August 2004

Table of Contents

Cal-Tax Home

Email Editor

Guest Commentary

Chris Micheli is an attorney and registered lobbyist at his Sacramento-based governmental relations firm of Snodgrass & Micheli, LLC. He can be reached at 916-447-2251 or cmicheli@
snodgrassmicheli.com.

As part of the 2004-05 California state budget, a tax amnesty program was enacted in order to generate additional tax dollars for the state's depleted General Fund. The amnesty program was enacted in SB 1100 (Senate Budget & Fiscal Review Committee) on July 31, 2004. This article reviews the legislative development of the amnesty program and provides an overview of the mechanics of the amnesty programs. The last amnesty enacted in California was a brief period in late 1984 through early 1985.

I. Development of Tax Amnesty Legislation

A. Introduced Version

Assemblywoman Judy Chu (D-Los Angeles) introduced AB 2203 in February 2004 with only legislative intent language included in the measure. Her entire bill read as follows: “It is the intent of the Legislature to implement tax amnesty for six months starting immediately, forgiving interest and penalties if owed amounts are to be paid by no later than June 30, 2005. For those that do not pay by June 2005, the penalties and interest will be increased by 5 percent and their names will be required to be posted on the Franchise Tax Board Web site, along with the amount of tax due. In addition, it is the intent of the Legislature to establish a five-year moratorium on any future tax amnesty.”

B. First Amended Version

The first version of AB 2203 that contained tax amnesty was limited to only income and franchise taxpayers. The bill was intended to add Chapter 9.1 (commencing with Section 19730) to the Revenue and Taxation Code. Under the earlier version of AB 2203, the Franchise Tax Board (FTB) would administer a tax amnesty program for personal income and corporate taxpayers.

C. Legislative Findings and Declarations

Although the following section was not included as part of the enactment of SB 1100, it is helpful to review this section that had been contained in earlier versions of AB 2203 (Chu) to understand the purpose behind the tax amnesty program. In AB 2203, the Legislature would have made certain findings and declarations as set forth below:

“(a) Tax evasion and the underground economy place an unfair burden on law-abiding taxpayers and jeopardize funding for critical state education, health, and public safety programs.

(b) Tax amnesty is an innovative and responsible way to increase state revenue to preserve vital state programs without proposing new tax burdens on business and working families, as well as to expose tax evaders operating in the underground economy.

(c) Tax amnesty also allows the state to repatriate unknown tax evaders who earn income tax free and place a greater burden on law-abiding taxpayers. Bringing in these underground profiteers results in increased new net revenue.

(d) The last time California had a full-scale tax amnesty program was in the 1984-85 fiscal year, and it successfully produced $154 million in gross revenues.

(e) Florida instituted an amnesty program that collected $268 million with nearly 57,000 tax amnesty agreements. This was the first amnesty program in 11 years for Florida.

(f) Illinois instituted an amnesty program that collected $532 million in 2003, making it the most successful amnesty program in United States history.

(g) New Jersey instituted an amnesty program that collected $277 million in 2002, and has had amnesty programs in 1987 and 1996 with each bringing in $359 million and $286.5 million, respectively.

(h) New York instituted an amnesty program that collected $520 million in the 2002-03 fiscal year.

(i) The Internal Revenue Service estimates that the federal government is losing $195 billion per year in revenue due to underground activity.

(j) It is the intent of the Legislature, in enacting the tax amnesty program contained in this act, to further improve voluntary compliance with state income and franchise tax laws and to accelerate the collection of currently owed state income and franchise taxes.

(k) A public purpose is served by the waiver of tax penalties and criminal prosecutions in return for the immediate reporting and payment of previously underreported and unreported tax liabilities.

(l) The benefits gained by this program include, among other things, accelerating receipt of taxes currently owed, permanently bringing into the tax system taxpayers that have been evading taxes, and providing an opportunity for taxpayers to clear their records and satisfy tax obligations before the Franchise Tax Board discovers them first.”

D. Opposition Concerns

After AB 2203 began moving through the legislative process in the Assembly, the California business community urged that the bill be expanded to include sales/use tax amnesty and employment tax amnesty. Eventually, the author of AB 2203 agreed to include a sales/use tax amnesty, but there never was agreement to add employment taxes. As a result, not all taxes are included in this amnesty program.

In addition, while AB 2203 was intended to create a "tax amnesty" program, the business community believed it did not represent a true amnesty because it only waives penalties, rather than penalties and interest (note the legislative intent language in the introduced version of AB 2203). Also, there was significant concern that the earlier version of the bill substantially increased penalties (such as the accuracy-related penalty) on all taxpayers, regardless of whether they participated in or were eligible for the amnesty program. Moreover, the earlier version of AB 2203 would have significantly raised the interest rate on under-payments, thereby creating disparity with the rate of interest paid by the state when taxpayers have overpaid their taxes.

Concerns were also expressed by tax practitioners that the amnesty period of February 1, 2005 through March 31, 2005 is just when professionals are all preparing tax returns. Finally, the earlier bill provided penalty and fee forgiveness for those who file late returns or amend returns to report unreported income, but the bill also proposed to increase the accuracy-related penalty from 20% to 50% of the understatement of tax for all taxpayers, not just those who did not come forward in the amnesty.

AB 2203 passed the Assembly on a partisan vote, shortly after Governor Schwarzenegger proposed a similar tax amnesty program in his May Budget Revision. Assembly Budget Committee Vice-Chair Rick Keene (R - Chico) issued the following statement after the Floor debate on AB 2203: "Republicans strongly support a tax amnesty program, but not this one. Democrats have drafted a misguided plan that imposes massive penalties on taxpayers, not just tax cheats. In other words, hard-working Californians would suffer under the Democrats' plan. Additionally, this proposal does not provide enough incentive for tax cheats to come clean. AB 2203 waives penalties, but not accumulated interest, which often exceeds tax liabilities and penalties for gross violators. It's an inadequate proposal to identify tax evaders and generate new revenue for California."

E. Proposed Amendments from Opposition

After much discussion among the business trade associations and tax practitioner groups, the following series of amendments were proposed to the author of AB 2203:

1. Concerning the additional interest rate of 2% on underpayments of tax, industry proposed that the rate apply only to cases in "collections" status.

2. Concerning the accuracy related penalty, industry believed the enhanced penalty should be the same rate as that found under last year's tax shelter legislation (SB 614 - Cedillo), which would amount to a doubling of the current 20% penalty to 40% (rather than 50% as proposed by the bill).

3. Also concerning the accuracy related penalty, industry believed this enhanced penalty should have an exception for disputes that are in administrative appeal (including audit, protest, or appeal) or in court (superior or appellate).

4. Concerning the netting of interest over and underpayments, industry proposed to limit the non-applicability of this conformity provision to those cases that are in "collections" status.

5. Concerning the BOE's authority to publish a list of the "Dirty Dozen" (i.e., delinquent sales/use taxpayers), industry believed that only a taxpayer's name should be published, not the taxpayer's address.

6. Concerning the grants of authority to the Franchise Tax Board as part of the amnesty program, industry believed these grants are too broad and unnecessary. For example, the provision that exempts all FTB actions from the Administrative Procedures Act should be modified to allow some limited public review and comment, without creating time burdens on the FTB. Also, the determinations of the FTB relating to the publication of names on a "Dirty Ten" list should be reviewable.

7. Concerning the 50% interest penalty, industry had the same concerns as expressed on the accuracy-related penalty (i.e., only apply the enhanced interest penalty to those taxpayers who are not currently litigating their matter administratively or in court).

8. Industry believed there should be a better incentive for nonfilers to come forward because penalty relief is not enough to bring them onto the tax rolls, especially when these nonfilers are faced with federal tax, penalties and interest once they come forward to the FTB. The FTB should allow relief of tax, penalties, fees and interest for back years if a nonfiler comes forward. This is similar to the existing “voluntary disclosure program” under R&TC Section 19191 (nexus program) where the FTB relieves tax, penalties, fees and interest to business entities, qualified shareholders and beneficiaries if they come forward and file returns for the immediately preceding six years.

9. Concerning the proposed amnesty filing period, industry believed there should be a 60-day extension beyond March 31, 2005 for filing new or amended returns. This means that tax practitioners would file their amnesty applications during the February 1 - March 31 filing period, but could actually file amended or new returns through June 30, 2005.

10. Industry was also concerned that there is a trap for the unwary buried in the proposed amnesty program. Individuals and corporations who apply for amnesty would not be allowed to file a claim for refund "for any amounts paid in connection with the tax amnesty program." This provision means that a taxpayer can only get money back that was paid as withholding, estimated tax, paid with the original return, or paid after the original return was filed, but before a taxpayer applied for amnesty. However, it would not include any amounts a taxpayer paid with the amnesty application or an amended return.

F. Budget Negotiations Result in Changes

As a result of the state budget negotiations, a number of amendments were made to the language contained in AB 2203. Ultimately, again, the provisions of tax amnesty were put into SB 1100 (Senate Budget & Fiscal Review Committee). First, sales/use tax amnesty was included. Second, the 2% interest rate differential on tax underpayments was removed entirely. Third, netting of interest on under- and overpayments will still be allowed (which is current law, but had been proposed to be repealed). Fourth, the accuracy-related penalty was doubled to 40% (from the current 20%), rather than increased to 50% (as had been previously proposed). Fifth, there is a "safe harbor" for tax disputes so that taxpayers with legitimate tax disputes would not be subject to the enhanced accuracy-related penalty. [Note, however, that there is no safe harbor for the enhanced interest penalty.] Sixth, tax returns must be filed within 60 days after the close of the amnesty period (i.e., May 31, 2005).

G. Final Version

The final version of the bill, which actually became SB 1100, deleted the amendments to CRTC Section 7063 (aka the “Dirty Dozen” list). So, the BOE's publication authority remains unchanged by this legislation.

The statute of limitations banning sales/use tax liabilities incurred prior to October 1, 1996 from being subject to amnesty was removed from the bill (former CRTC Section 7071). As a result, there is no limit on tax years for sales/use tax amnesty, except the liability must have been incurred prior to January 1, 2003.

The amnesty period was modified in both the BOE and FTB sections so that returns must be filed within 60 days (by May 31, 2005) after the amnesty period closes (i.e., March 31, 2005).

In both the BOE and FTB sections, a new provision was added: “In the case of any taxpayer that has filed for bankruptcy protection under Title 11 of the United States Code, submits an order from a Federal Bankruptcy Court, allowing the taxpayer to participate in the amnesty program.” As such, taxpayers in bankruptcy may participate in the amnesty programs if they obtain a court order.

Prior language provided the BOE “shall have the authority to impose penalties at a rate that is double….” It was changed to read that the “Board shall impose penalties at a rate that is double…” As a result, discretion was removed so that the BOE must impose these enhanced penalties.

In both the FTB and BOE sections, the language was modified on the 50% interest penalty to be “for each period for which amnesty could have been requested.” So, this enhanced penalty provision can be assessed when a taxpayer could have requested amnesty but did not do so.

The prior version of the bill would have amended CRTC Sections 19108 and 19113. However, those provisions were removed from the final version of the bill. Therefore, these two code sections remain on the books and, under Section 19113, interest netting of under- and overpayments is still allowed.

The prior version of the bill would have deleted CRTC Sections 19107 and 19110. However, those provisions were removed from the final version of the bill. Therefore, these two code sections remain on the books.

CRTC Section 19164 was modified to read: "(i) Except for understatements relating to tax shelter items to which paragraph (5) applies, in the case of any proposed deficiency assessment issued after the last date of the amnesty period specified in Chapter 9.1 (commencing with Section 19730) for any taxable year beginning prior to January 1, 2003, the penalty specified in Section 6662(a) of the Internal Revenue Code shall be computed by substituting “40%” for “20 percent.” As a result, the accuracy related penalty is increased to 40% (rather than the proposed increase to 50%).

In addition, “safe harbor” language was added to CRTC Section 19164 to read: "Clause (i) shall not apply to any taxable year of a taxpayer beginning prior to January 1, 2003, if, as of the effective date of the amnesty program period specified in Section 19731, the taxpayer is then under audit by the Franchise Tax Board, or the taxpayer has filed a protest under Section 19041, or the taxpayer has filed an appeal under Section 19045, or the taxpayer is engaged in settlement negotiations under Section 19442, or the taxpayer has a pending judicial proceeding in any court of this state or in any federal court relating to the tax liability of the taxpayer for that taxable year.”

Prior proposed amendments to Section 19521 were removed from the bill. As a result, the proposed 2% interest rate differential was removed from the bill.

The earlier version of AB 2203 had proposed that the FTB be granted authority to make available as a matter of public record and on its Internet Web site each quarter a list of the 10 largest corporate tax delinquencies and 10 largest personal income tax delinquencies. The proposed Top Ten list of delinquent taxpayer accounts for the FTB (prior proposed Section 19735) was removed from the final version of the bill.

Not addressed by the amendments in the final version of this bill was the broad grant of authority to the FTB (e.g., the FTB's actions are exempt from the state APA). There is no “safe harbor” language in the 50% interest penalty sections for BOE and FTB penalties. The “no refund or credit” language remains in the bill. And, the BOE's "Dirty Dozen" list of delinquent sales taxpayers can still include the taxpayer's address.

II. Summary of Tax Amnesty Programs

Under SB 1100, there is an amnesty program for sales or use and personal and franchise tax under-reporting or lack of reporting. The following is an explanation of the BOE and FTB programs:

The sales/use tax amnesty is contained in the newly added Article 2 (commencing with Section 7070) of Chapter 8 of Part 1 of Division 2 of the Revenue and Taxation Code. The Board of Equalization (BOE) shall develop and administer a tax amnesty program for taxpayers subject to sales/use tax.

The personal and corporate tax amnesty is contained in the newly added Chapter 9.1 (commencing with Section 19730) of Part 10.2 of Division 2 of the Revenue and Taxation Code. The Franchise Tax Board (FTB) shall develop and administer a tax amnesty program for taxpayers subject to personal or corporate tax.

The tax amnesty program shall be conducted for a two-month period beginning February 1, 2005 through March 31, 2005, or during a timeframe ending no later than June 30, 2005. The program shall apply to tax liabilities due and payable for tax reporting periods beginning before January 1, 2003.

Under this scheme, the FTB and BOE will waive all unpaid penalties and fees that would be owed as a result of previous nonreporting or underreporting of tax liabilities or prior nonpayment of any taxes previously assessed for that taxable year. No criminal action will be brought against the taxpayer, unless one of the following grounds exists: The taxpayer is on notice of a criminal investigation or is under criminal investigation or a court proceeding has already been initiated.

However, the amnesty program does not apply to any nonreported or underreported tax liability amounts attributable to tax shelter items that could have been reported under either the voluntary compliance initiative or the Internal Revenue Service's Offshore Voluntary Compliance Initiative described in Revenue Procedure 2003-11.

Under the amnesty program, a taxpayer would have to be eligible for amnesty and then file a completed amnesty application with the FTB or BOE. Of course, a completed original tax return or an amended tax return, as well as payment of the taxes and interest due, would have to be filed by the taxpayer. Although installment payment agreements would be permitted, all payments would have to be made by June 30, 2006.

The BOE or FTB may enter into an installment payment agreement in lieu of the complete payment, but only if final payment under the terms of that installment payment agreement is due and is paid no later than June 30, 2006. The installment payment agreement shall include interest on the outstanding amount due at the rate prescribed by law.

If, subsequent to the amnesty period, the BOE or FTB issues a deficiency determination upon a return filed, or upon any other nonreporting or underreporting of tax liability by any person who could have otherwise been eligible for amnesty, the FTB or BOE shall impose penalties at a rate that is double the rate of penalties and criminal action may be brought only with respect to the difference between the amount shown on that return and the correct amount of tax, or the amount of unreported or underreported tax.

There shall be added to the tax for each period for which amnesty could have been requested, for amounts that are due and payable on the last date of the amnesty period, an amount equal to 50 percent of the accrued interest for the period beginning on the date in which the tax was due and ending on the last day of the amnesty period. The penalty imposed by this section is in addition to any other penalty imposed. A taxpayer may not file a claim for refund for any amounts paid in connection with the penalty imposed.

The FTB and BOE are granted broad authority to issue any necessary forms, instructions, notices, rules, etc., and are provided a specific exemption from California's Administrative Procedures Act (APA).

In addition, the FTB and BOE are required to conduct a public outreach program and adequately publicize the tax amnesty program so as to maximize public awareness and participation. Also, the FTB and BOE are required to send written notices to taxpayers of their eligibility for the tax amnesty program.

Finally, taxpayers who fail to subsequently pay any amounts due under the amnesty program would be required to then pay all taxes, interest, and penalties (that had previously been waived). Note that taxpayers would not be able to file a claim for refund of any amounts paid in connection with any penalty, fee, or interest imposed.