California’s Franchise Tax Board is taking too long to complete audits and resolve taxpayers’ refund claims, protests and appeals, costing businesses hundreds of millions of dollars, according to the California Taxpayers Association.

Gina Rodriquez, vice president of state tax policy for CalTax, voiced her concerns last week at the FTB’s annual Taxpayers’ Bill of Rights hearing. The Bill of Rights, which was enacted by the state Legislature in 1988, spells out the rules and procedures for tax audits and taxpayer protests and appeals of those audits. The protest is the first step in the audit appeal process.

The FTB has consistently shortchanged taxpayers by not following its own guidelines, according to Rodriquez. “CalTax brought this to your attention last year,” she told the tax board. “However, the FTB seems to have fallen a bit short in addressing our concerns. I want to go through this with you again this year.

“Taxpayers’ liabilities should be determined within a reasonable timeframe. Once determined, any overpayment should be returned to them as quickly as possible. The FTB’s high compliance backlog seems to violate the spirit of the Taxpayers’ Bill of Rights. The FTB must do more to avoid any conflict between protecting revenue and providing due process to taxpayers.”

FTB guidelines require the agency to resolve tax protests in two years. But in 2013 it was taking FTB auditors nearly twice as long, 44 months, to close out protest cases, according to Rodriquez.

Report

The 2014 annual report to the Legislature by the FTB’s Taxpayers’ Rights Advocate Steve Sims has also noted the problem. “For the past several years, I have raised concerns about the additional time and resources required for taxpayers to protest an assessment,” said Sims in the report.

“I am pleased that the focused efforts by our Legal and Audit Divisions to resolve older protests resulted in a 200 percent increase in the number of cases resolved, and an overall reduction of 12 percent in the total number of protest inventory cases. Yet, for the business-entity, docketed protests resolved by our Legal Division for FY 2013/14, only 47 percent of the tax at issue was sustained. This once again raises concern about the number of revisions to assessments that occur once a business entity taxpayer elects to file a protest.”

The FTB has also fallen short in responding in a timely manner to taxpayers’ claims for refunds, said Rodriquez.

“The FTB has in its inventory more than 500 refund claims that are more than three years old,” she said. “This is an unacceptable number, as it means hundreds of millions of dollars – and maybe more, we don’t have a real good handle on the dollar amount – [withheld from] the taxpayers’ working capital, stifling economic advancement.”

CalTax doesn’t know how many hundreds of millions of dollars in potential refunds are being tied up by the FTB’s delays because “the FTB does not have a complete picture of its refund claim inventory,” said Rodriquez. “[FTB] staff is unable to tell CalTax whether the inventory has increased since the 2008 enactment of the Large Corporate Underpayment Penalty, also known as the LCUP.

“The 20 percent LCUP is quite punitive. So punitive, in fact, that taxpayers are forced to file their original returns with an overpayment to avoid the imposition of the penalty. Then they subsequently have to file refund claims for legitimate issues. The LCUP does ultimately increase government and taxpayer costs due to the increased workloads in the returns. The legislative purpose in enacting the LCUP in the 2008 budget negotiations was to raise revenue. And I ask: Has that goal been reached?”

No interest

Adding insult to injury, the FTB does not pay interest on the refunds, potentially allowing the state to use the money for years, itself accruing interest, without any compensation to the taxpayers.

Noting the IRS resolves federal tax refund claims much quicker, Rodriquez asked, “Why can’t the FTB have a dedicated staff to work those refund claims? We know we have a problem; let’s address it with some resources.”

FTB is also dragging its heels on audits, according to CalTax.

“Delayed audits have led to unfair audit practices,” said Rodriquez. “FTB is not completing many multi-state and high-level audits in a timely manner. In addition, CalTax members have reported a growing trend among auditors not to process overpayment issues before the audit closes. Some auditors request that taxpayers file a claim for a refund to address the overpayment issue for the same year that it’s under audit. This not only violates the published audit guidelines, but it worsens the high [backlog] inventory problem we have with refund claims.”

In addition, the FTB is taking too long to resolve appeals, she said. “Taxpayers deserve to have their appeals heard within a reasonable time frame. As years pass with a pending appeal, interest accrues, the audit file becomes stale, taxpayers die, key witnesses move on or become unavailable. Additionally, taxpayers lack any guidance for the years subsequent to the years under appeal.”

Concerns

Sims acknowledged CalTax’s concerns, but said the FTB is working to improve its performance, despite not having enough staff members. “[M]any of those issues have been raised in my annual report to the Legislature,” he said. “But I also want to talk to the effort the department has made in terms of trying to fix some of the problems. I’ve been working with our audit and legal division on this issue for more than the two or three years it’s been raised – more like five years. And I do want to say a lot has been done in terms of improving the process.

“One of problems regarding the protest inventory – she’s correct, it’s taking too long, in my opinion. But at the same time, they have reduced the volume of protests. I don’t know that we would have been able to do both at the same time because of the limited resources. Resources are somewhat limited. There is a resource issue that really needs to be addressed.”

Another reason for tax disputes taking longer to resolve is that they tend to be more complex than in prior years. “Taxpayers are becoming a lot more sophisticated,” he said. “The issues that are getting filed on these claims, they are full-blown audit-type issues. They require experienced resources. The department has taken certain steps to involve attorneys in the process a lot earlier to try to assist in handling these types of issues.”

Issues

Board Member Jerome Horton would like more information on the causes of the delays. “Why don’t we set up a meeting so I can have an opportunity to take a look at these in a little more detail,” he said. “I would like to have the department delineate those items that are systemic, those that are institutional and then those that are resource-type issues. If we are having a resource issue, we should consider requesting additional resources to be able to address those.”

A tax concern was also raised by Lynn Freer, president of Spidell Publishing, which provides publications and seminars for tax professionals. She said California tax law differs from federal tax law concerning the Affordable Care Act, which she dubbed “the Accountants’ Crying Act.” That lack of conformity can complicate taxes for self-employed filers who receive an insurance premium credit in 2014 only to find out they have to pay the credit back in 2015 because their income turned out to be too high to qualify for the credit.

“There are all sorts of technical issues involved,” said Freer. “So we would like to request guidance. We would like a rapid resolution. But one step further, it would be nice to have conformity. If we were to automatically conform to federal law, it would be much easier for these taxpayers. Unfortunately, folks who are involved in this premium credit are typically going to be lower-income taxpayers. They are least able to afford to pay folks to figure these things out, or least able to handle problems when they arise later.”

The FTB board did not respond to her request for Obamacare tax clarification.

By Wayne Lusvardi

The California Taxpayer’s Association spotted a provision in Proposition 31 whose importance no one has noticed until now. It appears to prohibit making any cuts or increases to the state budget of $25 million or more.  In other words, it appears to freeze 99.999 percent of the state budget at its current funding level.

This sounds like the reincarnation of Proposition 13, the 1978 initiative that froze property taxes at the 1975 level until properties were re-sold.  But CalTax opposes Prop. 31 because it could be gamed and turned into Frankenstein monster on Nov. 6 — right after Halloween.

The key tax provision of Prop. 31 is Section 4.  In effect it would prohibit the Legislature from passing any bill that reduces or increases taxes by $25 million or more — unless the same bill provides for a tax increase or spending cut from some other program.  CalTax says that the $25 million threshold is so low that it would apply to any meaningful tax reduction or tax incentive.  It also would apply to any tax increase of $25 million or more.

Prop. 31

Under Prop. 31, a revenue reduction would apply to any “tax, fee, penalty reduction, or elimination of any type of incentive, tax exemption or tax deduction,” says CalTax.  But CalTax has the following concerns about Prop. 31:

* Any change to an existing job creating tax incentive would be affected.

* It could be gamed by bad budget estimates that may kill its touted tax limitations.

* Past budget reform proposals have only included budget increases, not revenue reductions.

* Prop. 31 has to be taken as a package of reforms with the bad as well as any good.

* Prop. 31 says it is about greater budget transparency.  But CalTax is concerned that the Department of Finance, state tax agencies, and the Legislative Analyst’s Office would exercise sleight of hand behind the scenes to create an appearance of new tax revenues or budget cuts where none really exist.

A crucial concern is that the $25 million limit on budget increases or decreases can be gamed in several ways.

One way it can be manipulated is by creating many $24.9 million expenditures.  Another way could be by using projected revenues for increasing spending, thus running up more deficits.

Expenditure bills could also be padded.  By inflating the budget of a program or project the governor then could use the veto power granted him under Prop. 31 to create the appearance he cut its budget in half.

The $25 million circuit breaker funding clause in Prop. 31 will only work with a responsible Legislature that does not use budget gimmicks.  Limiting spending is not likely to happen with a tax-and-spend California Legislature, or with the local “Strategic Action Plan Committees” created under Proposition 31.

No Limits on Big Ticket Funding Items

Another big difficulty with Prop. 31 is that it apparently does not put any limits on using bond financing or voter initiatives for state or local programs and projects.  As even the liberal Los Angeles Times wrote:

“But Proposition 31 simply fails to deal with the big-ticket items: bond measures, which add new annual payment obligations, and voter initiatives, which routinely impose new costs without identifying new revenue. Lawmakers thus would have a new incentive to rely ever more often on bonds and the ballot box — to the state’s fiscal detriment.” 

A recent example is the city of Pasadena, which is considering using $3 million in state water bond funds under Proposition 84 to re-landscape a flood control basin, expanding recreation facilities and open space, and installing a public bathroom as well as some upgrades to water works facilities. This is a local parks project funded by statewide taxpayers.

Water treatment

The city of Maywood is also planning on using statewide water bond revenues to finance a new water treatment plant under the guise of cleaning toxins from groundwater.  Statewide taxpayers would end up paying for local public works projects wearing the mask of an environmental project.

Under the mechanism of bonds, the financing of local parks, open space acquisition, public recreation, and local water and sewer projects are being regionalized.  The “user pays” principle is being abrogated and the financing of projects and programs is becoming socialized.

Under Prop. 31, this regionalization of public financing would be expanded. The stated purpose of Prop. 31 in its own wording is:

“To improve results, public agencies need a clear and shared understanding of public purpose. With this measure, the people declare that the purpose of state and local governments is to promote a prosperous economy, a quality environmental and community equity.  These purposes are advanced by achieving at least the following goals: increasing employment, improving education, decreasing poverty, decreasing crime, and improving health.”

In other words, Prop. 31 would be used to transfer funds from a large state or county taxpayer base for local prisons, public schools, and health and welfare programs. What regionalization — or socialization — does is create the image that everything that politicians can promise can be had for nearly free, or for a pittance of taxes.   It would do this by spreading the financing base over a wider tax base than city governments.  But the reality is that taxes would then become out of control.

A major concern about Prop. 31 is its silent “tax sharing” component.  It provides for the creation of regional government committees that would transfer taxes from suburbs to big cities and big-city school districts that are broke.

Prop. 31 is the opposite of Prop. 13.  It is a Frankenstein monster wearing the tax fighter mask of Howard Jarvis or the Jerry Brown mask of a monk.  Prop. 31 is an after-Halloween trick, not a treat.