California has long been a leader when it comes to imposing harsh tax penalties. Although the most recent penalty to gain notoriety was the State’s onerous penalty for underpayment of large corporate income taxes, California’s love affair with penalties is not restricted to the realm of income taxation. Indeed, a recent series of cases addressing the State’s property tax penalties illustrates that delinquent taxpayers can face very steep penalties if they fail to establish the proper grounds for abatement when they find themselves in the untenable position of having missed a tax payment deadline. In addition, this line of cases may be an indication of the tough stance courts may take when the counties start imposing the recently enacted penalty for failure to file timely change in control and/or change in ownership statements. This article discusses these penalties and what taxpayers can do in order to avoid or abate them.
Late Payment Penalties
Perhaps the most common penalty incurred by property taxpayers is the automatic 10 percent penalty imposed for late payments. In the past year, the courts have dealt with at least five cases where delinquent taxpayers sought relief from this penalty. Unfortunately for the taxpayers, the courts upheld the penalty in all five cases. As one court put it, when taxpayers seek abatement of the late payment penalty, “oops, forgot to make a payment, is categorically not going to meet the test [for cancellation of the penalty].” AvalonBay Communities, Inc. v. County of Los Angeles, 2011 WL 2905602, 4 (Cal. App. 2nd Dist., July 21, 2011).
In addition, regardless of how disproportionate or unfair the penalty may seem, the courts have steadfastly upheld imposition of the penalty when the taxpayer fails to establish the necessary grounds for abatement. For example, in AvalonBay, the court upheld a $215,000 penalty, even though the payment deadline was missed by only two days due to a mistake by the company’s employees. Although the two day mistake resulted in a $215,000 penalty, the court upheld its imposition because the failure to make a timely payment was due to circumstances within the taxpayer’s control. Similarity, in First American Comm. Real Estate Svcs., Inc. v. County of San Diego, 196 Cal. App. 4th 218 (2011), the court upheld a roughly $600,000 penalty, even though the deadline was missed by just one day due to an error in the format of an internal spreadsheet used to make its wire transfers. Although the First American court acknowledged that the situation presented a sympathetic case for cancelation of the penalty because the taxpayer missed the payment due to an inadvertent error and corrected the problem as soon as possible after the error was discovered, the penalty was sustained because the taxpayer failed to present any grounds meeting the statutory requirements for abatement. Indeed, the court pointed to the taxpayer’s initial actions and correspondences as proof that the statutory requirements for abatement were not met.
So, what are taxpayers to do when they find themselves in the undesirable position of having missed a property tax payment? Well, if the amount at issue is substantial, the first thing taxpayers should do is obtain legal counsel familiar with the nuances associated with property tax scheme. The law provides a means for abatement of delinquency penalties when the failure to pay timely is due to reasonable cause, or when there was an inadvertent error in the amount of payment. In addition, we have had tremendous success helping clients abate late payment penalties due to procedural errors by the tax collector. Thus, if a taxpayer finds itself in a situation where it may be facing a late payment penalty, it should immediately engage competent counsel to help it present the circumstances – from the onset – in a manner that establishes the factual predicates described in the statutes that will lead to cancellation of the penalty, as failure to do so will lead to imposition of the penalty.
Change in Control Reporting Penalties
As we previously reported, in 2010, California added a significant penalty for failing to submit timely changes in control statements. In general, when a corporation, partnership, limited liability company, or other legal entity obtains control through direct or indirect ownership or control of more than 50 percent of the voting stock of any corporation that is not a member of the same affiliated group, or obtains a majority interest in capital and profits in a partnership or limited liability company, or obtains a majority interest in any other legal entity, including any purchase or transfer of 50 percent or less of the ownership interest whereby control or a majority ownership interest is obtained, the purchase or transfer is a change in ownership of property and is subject to reassessment. In addition, when shares or other ownership interests representing cumulatively more than 50 percent of the total interests in an entity are transferred by any of the original co-owners in one or more transactions, a change in ownership occurs, and property that was previously excluded from reassessment under section 62(a)(2) of the Revenue and Taxation Code (excluding from the definition of “change in ownership” transfers between individuals and legal entities, or between legal entities, that results solely in a change in the method of holding title to real property and in which proportional ownership interests of the transferors and transferees remain the same after the transfer is not a change in ownership requiring reassessment) must be reassessed. Under the new law, failure to file a change in control statement within 45 days from the date of the entity’s change in control, or the date of a written request by the State Board of Equalization (“BOE”), will result in a penalty of 10 percent of the taxes applicable to the new base year value reflecting the change in control of the real property owned by the legal entity (or 10 percent of the current year’s taxes on that property if no change in control occurred).
Although most entities are well advised of their reporting obligations when acquiring other entities or when performing some form of corporate reorganization, in the context of a family trust, a reassessable change in control often is not noticed until well after the effective date. For example, when a trust with multiple discretionary future beneficiaries holds a legal entity that owns real property, and becomes irrevocable upon the trustor’s death, a dilemma may be encountered when the trust’s assets (e.g., the legal entity that owns real property) are not distributed until more than 45 days after the trust become irrevocable. Under California law, the change in control relates back to the date of the trustor’s death, and there may be no way for the beneficiaries to know of the change in control of the legal entity because the allocation of interests to each beneficiary is not finally determined until the distribution occurs. In this situation, if a change in control has occurred, the 10 percent penalty would apply even though there was no way to know within the 45 days that there was an obligation to file.
Although a county’s board of supervisors may order this penalty abated if the assessee establishes that its failure to file a timely change in control statement was due to reasonable cause and not due to willful neglect, the BOE, nevertheless, recommends filing a change in control statement, in such situations, with as much information as the parties have available to them within 45 days of the date of the trustor’s death – even though the ultimate distribution of the legal entity’s interests is uncertain. Moreover, because language in the statute for abatement of the failure to report penalty is similar to that examined by the courts for abatement of the late payment penalties, it is quite possible that the courts will take a similarly hard stance against taxpayers seeking abatement of this penalty as well. Consequently, in order to avoid the steep penalty associated with failing to timely report a change in control (even if ultimately deemed to constitute no reassessable event), practitioners are advised to scrutinize their client’s acquisitions, reorganizations, and even trust administration practices, to assure that the change in control reporting requirements are strictly adhered to.
Change in Ownership Reporting Penalties
Finally, similar to the change in control reporting penalty, property taxpayers are occasionally ensnared by California’s penalty for failing to timely report a change in ownership to the local assessor. Unlike the change in control statement, discussed above, which is filed with the BOE, a change in ownership statement is filed with the local assessor. If a person or legal entity fails to file this statement within 45 days of a written request by the assessor, then a penalty of either $100, or 10 percent of the taxes applicable to the new base year value reflecting the change in ownership of the real property, whichever is greater, but not to exceed $2,500 if the failure to file was not willful, shall be added to the assessment made on the roll.
As with the change in control reporting penalty, the change in ownership reporting penalty may be abated by the board of supervisors upon a showing that the failure to timely file was due to reasonable cause and not willful neglect, however, most taxpayers can easily avoid this penalty simply by responding to the assessor’s written request within the 45-day period.
As discussed above, California’s property tax penalties can be very harsh. The courts have strictly enforced the 10 percent late payment penalty, so taxpayers should engage counsel immediately if they miss a payment because it is critical that the taxpayer frame its position in a manner that meets one of the tests that will eventually lead to abatement. With regard to the penalty for an untimely change in control statement, there is no reason to believe that the courts will be any more lenient when enforcing this penalty than they are enforcing the late payment penalty. Unfortunately, because the penalty associated with a missed (or delinquent) change in control statement will be based on the legal entity’s entire state-wide real property portfolio, a failure to timely report can result in a truly massive penalty. Consequently, taxpayers are advised to engage counsel well versed in California’s labyrinth of property tax laws when they are contemplating the acquisition of a legal entity, a corporate reorganization, or even the administration of a trust holding real property.