BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
SBx6 6 - Hollingsworth
Introduced: February 24, 2010
Hearing: May 12, 2010 Tax Levy Fiscal: Yes
SUMMARY: Repeals the 20% Penalty for Understatements
Exceeding $1 million.
EXISTING LAW penalizes taxpayers filing under the
corporate tax 20% of any understatement that exceeds $1
million on original returns for taxable years beginning on
or after January 1, 2008 (SBx1 28, Committee on Budget,
2008). The measure also applies to understatements on
amended returns filed on or before May 31, 2009 for taxable
years beginning before January 1, 2008. The penalty
applies to the total amount of the understatement for an
entire combined report, and excludes any understatement
attributable to a change in law under specified
circumstances or when the taxpayer relied on written advice
from the Franchise Tax Board (FTB). The penalty applies in
addition to any other penalty, and offers the taxpayer no
appeal rights.
THIS BILL repeals the penalty.
FISCAL EFFECT:
According to FTB, SBx6 results in revenue losses to
the state $760 million in 2010-11, $520 million in 2011-12,
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and $490 million in 2012-13.
COMMENTS:
A. Purpose of the Bill
According to the author, "The current strict liability
penalty has a substantial negative impact on corporate
taxpayers doing business in California. Given the
complexity of California's tax code and the many
considerable valuation issues involved in tax preparation
for large companies, $1 million could easily be in dispute
due to circumstances outside the company's control. Even
if a company has a reasonable defense for the
understatement, the company must still pay the penalty
under current law. The only way for businesses to avoid
this excessive underpayment penalty is to significantly
overpay their tax bill every year, resulting in a short
term loan to the state pending resolution of their refund
claims. During these difficult economic times, the state's
top priority should be creating jobs and increasing capital
investment in California. The current underpayment penalty
unfairly targets the largest job creators and investors by
taking money out of their pockets that could instead by
used to bolster their workforce and capital investment. In
turn, smaller companies and subcontractors that provide
services and goods to these larger companies also suffer
from less business."
B. Rough Justice
California's one-of-a-kind Large Corporate
Understatement Penalty (LCUP) is a blunt tool; the penalty
increases the incentive for taxpayers to pay higher tax
amounts on an original return to avoid the 20% of
understatement penalty, and then file a claim for refund of
tax, where no accuracy-related penalties apply. The system
has evolved to kind of an amnesty program without the
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absolution of penalties, interest, or criminal sanction;
the state collects more money earlier, and the final amount
of tax due is adjudicated as part of the claim for refund
process. Taxpayers particularly abhor the LCUP because the
penalty is assessed with strict liability: if FTB assesses
the penalty, taxpayers must pay and cannot appeal.
Despite the LCUP's rough justice, one consistent them
in tax policy in California is that penalties increase
compliance, as evidenced by the Voluntary Compliance
Initiative and the state's amnesty program. Before the
LCUP, firms would make smaller tax payments initially, and
await the possibility of an audit. If audited, , FTB may
or may not detect advanced strategies to depress income,
increase expenses, or apply credits or deductions that the
taxpayer may not be legally entitled to claim. With the
LCUP, the taxpayer is more cautious, and unlikely to pursue
more questionable tax strategies when filing the original
return, resulting in a higher tax amount when filing the
original return. The taxpayer must then demonstrate the
rationale for a lower amount of tax when filing its claim
for refund. While repealing the penalty would cause large
taxpayers to pay less tax on original returns, it would
certainly damage compliance with a tax system, which
already suffers from having no penalty on erroneous claims
for refunds, as was pursued in AB 1561 (Calderon, 2008), AB
1580 (Calderon, 2009), and SBx8 32 (Wolk), or on amended
returns that contain abusive tax shelters, as proposed by
SB 401 (Wolk) prior to being amended.
Support and Opposition
Support:California Association of Realtors, California
Taxpayers' Association, California Aerospace Technology
Association, California Bankers Association, California
Chamber of Commerce, California Manufacturers and
Technology Association, Technology Association of America,
and Western States Petroleum Association
SBx6 6 - Hollingsworth
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Oppose:California Tax Reform Association
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Consultant: Colin Grinnell