What is a change of law? This is the question that has emerged since Gillette Co. v. Franchise Tax Board was finally resolved after the U.S. Supreme Court declined review of the case in October.
What constitutes a “change in law” is important because it could mean escaping big penalties for corporate taxpayers affected by Gillette. But taxpayers attempting to make this argument are likely to face an uphill battle, Eric J. Coffill, Senior Counsel at Sutherland and one of the authors of Bloomberg BNA’s California Corporate Income Tax Navigator Chapter, told Bloomberg BNA.
The FTB has indicated that the fate of these taxpayers will be decided on a case-by-case basis, a murky description that does nothing to address the elephant in the room: California’s large corporate understatement penalty (LCUP) under Cal. Rev. & Tax. Code § 19138.
Shortly after § 19138 was enacted in 2008, the California Taxpayers Association (CalTax), a taxpayers’ group representing individual and corporate taxpayers, sued the FTB claiming that the provision was unconstitutional because it was not approved by the two-thirds legislative vote required for a “state tax” increase. In California Taxpayers Ass’n v. Franchise Tax Bd., 190 Cal. App. 4th 1139 (Cal. Ct. App. 2010), the Third District Court of Appeal rejected CalTax’s challenge.
Here is the quick and dirty about the LCUP, according to the FTB website:
The LCUP applies to corporate taxpayers with a large understatement of tax. For tax years affected by Gillette, this means more than $1 million or 20 percent of the tax reported, whichever is more.
The LCUP is 20 percent of the entire amount of the understatement of tax, which is measured by the difference between the correct tax liability and the tax reported.
Taxpayers cannot protest the LCUP.
There is no reasonable cause exception; however, there is an exception if the understatement is due to a change of law.
This is where things dicey. Some practitioners think the change of law exception could be used by citing the California Court of Appeal decision in Gillette or even the California legislation repealing the election and then saying the law changed from that opinion. “I don’t think the FTB likes that pitch,” cautions Coffill.
The FTB takes a … squishier approach. “Taxpayers that filed their original returns using Single or Double-Weighted Sales Factor as required by the statute, then filed a protective refund claim under FTB Notice 2012-01 would not necessarily be subject to the LCUP when that claim is denied because the LCUP doesn’t apply to subsequent claims or amended returns, only original returns,” Chris Smith, the Trade Media Liaison for the FTB Taxpayers’ Rights Advocate’s Office told Bloomberg BNA in a Jan. 5 email.
FTB Notice 2012-01 instructs taxpayers interested in filing a protective claim for refund to file an amended return that seeks to retroactively elect the apportionment method contained in the Multistate Tax Compact. “If the Gillette election is only on an amended return that is a refund claim, the claim just gets denied and there is no deficiency so no penalty issue,” observes Coffill.
What about the change of law exception and all the other taxpayers affected by Gillette who may be subject to the LCUP?
“If the money is big, it is likely someone will end up taking a case to court,” says Coffill. “But the LCUP is going to be tough to beat in court the way the statute is written. FTB has never liked the Gillette issue, so I do not see them cutting taxpayers a lot of slack on this one. One glimmer of hope is that FTB is required under § 19138(f) to implement the change of law exception in a reasonable manner.”
For those of you who thought Gillette was tied up with a bow in time for a new year, not so fast. A new battle could be brewing between the FTB and corporate taxpayers in 2017.
Continue the discussion on LinkedIn: How can taxpayers prepare themselves for the LCUP?
For more information about state tax issues, sign up for a free trial on Bloomberg BNA’s Premier State Tax Library.
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