BILL ANALYSIS �
AB 1777
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Date of Hearing: April 28, 2014
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Raul Bocanegra, Chair
AB 1777 (Quirk-Silva) - As Amended: April 7, 2014
SUSPENSE
2/3 vote. Fiscal Committee.
SUBJECT : Income taxation: timeliness penalty: abatement
SUMMARY : Requires the Franchise Tax Board (FTB), upon taxpayer
request, to abate a timeliness penalty (Failure-to-File or
Failure-to-Pay), as specified. Specifically, this bill :
1)Allows a taxpayer to request abatement under the provisions of
this bill for a timeliness penalty that has previously been
considered and rejected for abatement, waiver, or rescission
pursuant to the provisions of the section under which the
penalty is imposed.
2)Provides that a taxpayer may, in lieu of requesting
consideration for abatement, waiver, or rescission pursuant to
the provisions of the section under which the penalty is
imposed, instead request abatement of a timeliness penalty
under the provisions of this proposal.
3)Provides that timeliness penalties shall be abated if all of
the following apply:
a) The taxpayer has not been previously required to file a
California tax return under the Personal Income Tax (PIT)
or the Corporation Tax (CT) law, or no other timeliness
penalty has been imposed by the FTB in the calendar year of
the request for abatement or in the prior four tax years;
b) The taxpayer has filed all returns required under the
provisions of this bill, the PIT or the CT law, as of the
date of the taxpayer's request for abatement; and,
c) Excluding the timeliness penalty that is the subject of
the abatement request, the taxpayer has paid in full, or
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arranged to pay pursuant to an installment agreement, any
tax penalties, fees, and interest due for all currently
required returns and the taxpayer is current with all
installment payments.
4)Defines "timeliness penalty" as a penalty imposed under
Revenue and Taxation Code (R&TC) Sections 19131
(Failure-to-File), 19132 (Failure-to-Pay), 19172 (Partnership
Failure-to-File), or 19172.5 (S Corporation Failure-to-File).
5)Provides that a timeliness penalty imposed and subsequently
abated due to a determination of reasonable cause or
reasonable cause and not willful neglect, with respect to the
taxpayer or the taxpayer's spouse, shall be considered to have
not been imposed.
6)Provides that a timeliness penalty is considered imposed on
the original due date of the return for the taxable year for
which the penalty is imposed.
7)Provides that if a taxpayer requests abatement for more than
one taxable year and two or more taxable years would be
eligible for abatement under this section, then only the
penalty for the earliest taxable year shall be abated.
8)Provides that this bill shall apply to requests for abatement
made before, on, or after the effective date of the act adding
this proposal.
9)Allows the FTB to issue any regulation necessary or
appropriate to implement the program.
10)Provides, notwithstanding Government Code Section 13340, a
continuous appropriation from the General Fund to the FTB for
amounts necessary to make the payments required by this bill
for the abatement of penalties paid before the effective date
of the act adding this bill.
11)Provides findings and declarations that the abatement of
timeliness penalties with respect to abatement penalties paid
before the enactment of this proposal serves a public purpose
and does not constitute a gift of public funds.
EXISTING FEDERAL LAW :
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1)Imposes a penalty for failing to file an income tax return by
the due date, unless it is shown that such failure is due to
reasonable cause and not due to willful neglect, of 5% of the
amount of tax required to be shown on the return, less any
earlier payments or credits, for the first month the return is
late. The penalty increases by 5%, to a maximum of 25
percent, for each additional month the return remains unfiled.
The penalty is calculated as the lesser of $100 or the amount
of tax required to be shown on the return for failing to file
within 60 days of the due date, including extensions.
(Internal Revenue Code (IRC) Section 6651.)
2)Imposes a penalty for failing to pay the tax shown on an
income tax return or an assessed deficiency by the due date,
unless it is shown that such failure is due to reasonable
cause and not due to willful neglect, of 0.5% of the tax due
for the first month the payment is late. The penalty
increases by 0.5% per month that the balance remains
outstanding to a maximum of 25%. IRC Section 6651.
3)Provides taxpayers, beginning in 2001, with additional
procedures for abatement under the First-Time Abate (FTA)
relief program for penalties incurred when failing to file an
income tax return by the due date or failing to pay the tax
shown on an income tax return. The FTA is available under the
Internal Revenue Service's (IRS's) general authority, rather
than being allowed by statute or regulation. The IRS, on
April 5, 2013, modified the FTA policy to require a reasonable
cause explanation by the taxpayer that will be considered
after the normal FTA analysis. If the taxpayer is not
eligible for penalty relief under the FTA, then the taxpayer's
explanation will be used to determine if penalty relief may be
granted under the reasonable cause exception.
4)The FTA relief is generally available if the taxpayer:
a) Has not previously been required to file a return or has
no prior penalties, except the estimated tax penalty, for
the preceding three years; and,
b) Has filed or filed a valid extension for, all currently
required returns and paid, or arranged to pay, any tax due.
A penalty assessed and subsequently reversed in full will
generally be considered to show compliance for that period.
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The penalty relief is only applied to a single tax period, and
may only be used once. (Internal Revenue Manual
20.1.1.3.6.1.)
5)Provides a reasonable cause exception to taxpayers who can
show that there was a reasonable cause for failure to comply.
In general, a failure to pay will be considered to be due to
reasonable cause to the extent that the taxpayer has made a
satisfactory showing that he exercised ordinary business care
and prudence in providing for payment of his tax liability and
was nevertheless either unable to pay the tax or would suffer
an undue hardship if he paid on the due date. (Code of
Federal Regulation (CFR) Section 301.6651-1(c).)
EXISTING STATE LAW :
1)Imposes a penalty for failing to file an income tax return by
the due date, unless it is shown that such failure is due to
reasonable cause and not due to willful neglect, of 5% of the
amount of tax required to be shown on the return, less any
earlier payments or credits, for the first month the return is
late. The penalty increases by 5%, to a maximum of 25%, for
each additional month the return remains unfiled. The penalty
is calculated as the lesser of $135 or the amount of tax
required to be shown on the return for failing to file within
60 days of the due date, including extensions. Imposes a
penalty of 15% per month, up to a maximum of 75%, if the
failure to file an income tax return was due to fraud. (R&TC
Section 19131.)
2)Imposes a penalty for failing to pay the tax shown on an
income tax return or an assessed deficiency by the due date,
unless it is shown that such failure is due to reasonable
cause and not due to willful neglect, of 5% of the tax not
paid by the original due date of the return. In addition to
the 5% penalty, a monthly penalty of 0.5% percent will be
imposed for each additional month or fraction thereof that the
tax remains unpaid, up to a maximum of 40 months. The
aggregate amount of penalty shall not exceed 25% of the total
unpaid tax. (R&TC Section 19132.)
3)Imposes a penalty when a partnership or S corporation fails to
file a return, unless it is shown that the failure is due to
reasonable cause, of $18 per month multiplied by the number of
persons who were partners in partnership or shareholders in
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the S corporation during any part of the taxable year. (R&TC
Sections 19172 and 19172.5.)
FISCAL EFFECT : The Franchise Tax Board estimates that this
bill will reduce General Fund revenues by $5.4 million in Fiscal
Year (FY) 2014-15, $24 million in FY 2015-16, and $23 million in
2016-17.
COMMENTS :
1)The author states "[a]uthorizing the FTB to implement
first-time abatement penalty relief would reduce taxpayer
dissatisfaction, result in increased filing compliance, and
decrease the costs incurred by taxpayers and the Board of
Equalization (BOE)."
2)Proponents state "[h]istorically, compliant taxpayers that
file or pay late are penalized with the same severity as
noncompliant taxpayers. The FTB currently lacks authority to
consider compliance history in the determination of whether to
abate these penalties. Penalty abatement, such as the one
proposed in AB 1777, can turn a delinquent tax debt on its
head, providing a taxpayer with a workable solution, as
opposed to a crushing financial problem. Additionally,
proponents claim that, "[p]roviding the FTB with authorization
to grant penalty relief for otherwise compliant taxpayers may
reduce taxpayer dissatisfaction and result in increased filing
compliance."
3)Committee Staff Notes:
a) FTA and Subsequent Updates . The FTA has been in place
since 2001 and provides a one-time abatement of certain
penalties for taxpayers who can show a history of
compliance. The FTA waiver is applicable to individuals
and businesses that have been assessed penalties for
failing for file, failing to pay, or failing to deposit
penalties. The program is meant to encourage voluntary
compliance and not penalize taxpayers that have a history
of tax compliance.
In September 2012, the Treasury Inspector General for Tax
Administration released a report (Report) on the
administration of the FTA. In general, the Report found
that the IRS did not apply the FTA consistently and did not
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encourage voluntary compliance. (Penalty Abatement
Procedures Should Be Applied Consistently to All Taxpayers
and Should Encourage Voluntary Compliance, Treasury
Inspector General for Tax Administration, RN: 2012-40-113,
Sept. 19, 2012.) Changes to Internal Revenue Manual were
later made as a result of the Report, including
clarification that a taxpayer must have filed all currently
required returns and paid or arranged to pay any tax due.
b) Penalties Increase Compliance . In general,
Failure-to-File and Failure-to-Pay penalties are imposed as
a method of increasing compliance. The federal FTA
provides a waiver for first-time filers or taxpayers who
have been compliant in the last three years. It is unclear
how a waiver of penalties for individuals failing to follow
the law will increase tax compliance. For taxpayers who
have been compliant in the last three years, and understand
their obligation to follow the law, it is especially
unclear as to how an FTA will increase compliance. The
federal FTA also appears to acknowledge that ignorance of
the law, in the case of taxpayers failing to file for the
first time, is acceptable.
c) Smaller Benefits under the FTA . The Treasury Inspector
General found, in its Report, that some of the taxpayers
who used the federal FTA instead of the reasonable cause
abatement had less of their penalties forgiven, in part,
because the accrued penalties are not assessed until there
are funds in the account to pay all or part of the accrued
interest. Similar issues would exist with the enactment of
this bill because a waiver of the Failure-to-Pay penalty
would only apply to the assessed penalty, which would not
include the accrual of the 0.5% per month. If the taxpayer
were to instead receive penalty relief under reasonable
cause, the entire penalty would be abated.
d) Inconsistent Application . According to the Report, not
all taxpayers with compliant histories received the federal
FTA waiver. Of the 500 taxpayers who were assessed a
penalty and who qualified for an FTA waiver, only 44
received a waiver under the federal FTA program.
Many taxpayers failed to request a waiver of penalties
under the FTA because the IRS did not widely publicize the
opportunity. In fact, the Report, which was published in
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2012, mentioned that the Form 1040 instructions did not
include information on the FTA waiver, nor did the IRS' Web
site, Eight Facts on Penalties. The Eight Facts on
Penalties Web site and the Form 1040 instructions have not
been changed since the release of the Report to include
information on the FTA waiver.
c) High Federal Error Rates . According to the Report, a
high percentage of incorrect FTA determinations were made
and not corrected by employees. As a way of helping
employees determine FTA waivers, the IRS developed the
Reasonable Cause Assistant program. Out of a sample of 63
cases, the Reasonable Cause Assistant program made 56
incorrect determinations. None of the incorrect
determinations were corrected by employees.
d) Current Procedures May Preclude Future Use of FTA . The
IRS, after modifying the Internal Revenue Manual, made
clear that the IRS will continue to evaluate a taxpayer's
compliance history for the FTA waiver before evaluating
other defenses, such as the reasonable cause. The Report
noted that considering FTA waivers before the reasonable
cause defense would simplify the abatement process for the
IRS, but it could also harm taxpayers. For example, assume
that a taxpayer receives a federal FTA waiver despite also
meeting the criteria for the reasonable cause defense in
year one. The following year, the taxpayer is late in
paying his taxes and receives a Failure-to-Pay penalty, but
has no reasonable cause for the late payment. Because the
taxpayer was granted an FTA waiver in year one, the
taxpayer will not be eligible for an FTA waiver for the
current penalty. Had the taxpayer received the reasonable
cause waiver in year one instead of the FTA waiver, the
taxpayer would have been eligible for an FTA waiver for the
subsequent penalty.
Unlike the federal FTA, this bill would generally allow a
taxpayer to choose between a waiver of penalties under the
reasonable cause exception or a waiver of penalties as
provided for by this proposal. Because the federal FTA
will continue to evaluate a taxpayer's compliance history
for FTA before evaluating other defenses, it may be
possible for a taxpayer to receive an FTA waiver at the
federal level and a reasonable cause waiver at the state
level. This may prevent future use of the FTA waiver at
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the federal level but not at the state level.
e) Four-Year Look-Back Period . In order to qualify for a
penalty relief under the federal FTA, a taxpayer must have
no prior penalties, except the estimated tax penalty, for
the preceding three years. This bill would require a
taxpayer to show that no timeliness penalty has been
imposed by the FTB for the year in which the request for
abatement is made and the preceding four tax years. Under
the provisions of this bill, it may be possible for a
taxpayer to receive a federal FTA waiver but not a state
waiver.
f) Multiple "First Time" Abatements . The provisions of
this bill would enact a First-Time Abatement program
similar to that of the federal program. Under the
provisions of this bill, the FTB is required to abate a
timeliness penalty if the taxpayer shows that: (i) no
timeliness penalties have been imposed in the preceding
four years, (ii) all returns have been filed as required by
law, and (iii) the taxpayer has paid in full, or arranged
to pay pursuant to an installment agreement, any tax
penalties, fees, and interest due for all currently
required returns. Because none of the provisions of this
bill specifically limits the use of this program in
subsequent years, it is possible that a taxpayer can
utilize this program once every four years, which may
actually discourage taxpayers from complying with the law.
g) Conformity Issues . In general, state conformity with
federal law promotes greater simplicity and eases
administration of complex tax laws. By enacting a state
version of the federal FTA, this bill would appear to bring
California closer to conformity with federal law. However,
the abatement program, as authorized by this bill, appears
to operate independently of the federal program and may
provide penalty relief when such relief is not available at
the federal level. The independent nature of a state and
federal FTA program may actually increase taxpayer
dissatisfaction and do little to increase compliance.
h) Implementation Concerns . As noted by the FTB's staff,
"[t]his bill would require changes to the department's
accounting systems to allow tracking of taxpayers that have
received penalty relief based on their compliance history.
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Additionally, the department would require the development
of procedures, training materials, notices, forms,
instructions, and other documents necessary to implement
the penalty relief this bill would allow." Additionally,
"staff estimates an increase in taxpayer requests for
penalty relief and a resulting increase in the volume of
'reasonable cause' determinations that would require
additional staff to maintain acceptable response times."
Finally, FTB's staff explains that "[s]ubdivision (f)
provides for a continuous appropriation from the General
Fund for refund amounts of penalties abated under this bill
that have been previously paid. Under existing law, these
amounts would be paid from the Tax Relief and Refund
Account and not the General Fund. In addition, because
existing law includes a continuous appropriation to pay
such amounts, this amendment is unnecessary."
i) Related Legislation . AB 2065 (Gorell), introduced in
the current legislative session, is identical to this bill.
AB 2065 has not been heard as yet by this Committee.
REGISTERED SUPPORT / OPPOSITION :
Support
Franchise Tax Board (Sponsor)
California Chamber of Commerce
California Grocers Association
California Manufacturers & Technology Association
California Society of Enrolled Agents
California Taxpayers Association
Council on State Taxation
Spidell Publishing Inc.
State Board of Equalization, George Runner
State Board of Equalization, Michelle Steel
Opposition
None on file
Analysis Prepared by : Carlos Anguiano / REV. & TAX. / (916)
319-2098
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