FTB Penalties at Every Turn

Can anyone keep track of all the different California Franchise Tax Board (FTB) fees and penalties? If you owe taxes, you’ve got to keep an eye on them, or your tax liability can quickly get out of hand. At a minimum, you should know that they exist.

The most obvious penalties are the “late filing penalty” and the “late payment penalty.” The late filing penalty is imposed for filing after April 15th, or after the extended due date, as the case may be. The amount of this penalty is 25 percent of the amount due. The late payment penalty is assessed if the full tax on the return is not paid by the original due date. The penalty is 5 percent of the amount that was not paid, plus .5 percent monthly, until it is paid (subject to a 25 percent maximum).

Other common penalties include the “estimated tax penalty” and the “demand to file penalty.” Obviously if you are required to make estimated tax payments and you either don’t pay in full or pay late, you’ll be subject to the estimated tax penalty. The demand to file penalty is almost what you’d think. If FTB sends you a letter demanding that you file a certain tax return, or provide certain information, and you disregard it, they will impose a 25 percent penalty. The catch is that they figure the penalty based on the FTB’s assessment before applying any payments or credits (not your own return), which sometimes has seemingly unfair results. Where else might you owe penalties and interest even if your tax return shows that a refund is due? Not with the IRS, that’s for sure.  The IRS does not typically care if you file a return if that return is going to result in a refund.

I do understand the rationale of requiring a return, even if reported income and withholding information suggests that no tax would be due. The reasoning is that the FTB simply wants the taxpayer to certify (by filing a return) that there is no additional income or taxable events that may have not been reported by third parties.

There are also a number of “cost recovery fees” that could be imposed by FTB that drive up the balance of a tax bill. FTB charges a fee if your account is assigned to filing enforcement or to collections. There are also fees associated with filing a tax lien or seizing and selling property. You can read all about FTB collection procedures in publication 1140.

Stopping Interest on Proposed Liabilities

You may not know this unless you’ve been through it, but when the IRS makes proposed adjustments to your taxes, interest begins to accrue beginning on the tax return due date.  And it is an even lesser known fact that one can completely stop interest from accruing on proposed tax balances by making what is called a “remittance.”  There’s a special term for it because we’re talking about proposed liabilities (before anything has officially been assessed).  After taxes are assessed, it is simply called a payment.

Why would anyone want to make a remittance?  The primary reason for making a remittance is that the taxpayer plans on disputing the adjustment, which could take a long time (especially if taken through the appeals process), and the taxpayer could potentially be on the hook for quite a bit of interest.  Paying a remittance sufficient to cover the total tax, penalties, and accrued interest will stop interest from running on the date it is received.  And if the taxpayer is successful in getting the liability reduced, the IRS will either return the excess or apply it to other tax liabilities.

There are two types of remittances: a deposit and an advance payment.  If you clearly designate your payment as a deposit, the IRS must return it to you, upon request, unless the IRS has already applied it against an assessed liability.  You may even qualify for interest being paid to you for the time that the IRS held your funds.  To qualify, you must provide a written statement that includes the tax type, tax year, and a copy of the 30-day letter.  An advance payment, on the other hand, is treated just like a regular tax payment and will only be refunded to you if you make a valid claim for a refund.

This is all fully explained in IRS Notice 1016 (Feb. 2006) which is often included as an insert in various IRS correspondence.  Be careful not to confuse this process with the cessation of interest on assessed tax liabilities.  The procedures above apply to proposed liabilities only.  Who knows how many of my clients have received this insert and read the title only (“How to Stop Interest on Your Account”) and assumed there is a way to stop interest on their assessed liabilities without paying in full.  The IRS should probably modify the title of this insert so that it is absolutely clear.

 

First-time Penalty Abatement in California

What kills people when they have an IRS tax debt is the interest and penalties.  If you don’t file and pay your taxes when they become due, you can eventually find yourself owing much more than the original tax assessment.  It is possible to negotiate an abatement of penalties, but it isn’t always easy, especially for “repeat offenders.”

By “repeat offender” I mean those who have a history of non-compliance, (i.e., failure to file on time and/or failure to pay on time).  The IRS treats repeat offenders differently.  If you have no missing returns and no prior penalties for the preceding three (3) years, then you may qualify for “first-time abatement penalty relief.”  First-time abatement may be granted without consideration of individual circumstances and excuses.  However, if you do not meet the criteria for first-time abatement, then your only recourse would “reasonable cause penalty relief,” which can be very difficult to prove.  Chances are, what you consider a reasonable excuse for not filing on time or not paying on time will not be considered reasonable by the IRS.

The California Legislature is currently considering adoption of a bill that would provide a first-time abatement option for California taxpayers.  Under AB 1777, the Franchise Tax Board would give preference to non-repeat offenders like the IRS.  The requirements would be as follows:

  1. No prior timeliness penalties imposed for current year and four (4) prior years;
  2. The taxpayer has paid all current tax due, or is in a valid installment agreement;
  3. The taxpayer is otherwise compliant with FTB filing requirements

As you can see, the first-time California late-filing penalty abatement, as proposed, would be more restrictive than the Federal version, as it requires a slightly longer history of compliance.  It seems like California looks to the IRS for guidance in administration of its tax laws, and then tries to figure out how it can make things just a little bit tougher for California taxpayer.

Do You have Reasonable Cause?

image via gerdleonhard.typepad.com

Sticking your head in the sand and trying to ignore your IRS tax debt can be costly. The most obvious problem is penalties and interest, which causes the debt to increase with every passing day.

And it is not as easy as you might think to get the IRS to disregard (or “abate”) the penalties. The IRS will consider penalty abatements if the taxpayer is able to show reasonable cause; however, this is a pretty high standard when it comes to tax obligations. Reasonable cause exists when the taxpayer exercised ordinary business care, but still failed to comply with their tax obligation (i.e., usually filing and/or paying late).

In its analysis of “ordinary business care” the IRS is supposed to weigh all applicable facts and circumstances, including the following:

  • taxpayer’s reason for non-compliance
  • compliance history
  • length of time
  • circumstances beyond taxpayer’s control

Death, serious illness, and natural disasters are typically some of the strongest “excuses” for building a penalty abatement case. Forgetfulness is almost always a losing argument. Most of the time it makes more sense to seek tax relief through other channels because penalty abatement is often a dead end road.