Office of Tax Appeals

OTA Establishes Precedent Despite Disagreement of Majority of its Judges


The Office of Tax Appeals posted 43 opinions to its website June 7, including five “pending precedential” decisions and two unanimous opinions that conflict with a new precedent announced the same day.

The OTA last month issued a “pending precedential” opinion in the Appeal of R. Jones in which a split panel of administrative law judges supported the Franchise Tax Board’s interpretation of when the “demand penalty” can be imposed. The Jones opinion was relabeled as “precedential” when the latest batch of opinions was posted to the OTA’s site this week.

Ironically, the new opinions include one (the Appeal of Ryan Michael Darling, A Professional Corp.) in which Administrative Law Judges Teresa Stanley, Kenneth Gast and John Johnson ruled that the FTB’s interpretation of the demand penalty is incorrect, and another unanimously denying the FTB’s petition for a rehearing of that appeal.

A third case on the same issue (the Appeal of D. Wallinga_and M. Wallinga) was decided in the FTB’s favor by a 2-1 vote. The majority opinion held that the FTB correctly applied the demand penalty, while dissenting ALJ Cheryl Akin wrote that “under the plain and unambiguous language” of the relevant statute, the penalty was improper.

California imposes a penalty for the failure to file a return or to provide information upon the FTB’s demand to do so, unless the taxpayer shows that the failure to respond to the demand is due to reasonable cause and not willful neglect (Revenue and Taxation Code section 19133). With respect to individual taxpayers, the FTB will impose a demand penalty if the taxpayer fails to respond to a current demand and the FTB issued a notice of proposed assessment (NPA) under the authority of Revenue and Taxation Code section 19087(a) after the taxpayer failed to timely respond to a request or a demand at any time during the four taxable years preceding the year for which the current demand is being issued.

Since 2019, the OTA has abated the penalty in several cases on the grounds that an FTB regulation misinterprets “during the preceding four taxable years” to improperly expand the period of time in which the penalty could be imposed. However, some OTA judges have agreed with the FTB that a failure to respond to a demand during the four taxable years means for any of the four taxable years preceding the year for which the current demand is issued.

CalTax analyzed the decisions in appeals involving the demand penalty, and calculated that from 2019, when the OTA first ruled against the FTB’s interpretation, through last month’s opinions, there were at least 21 appeals involving this specific issue and more than 76 percent were decided in favor of the taxpayer and against the FTB’s interpretation. The appeals were decided by at least 25 different ALJs, and 72 percent of the ALJs rejected the FTB’s interpretation.

Based on that analysis, CalTax asked the OTA to withdraw the Jones decision’s precedential status. “When cases are overwhelmingly being decided one way, it sets a bad precedent for both taxpayers and the agency when the OTA reverses course and designates a pending precedential decision that represents a minority viewpoint of the OTA’s panels of ALJs,” CalTax wrote. “This would allow future about-face decisions from the OTA regarding any issue, and would increase the number of appeals. The FTB, in this case, would be rewarded with a precedential Jones decision for continually bringing these cases forward even though the OTA soundly rejected the FTB’s legal arguments on numerous occasions.”

In other notable opinions:

Taxpayer Liable for Sales and Use Tax Obligations Despite Change in Ownership. The OTA ruled in a pending precedential decision that the taxpayer was the only retailer operating an audited restaurant for the entire audit period, and thus is liable for the tax on unreported taxable sales made during the audit period.

The taxpayer, Las Playas #10 Inc., doing business as Del Mar, was formed as a corporation in April 2012. In December 2014, ownership of the corporation was transferred, and a statement of information filed with the secretary of state showed “a complete change of corporate directors and officers.”

The CDTFA audited the restaurant and determined that it failed to report taxable sales of $686,524 from July 1, 2012, through June 30, 2015. The taxpayer petitioned for redetermination, arguing that “it was not responsible for tax liabilities arising on or after December 17, 2014, because its ownership changed on that date.” The CDTFA denied the petition, and the taxpayer appealed.

The OTA held that the taxpayer is “confusing the identity of the retailer (the corporation) with the identity of the owners of the retailer (the shareholders).” Although there was a change in corporate ownership and officers, the corporation still was the retailer during the entire audit period, and the ownership change is “immaterial for sales and use tax purposes,” the OTA wrote.

The taxpayer “continued to be the retailer liable for sales tax on the taxable sales made by the business after the December 17, 2014, sale of stock,” the OTA concluded.

Since CDTFA met its initial burden of “showing that its determination was reasonable and rational,” the OTA also found that no reduction was warranted.

The OTA was sympathetic to arguments raised by the restaurant’s new owners that “the burden of the audit liability will require them to sell the business, stripping them of their only source of income to raise a family,” but the ALJs dismissed this argument because “financial hardship is not part of the legal analysis before us.”

OTA Rules That it Lacks Jurisdiction to Enforce Taxpayers’ Bill of Rights. In the pending precedential Appeal of Jacqueline Mairghread Patterson Trust, involving a section 1031 like-kind exchange of property, the OTA unanimously ruled that it does not have jurisdiction over claimed violations of the Taxpayers’ Bill of Rights, and that the taxpayer missed its deadline for filing for a refund of a payment made during the transaction.

The taxpayer argued that after a real estate transaction that involved a 1031 exchange, a withholding agent withheld $3,642 from appellant’s allocable share of the sales proceeds. The withholding agent remitted this amount to the FTB in 2014 via check and included a voucher. The FTB did not credit the payment to the appellant’s tax account until late 2019, after the taxpayer already had paid its full liability for the year in question.

The dispute was over when the taxpayer became eligible to file a refund claim for the $3,642, and thus whether the claim was filed on time or – as the OTA ruled – roughly one month too late even under the most permissive scenario. The taxpayer unsuccessfully argued that the statute of limitations didn’t begin until the payment was credited to its account in late 2019.

“We realize that the withholding agent played a role in the facts at issue; specifically, when the withholding agent remitted a check and voucher to respondent, neither the check nor voucher included appellant’s name or FEIN,” the OTA wrote. “But appellant’s ‘untimely filing of a claim for any reason bars a refund.’”

The taxpayer argued that the FTB violated its rights under the provision of the Taxpayers’ Bill of Rights that says if the FTB receives a payment from a taxpayer and cannot associate the payment with the taxpayer, the agency “shall make reasonable efforts to notify the taxpayer of the inability within 60 days after the receipt of the payment.” Because there was nothing on the check or voucher to associate the payment with the taxpayer, the FTB was required to contact the withholding agent to make reasonable efforts to clarify the situation within 60 days, the taxpayer argued.

“Although the parties make several compelling arguments about R&TC section 21025 [the Taxpayers’ Bill of Rights statute], we cannot take a position on this issue,” the OTA opined, concluding that “except for reimbursement claims under R&TC section 21013, OTA does not have jurisdiction to hear matters based on alleged violations of the Taxpayers’ Bill of Rights,” and the appeal in this case “does not concern a reimbursement claim.”

Siblings Have Similar Circumstances, Get Different Treatment From the FTB. The Appeal of Visconsi involved a California nonresident and minority member of a limited liability company that is treated as a partnership for both federal and California income tax purposes. The taxpayer missed the deadline for filing her 2017 California return, but eventually filed it on May 15, 2019.

Both the taxpayer and the LLC had mailing addresses in Ohio. The taxpayer’s brother also was an Ohio resident and a member of the LLC. The brother’s situation “is identical to appellant’s except that he late-filed his 2017 California return more promptly, on January 31, 2019,” the OTA wrote.

The FTB originally determined that both the appellant and her brother were liable for the maximum 25 percent late-filing penalty. Both paid and filed claims for refund that were denied by FTB. Then, they filed separate appeals with the OTA. On appeal, the FTB abated the $1,496 penalty imposed against the appellant’s brother, but not the $1,267 penalty imposed against her.

The taxpayer offered two arguments for why there is reasonable cause to abate the late-filing penalty. First, she asserted that she had no reason to believe she had a California filing requirement for 2017 until January 2019, when the LLC issued an amended Schedule K-1 showing she had significant California-source income from the company, after which she filed a return. Second, she argued that she should be treated like her brother, whose penalty was abated by the FTB for reasonable cause.

The FTB argued that the taxpayer’s brother exercised ordinary business care and prudence by filing his return the same month he realized one was needed, whereas the appellant did not.

“Hypothetically, appellant provided an adequate explanation for filing her return within a few weeks of receiving her amended … K-1 in January of 2019; in reality, appellant provided no explanation for filing her return four months later,” the FTB argued. “As a result, appellant has failed to establish reasonable cause to abate the delinquent filing penalty.”

ALJs Jeffrey Margolis and Kenneth Gast ruled in favor of the taxpayer, saying she acted “reasonably and not with willful neglect.” In the majority opinion, they added: “Obviously, upon the receipt of the amended Schedule K-1 in January 2019, appellant would need to analyze it, determine whether it gave rise to a California filing obligation, contact a tax advisor with expertise in preparing an out-of-state return, and provide the preparer with the necessary information to prepare and file the return. This obviously takes some time ….”

Dissent by ALJ Andrew Wong dissented, writing: “Although there was reasonable cause for appellant’s failure to file a California nonresident tax return until January 2019, appellant has not explained whether or how she exercised any ordinary business care or prudence from January 2019 until May 15, 2019, when she finally filed her return.”