Critics Assail Way State Penalizes Tax Non-Filers

California’s penalty for failing to file a tax return is the stiffest of any state, and harsher than that levied by the Internal Revenue Service. Even the state’s tax agency agrees that the 25% penalty is sometimes too stringent, especially when levied against taxpayers who are owed a refund.

But efforts to soften the penalty have run aground in the Legislature, angering taxpayer advocates who protest the fine is onerous and unfair.

What riles critics is that California alone assesses its penalty based on the year’s entire tax bill, not just the amount still owed on the filing due date. The penalty can turn a potential refund or a small tax bill into a debt of hundreds or even thousands of dollars.

“No other state bases a penalty on a percentage of a tax that has already been paid,” said Marvin Klotz, a Venice enrolled agent who has made fighting the penalty a personal crusade. “I have a client who was penalized over $1,400 despite the fact that she owed no California tax.”

The IRS, by contrast, has no penalty per se for failing to file if a taxpayer is owed a refund. Rather, the federal agency will keep the refund amount permanently if the taxpayer does not file for it within three years. If the taxpayer owes tax and hasn’t filed, the IRS assesses a maximum penalty of 25% based on the amount that is unpaid--not the total tax bill.

A bill that would change the state’s penalty is currently stuck in the California Legislature, its future uncertain. The legislation, sponsored by Assemblymen Tony Strickland (R-Thousand Oaks) and Howard Kaloogian (R-Encinitas) and supported by the FTB, would authorize the FTB to assess the penalty only after deducting withheld taxes and any allowable credits, in effect ending the fine for anyone owed a refund and lessening the blow for those who have paid at least part of their bill.

Legislative analysts estimate that changing the law this way would cost California about $15 million a year. Klotz believes the cost alone might prevent the bill’s passage.

“The legislature, as you might imagine, is hypersensitive to any change that might reduce revenue,” Klotz said. “Fairness issues are often disregarded when revenue is in play.”

But the penalty is not an issue that generates much sympathy among lawmakers--or taxpayers who file on time--especially since the revenue lost from making a change would have to be made up somewhere else, said Lynn Freer, publisher at Spidell Inc., a tax information service in Anaheim.

“I’m going to have a tax increase to pay for someone who doesn’t file?” Freer asked rhetorically. “I can’t get behind that.”

The FTB once felt the 25% penalty (which dates to 1972) and strict enforcement of it were necessary to encourage people to file, FTB Executive Officer Gerald H. Goldberg said. Today, however, technology and information-sharing with other agencies and private businesses make it easier to catch non-filers, Goldberg said.

The FTB compares the returns it gets against tax withholding data provided by the state Employment Development Department and with mortgage interest statements provided by lenders. If the FTB finds a non-filer, it can then fire off a notice requesting that the taxpayer file a California return.

The FTB plans to improve its detective work in the future. The agency recently signed a $29-million contract with IBM to develop a program to better identify non-filers. The agency expects the system to be on line by December 2001, and that it will help to raise an additional $36 million annually.

Even though the FTB no longer believes its penalty procedures are completely justified, the law is still on the books and must be enforced, Goldberg said.

Nonetheless, the FTB has already modified its approach somewhat after pressure from its three-member governing board, said Dean Andal, vice chairman of the state Board of Equalization and former FTB member.

Following a kind of “don’t ask, don’t tell” approach, the agency no longer sends notices demanding the penalty to those who may be owed a refund, based on information gleaned from the EDD.

However, the information the FTB gets on withholding is not always accurate, so the agency may indeed dun someone who owes no tax. And once the FTB has sent a penalty notice, it is required to follow through and base the 25% penalty on the total tax bill, Spidell’s Freer said.

Greg McKay, 51, is one taxpayer who found out the hard way several years ago about the state’s non-filing penalty. He ended up paying $150 to the state, instead of getting an expected $100 refund, after he forgot to file a state return while moving from Glendale to Downey.

“I was furious and thinking about sending them a nasty letter, but I held my tongue,” said McKay, a medical transcriber. “I didn’t want to develop some sort of reputation with them.”

Another of Klotz’s clients was late to file and pay the last $371 of his 1996 tax bill. The FTB based his penalty on its estimate of his total tax bill--$1,297--and added interest and a $71 “enforcement cost recovery fee” to boot.

Klotz was able to get the bill reduced after proving that the FTB had misfigured the client’s withholding. But the client still wound up paying an extra $528, instead of the $100 or so he would have owed had the penalty been based only on the tax owed, Klotz said.

Times staff writer Liz Pulliam can be reached at liz.pulliam@latimes.com.

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If You Get a Letter From the FTB

The Franchise Tax Board sends out hundreds of thousands of notices to taxpayers every year, most often seeking further information or payment of additional taxes or penalties. Here are some tips that can help keep a simple notice from turning into a big problem:

1. Don’t ignore it. Failure to respond can subject you to penalties, interest or additional taxes. Act even if you think the notice is obviously in error. Contact the FTB at (800) 852-5711.

2. Review before you pay. A “Notice of Proposed Assessment” is not a tax bill. It’s an estimate of what the FTB thinks you owe based on its data or that of other agencies or private companies. That data can be wrong. Sometimes, for example, the FTB may base its estimate of a taxpayer’s income on the average for those in that person’s line of work.

3. If you can’t resolve the matter yourself, get help. A tax preparer familiar with the FTB can help you negotiate the maze of laws and rules that can affect the outcome of your case.

4. If all else fails, contact the state taxpayer advocate. The advocate helps taxpayers who haven’t been able to solve disputes with the FTB through normal channels. Write to the Taxpayer Advocate Bureau, P.O. Box 1468, Sacramento, CA 95812; or send a fax to (916) 845-6614.