State Budget:
Proposed FTB Penalty for Erroneous Refund Claims Approved by Senate Subcommittee, Still Being Considered by Assembly Panel

A Senate budget subcommittee this week approved Governor Jerry Brown's budget proposal to authorize the Franchise Tax Board to impose a 20 percent penalty on erroneous claims for refunds, while an Assembly budget committee deferred action on the item.

The governor's May budget revision summary misleadingly describes the proposal as a penalty for filing a fraudulent claim for a tax refund. The governor's draft legislation to implement the recommendation is far broader, covering any erroneous claim for a refund, and could be interpreted by the FTB to apply to math errors.

The agenda for the May 21 meeting of the Senate Budget Subcommittee No. 4 described the penalty as one that relates to "fraudulent claims for refund." During testimony, representatives of the FTB and the governor's Department of Finance described the proposal as a penalty on "unsubstantiated refund requests," and said it would conform California to federal law. Proponents said the proposal would generate revenue both from the penalty itself, and by discouraging unsubstantiated refund claims.

CalTax Fiscal Policy Director Therese Twomey testified in opposition, noting that the proposal specifically bars taxpayers from protesting the penalty to the FTB or appealing to the Board of Equalization. This lacks due process, and "places the Franchise Tax Board in the position of being the judge, jury and executioner," Ms. Twomey said.

While proponents state that the proposal conforms to federal law, opponents noted that California has a large corporate underpayment penalty (LCUP), for which there is no federal counterpart.

Many taxpayers are forced to overpay their taxes in order to avoid being hit with the massive LCUP, Ms. Twomey noted. If the state now adds a large penalty for overpaying, taxpayers will be subject to a "whipsaw effect," she said.

The Department of Finance stated that the penalty would be applied only when a claim for refund had no "reasonable basis," based upon the FTB's interpretation of a federal regulation; and the FTB stated that it would use the same definition of "reasonable" that is used when imposing the accuracy-related penalty for underpayments. The Legislative Analyst's Office said "reasonable basis" would end up being defined by the courts. "Certainly in the future there will be litigation," an LAO representative testified.

"If the FTB doesn't think it's reasonable, then you get a 20 percent kick in the head," Senator Doug LaMalfa commented. "I find this pretty objectionable and heavy-handed," he added.

The committee voted 2-1 to recommend that the Senate Budget Committee approve trailer bill language to impose the penalty.

The issue came before Assembly Budget Subcommittee No. 4 on May 23, with proponents and opponents reiterating the testimony they provided to the Senate panel. Ms. Twomey voiced an additional concern with the proposal, stating that the state's litigation costs potentially could eclipse the $1 million in new revenue projected by proponents of the penalty.

Assembly members from both parties expressed skepticism about the proposal. "If somebody is overpaying, I'd like to give them an award – I'd give them a plaque and say 'thank you,'" Assemblyman Dan Logue commented.

Assemblywoman Joan Buchanan, who chairs the subcommittee, said, "If you overpay your taxes, that should be good for the government, because the state is getting the float on that money." Assemblyman Roger Dickinson agreed, saying, "If the state's got the money, the state has the benefit of the money."

Mr. Logue asked the FTB, "Are you prepared to give the taxpayers of California a 20 percent fee if you overcharge them on their taxes?" He added: "Here we go again. … We are to the point we are charging people for errors. … There is something fundamentally wrong with charging people a penalty when they overpaid."

After discussing the proposal, the Assembly subcommittee decided to hold it open for a possible vote at a future meeting.

In other budget subcommittee action:

BOE Request for Computer Upgrade Funding Advances. The budget subcommittees in both houses approved the Board of Equalization's request for 113 positions and $18.1 million in 2012-13 and 242.1 positions and $30.1 million in 2013-14 to proceed with its Centralized Revenue Opportunity System computer upgrade.

The budget request is 28 percent lower than one made by the BOE earlier this year. The BOE said the legislative analyst made suggestions to lower costs by delaying the hiring of some personnel, among other things, and said the computer system still should generate the same amount of revenue – a projected $38.8 million in 2012-13 and $66.5 million in 2013-14.

During the subcommittee hearings, BOE representatives faced questions about why the first request was so much higher, and why steps toward economizing were not taken initially. "Why wasn't this analysis done right from the get-go?" Ms. Buchanan asked. She said that when the state is considering cutting funds for child-care programs, every agency should be looking for ways to save money so more funds will be available for social programs.

Senator LaMalfa asked that the BOE provide the Legislature will an annual fiscal report on the CROS project.

Action Deferred on Request for Fire Tax Implementation Funds. The BOE's request for $6.4 million and 56.5 positions to administer the state's new fire tax – described as a "fee," imposed on property owners in areas where the state is responsible for providing firefighting services – was approved earlier this month by the Assembly budget subcommittee, but was left open May 24 by the Senate budget subcommittee.

Senator Evans said she wanted to leave the issue open to ensure that it will go to a conference committee for more discussion. She expressed concern that many rural property owners in her district will have to pay the state "fee" in additional to local fees that they already pay for firefighting services.

Senator LaMalfa said he is "greatly concerned" that the state is ramping up to administer a tax that he believes will be found unconstitutional (it was approved without a two-thirds legislative vote). He said the cost of litigating and administering the tax could eat up the entire $50 million in estimated annual revenue. Senator Evans voiced a similar concern.

Senator LaMalfa made a motion to reject the funding request, but his motion failed on a party-line vote of the three-member subcommittee.

May 25, 2012
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