Tax Crusader Wins 3-Year Battle to Help State’s Nonfilers

Beginning next year, Californians will no longer be hammered financially simply for forgetting to file their state tax returns on time--thanks to crusader Marvin Klotz.

Klotz, a tax preparer, has for three years been waging war against the state Franchise Tax Board’s penalty for failing to file an income tax return.

The penalty--25% of the entire year’s state tax bill, not just the amount still owed--sometimes turned potential refunds into big tax debts. Klotz, an enrolled agent in Venice Beach, had one client who was penalized more than $1,400, even though she would not have owed a dime in taxes had she filed her return on time.

California’s penalty was the harshest of any state, tougher even than the Internal Revenue Service’s policy. The IRS has no penalty for failing to file if a taxpayer owes no tax or is owed a refund. Instead, the federal agency will keep the refund amount permanently if the taxpayer does not file for it within three years.

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The state’s penalty irritated many taxpayers and preparers, but the professorial Klotz decided to do something about it. He lobbied the FTB with letters, articles and personal appearances before the agency’s governing three-member board, asking them to suspend or change the penalty.

The board finally agreed last year that the punishment was sometimes unfair, but said the agency was bound by state law to charge it. Klotz disagreed, pointing out the law said the agency “may” impose the penalty, not that it must.

The FTB asked the Legislature to change the law, to no avail. So at its meeting last month, the board decided to quietly revise its policy.

Starting Jan. 1, 2001, the 25% penalty will no longer be imposed on first-time nonfilers. A first-timer is defined as anyone who hasn’t received a failure-to-file notice from the state in the previous four years.

Once the state identifies someone who hasn’t filed, it will send the potential taxpayer a request to submit a return. If that request is ignored, the state will cobble together a return based on the information it has on file--W-2s filed by employers, interest and dividend payments filed by financial companies, mortgage loans filed by lenders--and send out a bill.

People who qualify for relief from the failure-to-file penalty will still face a 25% failure-to-pay penalty on any amounts they owe. That penalty is pretty standard in the tax world and matches what the IRS imposes.

The state expects about 180,000 taxpayers to save a total $66 million over the next four years, said FTB spokeswoman Denise Azimi.

The decision was a major policy change that was long overdue, said Lynn Freer, president of Spidell Publishing Inc., an Anaheim tax research firm that thanked Klotz on its Web site when announcing the policy change last week.

“His tenacity and his refusal to take ‘no’ for an answer” were critical in getting the FTB to act, Freer said. She believes the way was also paved by some sympathetic FTB staffers and by budget surpluses, which may make the agency somewhat less focused on wringing every possible dime from taxpayers. Change that costs the state money is “easier . . . when the state has a lot of money,” Freer said.

The penalty made some sense when it first was imposed in 1972. Back then, tax agencies had fewer ways to sniff out people who weren’t filing state returns. The state Legislature felt the big stick of a heavy penalty would induce more potential scofflaws to file.

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Today, however, the FTB has gotten amazingly efficient at sorting through employment, mortgage and financial records to find people who should be filing but aren’t. Last year, the agency invested $30 million in a system to isolate and identify nonfilers. The penalty as originally concocted had outlived its usefulness, and the FTB’s action shows the agency has become a bit more compassionate in its approach.

Buoyed by his success, Klotz has targeted another pet peeve: a state tax law that penalizes investors in some government bond mutual funds.

California taxpayers who buy Treasury bonds are allowed to exclude the interest income from their California returns. But people who invest in Treasuries through mutual funds are technically not allowed to exclude the interest unless 50% or more of the fund’s assets are tax-exempt bonds.

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This may be one of the more widely ignored tax laws in existence. People who prepare their own taxes often don’t know about the law, and it’s an open secret among tax preparers that the law is unlikely to be enforced. Freer said Spidell advises preparers to simply exclude the income from mutual funds that invest in Treasuries, regardless of whether the assets meet the 50% requirement, since the FTB is unlikely to question the exclusion.

Still, the law is on the books, and Klotz believes the rule violates federal law that prohibits state taxation of Treasuries and other federal debt obligations.

He’s starting his campaign with an article for Spidell’s tax newsletter. An appearance at the FTB can’t be far behind.

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Liz Pulliam Weston is a personal finance writer for The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at liz.pulliam@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times’ Web site at https://www.latimes.com/moneytalk.