California and Out-of-State Taxpayers: Amnesty Penalties Questioned
Imagine receiving a letter from your bank stating your account will be levied in a matter of days because the California Franchise Tax Board (FTB) has determined you have a tax liability dating back 19 years.
Until recently, there was no statute of limitations on the amount of time FTB had to collect tax liabilities that had become due and payable. The government was allowed to issue tax levies, liens and implement court enforced collections until the full amount of tax was paid. In 2007 this changed, and now the FTB must collect tax liabilities assessed after July 1, 2006 within 20 years of assessment, in most cases.
The 20 year statute date can be extended if, for example the taxpayer obtains a collection stay, such as in a bankruptcy proceeding, an approved installment agreement or other suspensions and postponements, which may toll the statute and extend it beyond the 20-year period.
In each case, the former resident is truly surprised by the FTB’s action, believing he properly filed and paid all tax due to California. Unfortunately, the taxpayer has the burden to prove he mailed his tax return to the FTB and that his tax return was accurate. Callers have admitted that with so many years having passed, it is hard to recall what was filed or paid with certainty, but even those with the best memories often do not maintain receipts for such a long period of time. Obtaining proof is even more difficult for many former residents who may have discarded California tax data after leaving the state.
For non-filers (or fraudulent tax return filers), there is no legal statute of limitations period for the FTB to assess tax. The FTB can, and does, estimate a non-filer’s tax liability based on available income and tax information that will allow the FTB to determine what the taxpayer would have owed had the taxpayer filed returns. For some taxpayers, the issue is resolved merely by filing an amended return for a year the FTB prepared a substitute for return for a taxpayer whom the FTB believe earned income.
In one recent case, the taxpayer earned only a few hundred dollars by one employer the last year he lived in California, some 18 years ago. The taxpayer did not remember if he filed a tax return that year, but the employer issued a W-2 for the modest wages paid. Assuming the taxpayer did not file a return that year, since the FTB received a copy of the W-2, the FTB filed the return for the taxpayer. First, however, the FTB did some homework and realized the former resident had been a licensed California attorney, and therefore the FTB imputed earnings to the taxpayer it estimated attorneys earned on average that year in California. This taxpayer did not have any wages other than the small amount reported on his W-2. Therefore, it was simple enough to file an amended return which satisfied the FTB. The taxpayer paid the relatively small amount of tax, interest and penalties due and the FTB withdrew its levy.
Many taxpayers are not so lucky and, for a variety of reasons, they simply cannot determine whether they filed a tax return for the year or years at issue, and what his or her income and possible deductions or credits would have been in the prior decades.
An added twist is the harsh amnesty penalty that applies to taxpayers whose liability predates the 2002 tax year. Recall that in December 2004, the FTB and the California State Board of Equalization announced an amnesty program for taxpayers who either did not file income, sales or use tax returns, or who underreported their income, sales or use tax for the tax year 2002 and prior. By participating in the program, delinquent taxpayers could file returns, pay the past-due tax and related interest and avoid most penalties and fees for taxable years 2002 and older, and avoid criminal prosecution.
The application period was a brief 59 days, lasting from February 1, 2005 through April 1, 2005. Taxpayers who qualified but did not participate in the program would suffer harsh consequences, including the amnesty penalty equal to 50% of the post-amnesty unpaid interest amount on any tax year eligible for amnesty and 50% of the unpaid interest subsequently assessed on deficiency amounts. Additionally, an increase to the accuracy related penalty would apply by doubling the 20% underpayment penalty to 40% of the understatement, for any assessment issued post amnesty.
A variety of exceptions applied to taxpayers already in audit, protest, appeal, settlement or litigation as of the beginning of the amnesty program.
In a recent review of California’s 2005 amnesty program, it appears there is sufficient evidence to prove that only taxpayers residing in California were targeted for this program; out-of-state taxpayers were not notified of the program, even when the FTB had the taxpayer’s current out-of-state address.
According to the Tax Amnesty Marketing Campaign 2005 Executive Summary (Executive Summary), the FTB’s amnesty program was marketed initially via direct mail to 1.2 million taxpayers who had balances on FTB’s accounts receivable system, an open bankruptcy, audit, appeal, or other legal action. Taxpayers who received the “invitations” to participate were provided the savings estimates they would receive through the program. These invitations were sent prior to the start of the program, in December 2004.
The FTB also targeted taxpayers via radio and television. The Executive Summary describes the approach of the campaign as “building on the ‘power, reach, and influence’ of radio, TV, and direct mail to the taxpayers.” Glass McClure, the Sacramento-based advertising agency that won the bid for this marketing campaign contract, estimated that 97.4 percent of all Californians would be alerted to the amnesty program an average of 17 times. (Tax Amnesty Marketing Campaign 2005 Executive Summary, Campaign Breakdown, page 4.)
The Executive Summary boasts that news conferences were held in Los Angeles and Sacramento and that telephone and in-person television, radio, newspaper and wire service interviews touched media markets from as far north as Eureka to as far south as San Diego, to assure that taxpayers across the state would receive the message.
Ultimately, 1.8 million amnesty invitation letters were sent to California taxpayers. While the outreach regarding the amnesty program is significant and impressive, the outreach appears to have been limited to taxpayers living within California’s boarders. Taxpayers who left California–even those for whom the FTB was aware of an updated and out-of-state mailing address–were not apparently invited to participate and no effort was made to notify such taxpayers. In several cases, the taxpayer no longer lived in California but had California source income, and therefore filed non-resident returns listing the current address outside of California. Clearly this would allow the FTB to invite such taxpayers to participate in the amnesty program, however none recall receiving a notice. Nothing in the Executive Summary suggests invitations or advertisements extended outside of California.
Now, years later, former residents may discover that the state of California is not only seeking to collect on a previously assessed tax liability that is past due, but also a substantial penalty for failing to participate in a program of which they were never aware. While it is too late for taxpayers to participate in the amnesty program for penalty relief, it seems reasonable that no additional penalty should be imposed for not participating in a program that California went to great lengths to advertise, but limited the advertisements and invitations to the California boarder. It appears the FTB only intended the program to apply to current California residents since those are the only taxpayers who were targeted, thus leaving a plethora of qualified participant taxpayers in the dark. Recall that the marketing campaign targeted 97.4% of Californians, an average of 17 times. To this author’s knowledge, the issue concerning the assertion of the amnesty penalty has not been raised with the FTB nor has the issue been litigated. However, the sudden flurry of taxpayers affected by this problem will require the FTB to address the question. In the meantime, former residents may attempt to avoid the problem of the FTB’s lengthy period of time in which to collect tax liabilities by ensuring their assets cannot be reached by a levy issued by the FTB. (Maintaining a bank account with a California branch is an easy target for the FTB, therefore some former residents do not bank with national banks.) Taxpayers who have recently been targeted and affected by FTB collection efforts may request penalty abatement relief and try to resolve the matter with the FTB, or wait 20 years for the collection statute to expire, whichever occurs first.
 California Revenue and Taxation Code Section 19255.
 The Tax Amnesty Program was available to most individuals, fiduciaries, estates and trusts, partnerships, limited liability companies, corporations and exempt organizations with unrelated business taxable income.