CLIENT ALERT February 2009 DEADLINE APPROACHES TO AVOID CALIFORNIA CORPORATE TAX PENALTY By Stuart A. Simon, Esq. Philip J. Wolman, Esq. L. Richard Walton, Esq. May 31, 2009 is the deadline for large corporations in California to avoid a new 20% penalty on underpayments of their corporate income tax and/or franchise tax liabilities. This penalty, enacted in October 2008, will be assessed in addition to any other penalties that may apply where there is an underpayment of California taxes of $1,000,000 or more. Corporations that are assessed the penalty will not be able to protest the penalty. There will be no reasonable cause exception to the penalty. The penalty may be avoided by amendment of California tax returns and payment of the tax shown on the amended return. Who is subject to the penalty? The penalty will apply to corporations, banks, and any other entity taxable as a corporation under the California Revenue and Taxation Code. This includes limited liability companies that have elected to be taxed as corporations. The penalty applies both to California corporations and corporations that do business in California such that they are subject to taxation in California on their apportioned income. What tax years are involved? The penalty will apply to tax years beginning on or after January 1, 2003, for which the statute of limitations on assessments is open on December 22, 2008. Under California’s four year statute, tax years 2004‐2008 were open for all taxpayers as of December 22, 2008. The 2003 tax year will be open on December 22, 2008 for calendar year‐end corporations that have extended their statute of limitations, as well as many fiscal year‐end corporations whose tax returns were still open for assessment on December 22, 2008. What is an “understatement of tax”? An understatement of tax is the amount of unpaid tax resulting from an adjustment by the government, or self‐
assessment by the Taxpayer on an amended return. Fortunately, there is a safe‐harbor for taxpayers who promptly file amended returns. What is a “large corporate understatement of tax”? For each tax year beginning on or after January 1, 2003, a corporate taxpayer that has an understatement of tax in excess of $1 million is subject to the penalty. Thus, if corporate taxpayers report as a combined group, the $1 million threshold is computed by aggregating the understatements of each of the members. What if the corporation is currently under federal examination? The penalty will apply any time there is an increase in the total tax liability for the tax year and the understatement of tax exceeds $1 million. Changes include federal and state adjustments, regardless of when the examination was started or completed. How will the penalty be computed? The penalty is 20 percent of the entire understatement amount when the understatement exceeds $1 million. For a combined group, the penalty for each taxpayer is determined by applying the 20% penalty to each taxpayer’s understatement. When will the Franchise Tax Board assess the penalty? The penalty will be assessed when an additional tax liability is formally assessed. For audit adjustments, this is when the additional liability on a Notice of Proposed Assessment becomes final. For self‐assessed amounts, such as amended returns, the penalty will be assessed when the additional tax is assessed on the records of the Franchise Tax Board. The penalty will be included on the Notice of Tax Due with the total tax, interest, and any other applicable penalty or fee. The penalty will begin to accrue interest from the date of assessment. CLIENT ALERT February 2009 What can corporations do to avoid or reduce the risk of the penalty? Corporations can file amended returns for tax years 2003‐2007 and pay the tax shown on the amended returns. The amended returns must be filed, and the tax paid, on or before May 31, 2009. This will increase the self‐
assessed tax base against which the understatement is measured, reducing the likelihood of incurring the penalty for the amended taxable years. Before returns are amended, there are several factors to consider. First, corporations will need to evaluate their tax positions as to positions that are reasonable but not certain. The strengths of the positions and the hazards of litigation need to be analyzed. If there is significant uncertainty as to a position or litigation hazards, it may be appropriate to amend the tax returns. Second, any information provided on the amended returns will be provided to the Internal Revenue Service. The Franchise Tax Board has confirmed that under its long‐standing information sharing agreement with the Service any amended return will be shared. Third, a claim for refund can be made for an amount paid with an amended return. The claim for refund will be subject to the normal statute of limitations for filing refund claims. A payment made with an amended return is not a deposit. The claim for refund must be filed within the later of four years of the due date for the original return, as timely filed, or one year from the date of overpayment. No downward adjustment will be made in the penalty base as the result of any amended returns filed after the extended due date for the original return. Corporations that file amended returns to protect against the penalty will need to be certain that they consider filing timely refund claims to protect positions that have substantial support and should not be conceded. Given that the opportunity to amend 2003‐2007 California corporate returns to avoid the 20 percent large corporate underpayment penalty will end on May 31, 2009, it is imperative that corporations consult with competent tax counsel to evaluate whether their tax positions may require amendment. This evaluation requires a review of both the substantive tax law and facts as to the positions, as well as analysis of the litigation hazards and strategies related to the positions. If you have any questions regarding the application of the new large corporate underpayment penalty, including the evaluation of possible amended returns, please call us as soon as possible. Stuart A. Simon is Senior Counsel in the Los Angeles office of Buchalter Nemer. He can be reached at 213.891.5019 or [email protected] Philip J. Wolman is a Shareholder in the Los Angeles office of Buchalter Nemer. He can be reached at 213.891.5390 or [email protected] L. Richard Walton is Of Counsel in the Los Angeles office of Buchalter Nemer. He can be reached at 213.891.5290 or [email protected] Buchalter Nemer is a full‐service business law firm representing national and global clients in eight primary areas of practice: Bank and Finance, Business Practices, Insolvency and Financial Solutions, Litigation, Labor and Employment, Intellectual Property, Real Estate and Tax and Estate Planning. The firm has offices in Los Angeles, Orange County, San Francisco and Scottsdale. For more information, visit www.buchalter.com This article is published as a service to our clients and friends. The material contained here is provided for informational purposes only and is not intended to constitute advertising, solicitation or legal advice.