CA Contacting Income Earners Who Did Not File in 2009

(It's been a long time since I've been able to check in here so I hope my first contribution is very helpful to make up for my absence.)

The FTB is casting a wide net. Notices are going to people who held an interest in a publically traded partnership.

Here is what I sent to some colleagues back in September, 2010:

Clients that own partnerships, including Master Limited Partnerships, are receiving notices from the state of California for the 2008 tax year. So far, we have heard from those who had an ownership interest in AllianceBernstein Holding LP but there may be more. These MLPs are traded in a similar manner to stocks. Many investors and brokers are unaware of the "special" tax treatment required for them.

I spoke to two people at the California Franchise Tax Board (FTB). The first one (Jake at station # 1099) addressed the issue for individuals. He said that the people who receive these notices should file a California tax return or at the very least respond to the notice.

However, my interpretation of the California law is that the tax preparer should do a mock up of a tax return to see if there is a tax liability. If there isn't, a letter stating the amount of income that is sourced from California isn't enough to generate a tax liability.

On the corporate tax side, I spoke to Diana at station # 1232. She said that anybody with the notice in their hands could speak to the California Franchise Tax Board at (800) 852-5711 on behalf of the taxpayer. California has a franchise tax for corporations. The minimum tax is $800 and the FTB is assuming that the corporation has nexus in the state so it is requesting payment of the $800 plus about $2,500 of interest and penalties in one instance.

Diana referred me to a private letter called "Application and Interpretation of Public Law 86-272" which addresses the corporate issue of nexus for corporations that receive the notice about an interest in a LP. We can point FAs to this notice, but it is up to the client's tax advisor to decide if the ownership qualifies for treatment as a de minimis activity.

snip

It happens every year -- nothing new. Several years ago my former son- in-law, who had moved to Nevada (really!) a year earlier, received a filing enforcement Notice of Proposed Assessment for several thousand dollars in tax, interest and penalties. (Earlier notices evidently had gone to an old address; the first he knew about this was the NPA.) He had been employed by a pest control company in California in the past, and in that job had to have a license issued by the Department of Consumer Affairs. The notice was based on the FTB's estimate of the average earnings of persons holding such licenses. We laughed hysterically. He would have been THRILLED if he had ever earned that much income!

A letter to the FTB explaining the circumstances resulted in withdrawal of the notice, but we still wonder how they came up with those numbers.

Katie in San Diego

It's real simple. Unlike criminal charges, where the gummint has to prove beyond a reasonable doubt that you did it, or civil cases, where the plaintiff has to prove negligence or a contract violation to a preponderance of the evidence, the Tax Man can simply say we owe money, and then we have to prove to a preponderance of the evidence that we don't (and the Tax Man decides on the quality of our evidence).

That's how they came up with those numbers.

You're dealing with two separate issues. The issue of preponderance of the "evidence" is generally irrelevant to this issue, because the facts are seldom in dispute. What is in dispute is the law applicable to those facts. And you're right, once the taxing authority determines a tax is due, the burden of persuasion on the law is on the taxpayer.

But how the FTB comes up with its numbers is entirely a different matter. In my experience, if you don't file a return, they figure out what they think your gross income is, and then impose a tax as if you were single, and without any deductions at all. I don't know if they actually think they will ever collect the highly inflated amounts this comes up with. But it can certainly shock the taxpayer into filing a return.

Well, I'm sure my old friends at the FTB use some real data sources to arrive at the estimated annual income of an individual holding a particular kind of state license. Surely they wouldn't just pull numbers out of the air, LOL. But they must include in the analysis the net incomes of the owners of such businesses -- Truly Nolen and Corky and Mr. Orkin themselves!

Katie in San Diego