On January 16, 2009, California State Controller John Chiang announced that California is facing a cash shortage issue that may result in a delay of more than $3.7 billion in outgoing payments, including payments of tax refunds. In a press conference, the Controller stated that the delays may take place beginning February 1, unless the California State Legislature can come up with a solution to California’s budget deficit.1 The San Francisco Chronicle estimated that up to $2 billion in income tax refunds could be delayed.2
While a delay in refund payments is problematic, the impact may be magnified as a result of California’s new 20% penalty. See Sutherland’s Legal Alert entitled “California Enacts a New Round of Onerous Penalties,” dated September 29, 2008, and Legal Alert entitled “California FTB Comments on New 20% Underreporting Penalty,” dated December 9, 2008. Effective October 1, 2008, California imposes a 20% penalty on corporations that underreport their tax liability by more than $1 million.
The penalty is always imposed, unless the underpayment arises from a change in law or reliance by the taxpayer on a Chief Counsel Ruling. The penalty is effective for tax years beginning January 1, 2003. To avoid the penalty, corporate taxpayers may file an amended return by May 31, 2009, stating the correct tax liability.
Sutherland Observation: As noted above, California taxpayers should evaluate whether to amend returns and pay additional tax. Making these decisions will depend on a number of factors, including:
- The strength of the underlying position, and the taxpayer’s willingness to litigate the underlying position;
- The likelihood that the amended return will draw audit attention to the underlying position (regardless of the strength of the position);
- The financial statement consequences of risking the imposition of the penalty (e.g., whether non-payment results in an increase in a liability or whether payment results in an increase in an asset and whether the liability will be in excess of any FIN 48 reserve);
- The financial statement consequences of not paying the additional tax or representing that it will be paid (e.g., accrual of penalty);
- The federal income tax deductibility (or non-deductibility) of the penalty (including effect on effective tax rate due to possible non-deductibility);
- The cash flow implications of amending a return (or risking the imposition of the penalty), taking into account California’s financial position;
- The cash flow implications from the inability to carryforward overpayments to a subsequent year to offset tax due;
- The statute of limitations issues associated with amending a return;
- The likelihood of a federal tax assessment (or refund) for post-2002 tax years;
- The likelihood that interest may accrue on the penalty; and
- Tax attributes, including Net Operating Loss Carry Forwards and Credits, and California restrictions on utilization of tax attributes.