-01) enacted the CUP along with provisions pertaining to
estimated tax payments, amnesty, and the operative date for
the Limited Liability Company (LLC) fee due date.
The CUP provisions provide that for any taxable year
beginning before January 1, 2008, amounts paid on or before
May 31, 2009, and reported on an amended return filed on or
before May 31, 2009, are treated as the amount of tax shown
on an original return. Taxpayers could file an amended
return for pre-2008 taxable years by May 31, 2009,
self-assess and pay any additional tax that might be due,
thereby increasing the amount of tax treated as paid with
the original return for those year(s).
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Preliminary results show that certain taxpayers did
file amended returns on or before May 31, 2009, and paid
approximately $2.7 billion in additional tax that might be
due for pre-2008 taxable years; the original estimate for
this program was $1.2 billion.
D.Penalties do change behavior
The cost benefit analysis that corporations enter into
when determining whether to come forward and pay all taxes
is significantly affected by the imposition of penalties.
A cost benefit analysis is done to determine how well, or
how poorly, a planned action will turn out.
A cost benefit analysis finds, quantifies, and adds
all the positive factors. These are the benefits. Then it
identifies, quantifies, and subtracts all the negatives,
the costs. The difference between the two indicates whether
the planned action is advisable. The real trick to doing a
cost benefit analysis well is making sure you include all
the costs and all the benefits and properly quantify them.
For example, businesses enter into a cost benefit
analysis for the CUP penalty: should we report all
understated or owed tax-even if we are not sure it is
owed-or risk the penalty? Given the response to the CUP,
businesses chose to come forward.
E.Is it fair to borrow today and only pay back in a year?
Businesses argue that this penalty is unfair and only
results in a short term loan from the business community;
they make the following statements about the CUP:
Unfair Application. The strictliability aspect of this
penalty makes it applicable to compliant taxpayers and tax
cheats alike, with no distinction between the two.
" Diverts Money Away From Capital Investment and Job
Creation. The only way for taxpayers to guard against the
20 percent understatement penalty is to overpay their tax
liability every year by millions of dollars - money that
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instead could be invested into the economy and jobs. Such
investment would improve the state's revenue collections in
the long term.
Impossible Standard. While the $1 million threshold for
application of the penalty may seem like a large amount of
tax understatement, for a taxpayer with a
multimilliondollar tax liability, avoiding the penalty
without substantial overpayment is impossible. Ironically,
the more taxes a taxpayer pays to the state, the more
likely the taxpayer is to be hit with the penalty.
" Catch22 for Taxpayers. Because taxpayers must greatly
overstate their tax liability to avoid imposition of the 20
percent understatement penalty, taxpayers are caught
between avoiding the penalty and filing a return they know
to be false. Deliberately overstating tax liability is a
violation of law, and taxpayers sign the returns,
certifying that they are true and correct under penalty of
perjury.
Administrative Burden for Taxpayers. The understatement
penalty could result in taxpayers filing returns two or
three times. These taxpayers may file an original return
with inflated income, and then one or more amended returns
to claim refunds to adjust the numbers on the original
return to reach accurate tax liability.
Substantially Worsens Business Climate and California's
Economy. The 20 percent understatement penalty targets the
state's largest job creators and investors by forcing them
to take money out of their workforce and capital investment
and loan it to the state pending resolution of their refund
claims. This is the absolute worst thing for the state to
do at a time when it must bolster the economy to create
California jobs and attract and increase capital
investment.
F.Of Balancing and Budgets
This bill responds to SBX1 28 (Senate Budget
Committee, Stats. 2008, Ch. X1-01) which enacted the CUP
along with provisions pertaining to estimated tax payments,
amnesty, and the operative date for the LLC fee due date.
The bill was intended as a budget balancer for the 2008-09
budget.
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Support and Opposition
Support:California Taxpayers' Association
California Bankers Association
California Chamber of Commerce
California Manufacturers and Technology
Association
Technology Association of America
Oppose:None Received
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Consultant: Gayle Miller