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Monday, August 2, 1999
State Agency
Rivals IRS in Toughness
Finances: Franchise Tax Board is ruthless, critics
say. Officials say they're doing jobs, have gotten friendlier.
By
LIZ PULLIAM, Times Staff Writer
California
has a state income tax machine that puts a collar on cheats and
keeps state coffers full, but a growing number of individual
taxpayers, corporations and tax attorneys complain that the agency's
efficiency too often is tainted by arrogance and a stubborn unwillingness
to compromise.
With 6,500 employees and tax collections
that top $34 billion, the Franchise Tax Board is second in size
and scope only to the Internal Revenue Service--and by all accounts
the state agency is the more efficient, more aggressive and more
relentless of the two.
But while the IRS came under fire
two years ago for alleged abuses of power, an inquiry that prompted
new controls and oversight, the Franchise Tax Board has received
far less scrutiny. Among recent developments that are raising
questions about the agency:
* For two years in a row, corporate
tax executives have ranked California's among the toughest, least
fair and least predictable state tax agencies in the country.
* The agency's refusal to compromise
led recently to a rare but important loss in the courts when
it was ordered to refund at least $250,000 to a Newport Beach
couple after the state Court of Appeal ruled the agency had made
up a tax bill "out of thin air."
* The state auditor has questioned
the cost-effectiveness of the agency's aggressive audit squad.
* Until recently, the Franchise
Tax Board rejected 96% of settlement offers by tax-strapped taxpayers
as well as most pleas for installment agreements so tax bills
could be paid off over time.
Tarzana accountant Michael Rozbruch
makes his living battling tax agencies for clients: protesting
assessments, arranging payment plans, negotiating for penalty
waivers. But when it comes to the Franchise Tax Board, he concedes
defeat before he even starts.
"You can always negotiate
with the IRS," said Rozbruch, a certified public accountant
and principal of Tax Resolution Services Co. "I tell my
clients to beg, borrow and steal if they owe the state."
The Franchise Tax Board and its
defenders say the agency has become more service oriented and
taxpayer friendly in the past year, though some conflict is inevitable
given California's size, huge economy and complex tax laws.
"Our typical audit is a corporate
audit or a very wealthy taxpayer with very sophisticated professional
representation," said Gerald H. Goldberg, who has been the
agency's top executive since 1980. "Aggressive taxpayers
are forever going to be challenging the limits."
Even some top state tax officials,
however, say the agency occasionally lets its vigilance go too
far. State Treasurer Kathleen Connell, who serves as chairwoman
of the Franchise Tax Board, and Board of Equalization member
Dean Andal have raised such concerns.
"The FTB probably has the
most competent staff of any state tax agency, but they're brutal,"
said Andal, who also served as one of three board members of
the agency last year. "They tend to look at every audit
as a battle. In the gray areas, they push the envelope rather
than work out a reasonable compromise."
State Is Ranked Most Aggressive
Many corporate taxpayers agree.
In both 1997 and 1998, company tax executives ranked California
at the top of a "worst offenders" list compiled by
CFO magazine to rate the tax agencies of the 50 states. The magazine
polled 300 of the nation's 1,000 largest companies, and 91 tax
managers responded.
These corporate financial officers
ranked California as the most aggressive of the states during
audits. The state was described as among the least predictable
in administering tax policy and among the most likely to take
a black-and-white stance on unclear areas of tax law.
By contrast, the Franchise Tax
Board has a lower profile with individual taxpayers, who are
far less likely to have contact with the state tax agency than
with the IRS. About one in five taxpayers gets some kind of routine
contact--typically an automatic penalty or request for more information--from
the IRS each year. About five in 1,000 people are audited.
The Franchise Tax Board contacts
fewer than one in 20 state residents for administrative matters,
and its audit rate is about half that of the IRS. In addition,
most state agency audits of individuals are merely follow-ups
on IRS audits. IRS leads account for the preponderance of the
agency'sindividual taxpayer audits.
Nonetheless, some taxpayers and
business leaders say that when the Franchise Tax Board does strike,
it is hard and sometimes arbitrary.
The agency admitted it didn't have
enough information when it made up a tax bill for John and Barbara
Wertin, a Newport Beach couple whose 1983 return was audited
by the IRS.
The Franchise Tax Board had destroyed
the Wertins' return, but rather than waiting for them to dig
up their copy, the state agency levied taxes and interest using
erroneous electronic information. The Wertins argued successfully
that the agency had to base assessments on an actual return.
The Franchise Tax Board "loitered,"
"dawdled" and then "panicked" as the statute
of limitations on the case began to run out, Court of Appeals
judges said in a case brought by the couple. "Instead of
seeking an extension of the statutory period from the Wertins,
who were under a duty to produce their returns, the Franchise
Tax Board ignored statutory directives and computed their tax
deficiency out of thin air," the judges wrote.
The Wertins' attorney, M. Edward
Mishow, said they offered to settle before going to trial. Now,
the Wertins are expected to get more than $600,000 from the state.
The Franchise Tax Board appealed but the state Supreme Court
refused to hear the case.
The agency "didn't get a dime,"
Mishow said. "I said, 'If you guys lose, it's going to make
an untenable precedent. . . .' You have to wonder why they didn't
have a better assessment of the risks."
Johan Klehs, chairman of the State
Board of Equalization and a Franchise Tax Board member, said
the case was a rare loss for the state, which he said wins 90%
of the cases that go to trial.
But critics say such cases add
to suspicion that the agency is trying to wring out the maximum
amount of tax regardless of circumstances.
The chief financial officer for
a large Silicon Valley company, a former Franchise Tax Board
auditor, said the state's auditors increasingly focus on big
assessments, bypassing areas in which a company might be owed
a refund.
"We overpay a lot and we underpay
a lot; that's what happens when you're filing in so many different
states," the executive said. "We really want them to
do a fair, complete audit and not ignore the areas where we might
get a refund."
The president
of California Taxpayers Assn., which represents more than 600
companies that do business in the state, said such fears about
the Franchise Tax Board are common.
"They won't talk for fear
of retribution . . . [but] we hear a lot of complaints from members
that they think decisions are made by auditors based on a revenue
result," Larry McCarthy said.
Other corporate executives, however,
suggest that complainers merely resent getting caught after taking
too many tax shortcuts.
"I think that's probably sour
grapes," said Larry W. Berlant, head of Ernst & Young's
state and local tax division in Los Angeles.
Franchise Tax Board member Klehs
agreed.
"The head of a corporation's
finance division has one job: to make sure the corporation pays
as little as possible," Klehs said. "The tax agency's
job is to collect the correct amount of tax, and therein lies
the rub. It's a healthy although stress-filled relationship that
has gone on since the beginning of time."
State Official Defends Agency
Meanwhile, Lynette Iwafuchi, head
of the Franchise Tax Board's auditors and a 24-year employee,
said the mandate for audits hasn't changed and that, unlike the
IRS, the agency has never rewarded auditors based on their assessments
against taxpayers.
Iwafuchi said the agency has largely
switched from general audits to more focused versions in an effort
to be less intrusive, not to raise revenue.
But she acknowledges that auditors
do get more pleasure from big assessments than small ones.
"I can tell you to this day
how many audits I did and what they were about and the great
issues I uncovered," Iwafuchi said. "That's where I
got my satisfaction."
The power of Franchise Tax Board
auditors has unnerved some taxpayers who have been targets of
audits initiated by the state.
Gerald M. Steiner, whose home was
damaged in the 1993 Anaheim Hills landslide, said he has spent
$20,000 so far in attorney and accountant fees to defend a casualty
loss deduction worth about $70,000 to the state. The IRS, meanwhile,
accepted the $727,000 deduction on his federal return, according
to Steiner and his accountant, Gary Capata.
"I feel like I've been raked
over the coals," Steiner said. "I've never experienced
anything like it in my life. They're relentless."
The auditor in the case rejected
the contention that Steiner's home had sustained significant
damage, even though the Small Business Administration estimated
repairs would cost $98,000 and an engineer hired by Steiner said
that restoring stability to his land would cost millions. More
than 40 families, including Steiner's, were evacuated from the
neighborhood of million-dollar homes in January 1993.
Steiner said he has been willing
to compromise, but so far the agency has rejected his efforts.
The cost-effectiveness of the agency's
approach to audits recently came under scrutiny after state Auditor
Kurt R. Sjoberg questioned whether a burgeoning audit staff had
resulted in greater revenues to the state.
The agency added 362 auditors between
1992 and 1996, promising the Legislature that the new positions
would boost collections. Although audit revenues rose by $558
million during that time, the additional auditors weren't responsible,
Sjoberg said. (Sjoberg's complete report is available on the
Bureau of State Audits' Web site at http://www.bsa.ca.gov/bsa/.)
Instead, the increased revenues
came from cases that the agency would have pursued anyway--follow-ups
on IRS audits and cases with potential for large assessments,
Sjoberg said. When Sjoberg looked at more marginal cases where
he expected the new auditors would be assigned, he found that
collections in those categories actually dropped by $128.6 million
between 1992 and 1996.
The Franchise Tax Board vigorously
protested the audit's conclusions, disputing the way that Sjoberg
made his calculations.
But now the situation is evolving
in other ways. Changes at the IRS mean the Franchise Tax Board
is starting to lose some of its best audit leads.
The agency's most profitable audits
come from following up on cases in which the IRS has assessed
extra taxes. Such audits generally result in $30 to $50 of state
tax for every dollar spent in auditing. Audits from IRS leads
account for 71% of the additional personal income taxes assessed
each year, Sjoberg found. Initiating its own audits generally
returns $4 to $12 in assessments for each dollar the agency spends.
But the number of IRS leads has dropped 40% since March 1998.
The Franchise Tax Board estimates
that each 10% drop in leads costs the state $41 million.
Critics worry that the dearth of
"easy money" may lead to even more aggressive audits.
Sacramento tax attorney Eric J.
Miethke believes there is little to stop the agency from becoming
more aggressive. Most members of the Legislature turn a blind
eye to its excesses rather than risk losing revenue, he said.
"It's like 'Heart of Darkness.'
As long as the ivory keeps coming in, we don't care what you're
doing up at the headwaters," Miethke said.
Klehs, a former state legislator
who was elected to the State Board of Equalization in 1994, said
that criticism is unfair.
"Every tax official is elected,
from the members of the board . . . to the county tax collectors,"
he said.
Times staff writer Liz Pulliam
can be reached at liz.pulliam@latimes.com.
State Audits Declining
Tax assessments from Franchise
Tax Board audits of both individual and corporate returns have
declined in recent years. Additional assessments from state audits
of individual tax returns peaked in 1995-96, while corporate
audit assessments peaked the next year. In millions of dollars:
Copyright Los Angeles Times