Date of Hearing: May 11, 2016

ASSEMBLY COMMITTEE ON APPROPRIATIONS

Lorena Gonzalez, Chair

ABPCA Bill Id:AB 2692

Author:(Brough) – As Amended Ver:April 26, 2016

Urgency: No State Mandated Local Program: Yes Reimbursable: No

SUMMARY:

This bill expands voluntary disclosure programs (VDP) administered by the Board of Equalization (BOE) and the Franchise Tax Board (FTB) to include qualified small businesses in California. Specifically, this bill:

1. Expands the type of retailer eligible for the BOE VDP include retailers located in California that have gross receipts of less than $1 million in the previous four quarters. These retailers must be determined by the board to have not reported or paid an amount because of reasonable cause and not because of fraud or negligence.
2. Expands the types of taxpayers eligible for the FTB VDP as follows:
   1. Includes “qualified small business,” which is defined as any entity with a total income of less than $1 million for the previous tax year that is located in or outside of California, as a taxpayer that may participate in the FTB VDP.
   2. Allows “eligible trusts” to have beneficiaries located in California instead of just nonresident beneficiaries.
   3. Includes limited partnership as the definition of an “eligible entity” that previously included corporations and limited liability companies.

FISCAL EFFECT:

1. One-time administrative costs to BOE and FTB of approximately $600,000 to update systems, develop procedures, and hire staff to respond to penalty abatement requests.
2. An unknown but significant impact on state revenues and penalty fee collections.

COMMENTS:

1. Purpose. According to the author, this bill would give taxpayers an opportunity to receive a temporary waiver relating to their delinquent taxes, fees, and penalties. Historically, California has collected over a billion dollars in revenue as a result of multiple tax amnesty programs. This bill is more limited in scope than amnesty programs and instead focuses on waiving penalties for small businesses that meet certain conditions.
2. Background on BOE’s Voluntary Disclosure Program (BOE VDP). Under the BOE VDP, the BOE encourages businesses to voluntarily register and pay tax obligations. It provides incentives for unregistered out-of-state companies to satisfy their use tax obligations.
3. Background on FTB’s Voluntary Disclosure Program (FTB VDP). The VDP is a statutory program that allows qualified entities, qualified shareholders, or beneficiaries of a trust that may have incurred an unpaid California tax liability or an unfulfilled filing requirement to disclose their liability voluntarily. The FTB may waive penalties associated with the return filings if the taxpayer meets specified requirements.

In its current form, the VDP is not available to small retailers or small businesses located in California. Currently, a qualified entity must meet the following conditions:

1. Is a corporation, limited liability company (not classified as a corporation), or trust;
2. Never filed a return with FTB;
3. The trust has never performed its administration duties in California;
4. The trust has had no resident beneficiaries (other than a beneficiary whose interest in that trust is contingent);
5. Never been the subject of an inquiry by the FTB with respect to liability for any taxes, and;
6. Voluntarily come forward, prior to any unilateral contact with FTB, and makes both an application for a voluntary disclosure agreement and a full and accurate statement of its activities in California for six months immediately preceding taxable or income years.
7. Tax amnesty programs. Tax amnesty programs allow taxpayers to voluntarily remit unpaid or underpaid taxes without incurring the full liability of penalties that they would otherwise have to pay. Under ordinary collection processes, these taxpayers not only owe the original tax, but also interest on the unpaid amount and various penalties and fees, and may be subject to criminal prosecution. The BOE generally charges a 10% penalty and the FTB generally charges a 5% penalty for failure to file a return or pay the tax by its due date, in addition to mandated interest rates and other penalties for negligence, fraud or other circumstances.

Early tax amnesty programs were often implemented with other enforcement strategies and compliance initiatives, with the goal of improving overall tax administration. In 1984-1985, California offered a three-month tax amnesty program to individual taxpayers, with legislative intent expressly stating that it would be a one-time opportunity. The amnesty program was also coupled with enactment of enhanced enforcement tools intended to increase the FTB’s ability to collect unreported or underreported tax.

1. Previous legislation. AB 1777 (Quirk-Silva), 2014, would have created a tax abatement program for small businesses. The bill was held in Assembly Appropriations.

Analysis Prepared by: Luke Reidenbach / APPR. / (916) 319-2081

Date of Hearing: April 18, 2016

ASSEMBLY COMMITTEE ON REVENUE AND TAXATION

Sebastian Ridley-Thomas, Chair

ABPCA Bill Id:AB 2692 (

Author:Brough) – As Introduced Ver:February 19, 2016

Majority vote. Fiscal committee.

SUBJECT: Personal income tax: corporation tax: sales and use taxes: tax penalty and fee waiver programs

SUMMARY: Requires the State Board of Equalization (BOE) and Franchise Tax Board (FTB) to administer tax penalty and fee waiver programs for specified taxpayers’ penalties and fees incurred in tax years prior to January 1, 2015. Specifically, this bill:

1. Requires the BOE to develop and administer a tax penalty waiver program for taxpayers subject to the Sales and Use Tax (SUT) Law:
   1. Provides that the program shall be conducted for a three-month period beginning February 1, 2017 to April 30, 2017, inclusive, or during an unspecified time frame ending no later than June 30, 2017.
   2. Provides that the program shall apply to tax liabilities due and payable for tax reporting periods prior to January 1, 2015.
   3. Waives all penalties for the non-reporting or underreporting of tax liabilities or the nonpayment of any taxes, except in cases when the taxpayer is on notice of a criminal investigation or a court proceeding has already been initiated against him or her at the commencement of the waiver program.
   4. Prohibits criminal action against the taxpayer for the non-reporting or underreporting of tax liabilities, unless criminal action is already underway.
   5. Specifies that no refund or credit shall be granted for any previously paid penalty.
   6. Requires the taxpayer to file a completed waiver application with the BOE, signed under penalty of perjury, in order to participate, and specifies that mere payment of any taxes or interest due alone shall not constitute an acceptable waiver application.
   7. Requires any taxpayer who has filed for bankruptcy protection under Title 11 of the United States Code to submit an authorizing order from a Federal Bankruptcy Court, in order to participate.
   8. Requires the taxpayer to file completed or amended tax returns for all underreported periods and pay in full the taxes and interest due, within the 60 days after the conclusion of the waiver period.
   9. Allows the taxpayer to apply for an installment agreement, in lieu of paying in full the taxes and interest due within 60 days after the conclusion of the waiver period, so long as full payment is received by June 30, 2018.
   10. Specifies that failure by the taxpayer to fully comply with the installment payment agreement shall render the waiver of penalties null and void and the full payment immediately due and payable, unless the BOE determines there was a reasonable cause for such failure.
   11. Requires the BOE to publicize the program to maximize public awareness and participation, and coordinate such actions with those for similar programs administered by the FTB.
2. Requires the FTB to administer a tax penalty and fee waiver for taxpayers subject to the Personal Income Tax (PIT) Law and Corporation Tax (CT) Law:
   1. Provides that the program shall be conducted for a three-month period beginning February 1, 2017 to April 31, 2017, inclusive, or during an unspecified time frame ending no later than June 30, 2017.
   2. Provides that the program shall apply to tax liabilities due and payable for taxable years prior to January 1, 2015.
   3. Waives all penalties and fees for the non-reporting or underreporting of tax liabilities or the nonpayment of any taxes, except in cases when the taxpayer is on notice of a criminal investigation, under criminal investigation, or a court proceeding has already been initiated against him or her at the commencement of the waiver program.
   4. Prohibits criminal action against the taxpayer for the non-reporting or underreporting of tax liabilities, unless criminal action is already underway.
   5. Provides that the program shall not apply to any non-reported or underreported tax liability amounts attributable to tax shelter items that could have been granted amnesty under previous state and federal programs, as specified.
   6. Specifies that no refund or credit shall be granted for any previously paid penalty or fee, and that a taxpayer may not file a claim for refund or credit for any amounts paid under this program.
   7. Requires the taxpayer to file a completed waiver application with the FTB, signed under penalty of perjury, in order to participate, and specifies that mere payment of any taxes or interest due alone shall not constitute an acceptable waiver application.
   8. Requires any taxpayer who has filed for bankruptcy protection under Title 11 of the United States Code to submit an authorizing order from a Federal Bankruptcy Court, in order to participate.
   9. Requires the taxpayer to file completed or amended tax returns for all underreported tax years and pay in full the taxes and interest due, within the 60 days after the conclusion of the waiver period.
   10. Allows the taxpayer to apply for an installment agreement, in lieu of paying in full the taxes and interest due within 60 days after the conclusion of the waiver period, so long as full payment is received by June 30, 2018.
   11. Specifies that failure by the taxpayer to fully comply with the installment payment agreement shall render the waiver of penalties and fees null and void and the full payment immediately due and payable, unless the FTB determines there was a reasonable cause for such failure.
   12. Provides that the FTB may propose a deficiency, impose penalties and fees, or initiate criminal action if a difference is determined between the tax reported on the new or amended return and the correct amount of tax due, upon conclusion of the program.
   13. Provides that no interest shall be allowed on any overpayment of tax reported on the new or amended return if it is refunded or credited within 180 days after filing.
   14. Provides that any standard, criterion, procedure, determination, rule, notice, or guidelines established by the FTB to implement this program shall not be subject to the regulatory review process undertaken by the Office of Administrative Law.
   15. Requires the FTB to publicize the program to maximize public awareness and participation, make taxpayers aware of the costs associated with failure to participate, and identify taxpayers who may be eligible for the program.
3. Provides that there shall not be an increased penalty structure on outstanding tax liabilities upon the conclusion of the program’s waiver period.
4. Provides that no reimbursement is required by this act pursuant to Section 6 of Article XIII B of the California Constitution because the only costs that may be incurred by a local agency or school district will be incurred because this act creates a new crime or infraction, eliminates a new crime or infraction, or changes the penalty for a crime or infraction.

EXISTING LAW:

1. Requires the BOE to collect and administer the SUT, and the FTB to collect and administer the PIT and CT, and sets forth penalties for the nonpayment or late payment of those taxes, and the failure to file or intentional filing of incorrect returns.
2. Authorizes the BOE to administer a voluntary disclosure program for in-state purchasers who fail to report use tax on purchases of tangible personal property from a retailer outside of this state, and for out-of-state businesses that fail to report use tax on sales to consumers in this state. If the taxpayer files all returns and pays all of the tax and interest due, the BOE limits the time it can assess use tax to the prior three years and waives penalties otherwise owed.
3. Authorizes the FTB to administer a voluntary disclosure program for out-of-state business entities that fail to file returns because they were unaware of the obligation. The FTB may waive penalties if the taxpayer files all returns that are due, pays all of the tax and interest for the preceding six taxable years, and agrees to future compliance with state tax law.
4. Establishes a tax amnesty program under the SUT and PIT that authorized BOE and FTB to forgive any penalties and interest on unpaid taxes between October 1, 2002 through June 30, 2003 for taxes owed prior to October 1, 2002, if the taxes were paid in full by taxpayers they identified as owing liabilities that would be uneconomical to collect and would not be paid in full within a reasonable amount of time.
5. Establishes a tax amnesty program under the SUT, PIT, and CT law that required BOE and FTB to waive all unpaid penalties and fees for taxpayers who filed for amnesty between February 1, 2005 through March 31, 2005 for tax years prior to January 1, 2003, and filed updated returns and paid in full owed taxes and interest. The program also:
   1. Sets the franchise and income tax accuracy-related penalty at 40% on any tax understatement for tax years prior to January 1, 2003 if that understatement is identified after the close of the amnesty period.
   2. Creates an enhanced penalty in the amount of 50% of unpaid interest for any taxpayer who failed to pay the full amount due at the end of the amnesty period or failed to come forward during the amnesty period and is later discovered.
6. Establishes two Voluntary Compliance Initiatives (VCI) that do the following:
   1. Waives penalties for taxpayers who amended their returns to unwind an Abusive Tax Avoidance Transaction (ATAT) and paid all taxes and interest, if the taxpayer came forward between January 1, 2004 through April 15, 2004 for tax years prior to January 1, 2003, and enhances penalties to curtail the use of abusive tax shelters.
   2. Waives penalties for taxpayers who amended their returns to unwind an ATAT or report income from the use of an off-shore financial agreement and paid all taxes and interest, if the taxpayer came forward between August 1, 2011 through October 31, 2011 for tax years prior to January 1, 2011, and increases FTB enforcement authority to identify such taxpayers who did not come forward.

FISCAL EFFECT: The FTB estimates a PIT and CT net revenue acceleration of $100 million in fiscal year (FY) 2015-2016 and $6.9 million in FY 2016-2017, but revenue loss of $65 million in FY 2017-18. The BOE estimates an overall SUT revenue gain of $200.6 million, of which $146.5 million would be accelerated payments and $54.1 million would be new revenue.

The FTB and BOE also estimate significant administrative costs related to education and outreach, programming, and return processing that have yet to be determined.

COMMENTS:

1. Author's Statement: The author has provided the following statement in support of this bill:

This bill would create a statewide voluntary tax amnesty program that will offer taxpayers an opportunity to receive a temporary waiver relating to their delinquent taxes, fees, and penalties. This proposed amnesty program helps incentivize taxpayers to make good on their liabilities.

Historically, California has collected over a billion dollars in revenue as a result of multiple tax amnesty programs. The most recent program conducted in 2005, collected $727 million in income tax and interest.  The California Franchise Tax Board estimates that 360,000 taxpayers would participate in this new amnesty program if AB 2692 is passed with a gross revenue gain of $240 million in fiscal year 2016/17.

1. Arguments in Support: Proponents of this bill state:

True tax and fee amnesty programs can be powerful tools for increasing collection of back taxes and fees, because they are cost-effective methods for increasing revenue without raising taxes…. Unlike a third-party collection approach, where the state pays a portion of the proceeds to the collection agency, amnesty programs typically are undertaken by existing staff. Additionally, encouraging the taxpayer to voluntarily come forward avoids cost associated with locating the taxpayer and imposing various sanctions.

1. Tax Amnesty Programs: Tax amnesty programs allow taxpayers to voluntarily remit unpaid or underpaid taxes without incurring the full liability of penalties that they would otherwise have to pay. Under ordinary collection processes, these taxpayers not only owe the original tax, but also interest on the unpaid amount and various penalties and fees, and may be subject to criminal prosecution. The BOE generally charges a 10% penalty and the FTB generally charges a 5% penalty for failure to file a return or pay the tax by its due date, in addition to mandated interest rates and other penalties for negligence, fraud or other circumstances.

Early tax amnesty programs were often implemented with other enforcement strategies and compliance initiatives, with the goal of improving overall tax administration. In 1984-1985, California offered a three-month tax amnesty program to individual taxpayers, with legislative intent expressly stating that it would be a one-time opportunity. The amnesty program was also coupled with enactment of enhanced enforcement tools intended to increase the FTB’s ability to collect unreported or underreported tax.

1. A Growing and Potentially Troubling Trend: Recently, tax amnesty programs have increased in popularity across the state and nation as they result in a short-term revenue boost for cash-strapped governments without needing to undertake the challenges associated with increasing tax rates or the tax base. However, there is no true gain in revenue associated with tax amnesty programs, except with regard to collection that would not have occurred under existing enforcement efforts. In fact, there is arguably a revenue loss in forgone penalties that would have otherwise been collected under existing enforcement efforts. Tax amnesty programs can also reduce overall taxpayer compliance, especially if they occur frequently, because taxpayers who would have otherwise paid on schedule may now believe they have a financial interest in noncompliance.

Since 1980, 46 states have conducted at least one tax amnesty program, with the majority of states conducting more than one program. While the federal government has never offered a general income tax amnesty, it has offered recent programs limiting taxpayers’ exposure to civil and criminal penalties in exchange for voluntary disclosure of their offshore accounts and assets. Over the last 15 years, California has enacted four iterations of amnesty programs, all of which have since concluded:

1. The 2002 Revenue Acceleration Project (RAP) authorized BOE and FTB to forgive both penalties and interest on unpaid taxes for tax liabilities they identified as uneconomical to collect and unlikely to be paid in full within a reasonable amount of time. The BOE and FTB collected approximately $7.3 million and $32 million, respectively, in revenue from RAP.
2. The 2003 VCI (VCI 1) waived penalties for taxpayers who amended their tax return to unwind use of an ATAT and paid all taxes and interest due. The FTB collected approximately $1.4 billion in revenue from VCI 1, and estimates that $600 million was simply accelerated revenue that would have been collected without amnesty.
3. The 2005 general amnesty program required BOE and FTB to waive all unpaid penalties and fees for taxpayers that: (1) failed to file a return, (2) understated their taxes on a previously filed return, or (3) failed to pay their tax obligation if they paid all taxes and interest due. The BOE and FTB collected approximately $600.2 million and $765 million, respectively, in revenue from this program, and estimates that $439.8 and $727 million, respectively, was simply accelerated revenue that would have been collected without amnesty.
4. The 2010 VCI (VCI 2) waived penalties for taxpayers who either utilized an ATAT or had unreported income from the use of an offshore financial agreement and paid all taxes and interest due. The FTB collected approximately $350 million in revenue from VCI 2.

With the exception of RAP, these tax amnesty programs also generally shielded participating taxpayers from criminal prosecution, while simultaneously increasing administrative enforcement authority and penalties to encourage future compliance.

1. Is Tax Amnesty Fair? Tax amnesty programs must balance accelerated collection of revenues otherwise due against principles of general fairness towards law-abiding taxpayers as such collection only occurs after special treatment is afforded to taxpayers who break the law. Taxpayers who benefit from amnesty are essentially given a loan from the government at an interest rate that may be lower than what is otherwise available to individuals and businesses who comply with the law, putting law-abiding taxpayers at a competitive disadvantage. Tax amnesty programs also often divert staff and resources from existing departments that provide assistance to law-abiding taxpayers.

Research shows that tax amnesty programs generally reduce revenue collections prospectively, but that coupling such programs with strengthened enforcement provisions may reduce future noncompliance and sentiments of unfairness amongst taxpayers who do not benefit from amnesty. This bill contains some provisions that balance revenue collection with tax compliance. Most importantly, this bill does not waive the taxpayer from paying all outstanding interest in full, which would otherwise amount to providing tax evaders with an interest-free loan.

However, the Committee may wish to consider some programmatic changes to create a more fair and balanced tax amnesty program. For example, similar to California’s earlier VCI programs, amnesty could be limited to certain categories of unreported or underreported taxes, focusing on liabilities otherwise unknown or uncollectable to the state instead of allowing recent accounts receivable to qualify for amnesty when the outstanding tax liability is already known and likely subject to current enforcement actions. Additionally, similar to California’s earlier VCI and tax amnesty programs, measures could be taken to reinforce the importance of tax compliance by limiting future amnesty programs, increasing penalties, or other enforcement reforms. In contrast, this bill give some taxpayers who qualified for, but did not participate in, prior amnesty programs a second chance at getting their now enhanced penalties waived, and explicitly provides that there shall not be an increased penalty structure on outstanding tax liabilities upon the conclusion of this program’s waiver period.

1. Alternative Strategies for Tax Compliance: Since the conclusion of earlier tax amnesty programs, California enacted legislation to require both the BOE and FTB to publish public lists of the 500 largest tax delinquencies and provide for the suspension of professional, occupational, and driver’s licenses of delinquents whose names appear on the lists, with the goal of increasing tax compliance and enforcement. The Financial Institution Records Match (FIRM) program was also implemented to match tax debtors’ record files at both boards against accounts held at financial institutions doing business in California, making collection efforts more effective. The BOE and FTB are also both undertaking tax system modernization efforts, the Enterprise Data to Revenue (EDR) Project at the FTB and the Centralized Revenue Opportunity System (CROS) at the BOE, which will augment the numerous initiatives already run by both departments to educate taxpayers about their tax liability and identify and collect underpaid or underreported taxes. The Committee may wish to consider whether a tax amnesty program is necessary for efficient tax administration in light of existing programs.
2. Voluntary Disclosure Programs: The BOE and FTB currently administer targeted disclosure programs for specific taxpayers who are not aware of an obligation to file taxes in California. The BOE voluntary disclosure program applies to in-state purchasers who fail to report use tax purchases from out-of-state retailers and out-of-state retailers who fail to report use tax on sales to in-state consumers. If the taxpayer has not been previously contacted by the BOE, files all returns, and pays all tax and interest determined to be due, the BOE will limit collection of use tax to the prior three years and grants penalty relief. The FTB operates a similar voluntary disclosure program for out-of-state entities, shareholders, and beneficiaries that fail to file returns because they were unaware of the obligation. If the taxpayer files all returns and pays all tax and interest due for the preceding six taxable years, the FTB will waive its authority assess prior years' tax and associated penalties. The FTB also administers a broader Filing Compliance Agreement for taxpayers that are not eligible for its voluntary disclosure program to abate penalties for which reasonable cause is a defense.

Administrators, practitioners, and taxpayers have generally deemed the voluntary disclosure programs operated by the BOE and FTB effective at bringing taxpayers into compliance with California filing requirements and generating increased business activity in the state. As an alternative to broader tax amnesty, the Committee may wish to consider ways to allow additional business entities with minimal presence in the state an opportunity to "come clean" and fully integrate into the state economy without the threat of harsh penalties.

1. Technical amendments: On Page 4, Line 20, strikeout “the” and insert “and”;

On Page 4, Line 39, strikeout “31” and insert “30”;

On Page 8, Line 22, strikeout “In addition, the Franchise Tax” and strikeout Lines 23 through 25, inclusive.

1. Related Legislation: AB 567 (Gipson) would provide medical marijuana dispensaries with a six-month window to settle sales tax and interest payment obligations, without being assessed a monetary penalty, or risk losing their dispensary license. AB 567 is currently pending hearing by Senate Health.
2. Prior Legislation: SB 86 (Committee on Budget and Fiscal Review), Chapter 14, Statutes of 2011, directed the FTB to establish a VCI for ATATs, between August 1, 2011 through October 31, 2011 for tax years prior to January 1, 2011, and increased FTB enforcement authority to identify such taxpayers who did not come forward.

AB 911 (Chu), Chapter 398, Statutes of 2005, made several changes to ease administration of the 2005 tax amnesty program.

SB 1100 (Committee on Budget and Fiscal Review), Chapter 226, Statutes of 2004, enacted a tax amnesty program under the SUT, PIT, and CT law, between February 1, 2005 through March 31, 2005 for tax years prior to January 1, 2003, and created an enhanced penalty for any taxpayer who either failed to pay all taxes and interest due or come forward during the amnesty period.

AB 2203 (Chu), of the 2003-04 Legislative Session, would have created a tax amnesty program under the SUT, PIT, and CT law; increased certain penalties and interest rates on unpaid tax liabilities at the conclusion of the amnesty period; and required the BOE and FTB to publish the names of taxpayers with the largest tax delinquencies. AB 2203 was never heard by the Senate Committee on Revenue and Taxation.

SB 614 (Cedillo and Burton), Chapter 656, Statutes of 2003, enhanced penalties to curtail the use of abusive tax shelters and directed the FTB to establish a VCI for ATATs, between January 1, 2004 through April 15, 2004 for tax years prior to January 1, 2003.

AB 2065 (Oropeza) Chapter 488, Statutes of 2002, established a tax amnesty program under the SUT and PIT, between October 1, 2002 through June 30, 2003 for taxes owed prior to October 1, 2002.

REGISTERED SUPPORT / OPPOSITION:

Support

California Taxpayers Association

Opposition

None on file

Analysis Prepared by: Irene Ho / REV. & TAX. / (916) 319-2098