(January 23, 2009) Eleventh-hour legislation passed without public hearing as part of the California 
budget package in October 2008 has resulted in many companies having to make a large, new and unexpected tax payment — possibly in the multimillions of dollars — now or before May 31, 2009, depending on the company’s tax filing schedule. 

The legislation, SBX1 28 (Committee on Budget), created a new, nationally unprecedented strict liability penalty, on top of significant penalties that already exist for underpayments and inaccuracies,  which California companies will have to pay if the Franchise Tax Board (FTB) decides that a company has underreported taxes in excess of $1 million after the bill's May 31, 2009 deadline. The amount of the penalty is 20 percent of the understatement amount.

The new penalty means that expansive amounts of capital may be tied up with FTB during this recession rather than being invested in our economy. The penalty's $1.5 billion in projected revenues is effected by essentially forcing companies to overpay their taxes by May 31, 2009 to include amounts reasonably in dispute, in order to ensure they incur no 20 percent penalty if the dispute is decided against them. If the dispute is decided in the company’s favor, it will eventually receive a refund, but in the meantime, the state has received a forced, below-market-rate loan. 

Impacts Tax-Compliant California Companies

For companies with large, complex tax returns, $1 million or more can easily and reasonably be in dispute. A $1 million understatement could result from circumstances outside of the company’s control. For example, companies that sell products internationally are sometimes in the middle of pricing disputes between the IRS and other countries, which when resolved can significantly change the company’s federal and state tax liability after the fact. Normally, these complexities are resolved between companies and FTB over time.

The SBX1 28 penalty, however, is a strict liability penalty — meaning it will apply even if a company has no culpability – for example, regardless of whether the company had a reasonable basis for the understatement or  the understatement was for reasons outside of the company’s control or knowledge.

This means that companies hoping to avoid the new penalty must make a “defensive” overpayment of their taxes by May 31, 2009. To do so, companies will be forced to guess or speculate what the defensive payment must be in order to take into account a multitude of unknown or uncertain possibilities that could affect their tax liability after they file. This may mean paying two to three or more times the potential understatement amount.

Overpayments will eventually be refunded, but meanwhile, at a time when companies are cash-strapped, this is a forced loan at below-market interest rates to the state of California. Additionally, the need to defensively overpay will mean expensive new administrative burdens and additional tax filings for companies. Refunds of defensive payments made in the 2005 state amnesty program, which contained a similar penalty structure, are still being processed by FTB.

Types of California Companies Affected

Companies of all types and sizes that have a significant business presence in California may be harmed by the new penalty. California’s largest job-creating companies and investors -- such as multistate or multinational companies -- will have less capital for jobs, research and development ( R&D) and economic sustainment and recovery. Smaller companies, such as subcontractors, that provide goods and services to these larger companies may suffer from less business.

Penalty Applies Retroactively and Permanently

The penalty retroactively applies to tax years going back to 2003. Since the penalty is permanent, tying up multi-millions with FTB may be something companies will have to deal with every year on an ongoing basis.

Action Needed

The California Chamber of Commerce is actively involved with this issue but needs to hear from impacted businesses. The CalChamber recommends that businesses consult with their tax professionals to determine whether the new tax requirements affect them. Please contact Kyla Christoffersen at kyla.christoffersen@calchamber.com if the new penalty is a priority issue of concern for your company and share how it is impacting your company.

Staff Contact: Kyla Christoffersen