Business Files Its Objections to State’s Hunt for Back Taxes

Business groups are pushing to scale back a new state law that imposes stiff penalties on taxpayers who do not pay all they owe.

The law parallels an aggressive move by tax officials to collect back taxes from tens of thousands of delinquent California residents and businesses. Under its terms, tougher penalties than any the state has ever imposed will apply to tax dodgers who do not come clean during a two-month amnesty that ends March 31.

Supporters of the program say scaling it back would cost the state too much. The face-off highlights a deep split in Sacramento over how aggressively the state should go after suspected tax cheats.

Corporations and anti-tax groups are promoting emergency legislation to narrow the scope of the law and soften -- if not eliminate -- some of the fines. The administration of Gov. Arnold Schwarzenegger is in discussions with the business groups about backing the legislation or asking tax officials to make some businesses exempt from penalties.

In a recent memo to state officials, the business-backed California Taxpayers Assn. said it sees dangers in the new law. “Taxpayers of all shapes and sizes are going to be caught completely off guard and face potentially severe financial hardship,” the group wrote.

Some Democrats, including the new law’s author, say easing the penalties could cost the state as much as half of the $280 million that tax officials estimate the amnesty could generate. It’s money Democrats say is badly needed as California continues to struggle with a multibillion-dollar budget shortfall.

Democrats hope to capture more of the estimated $6.5 billion in revenue projected to be lost each year from tax evasion. They see it as a way to shield healthcare, social services and schools from cuts without new taxes.

Among those whom Democrats are targeting: the estimated 800,000 Californians who earned income and are legally required to file returns but don’t bother to do so.

“We’re simply collecting what we are owed,” says Assemblywoman Judy Chu (D-Monterey Park), who wrote the amnesty law. She said the state needs tough penalties to encourage taxpayers to step forward.

“A tax amnesty doesn’t work unless you have both a carrot and a stick,” she said, adding that the same approach has been used in Illinois and New York without crippling effects on businesses.

Industry groups say their main concern is that the new fines could be imposed unfairly on taxpayers who have legitimate reasons not to participate in the amnesty. They say companies involved in complicated tax disputes with state and federal agencies, for example, may not even know how much -- if any -- they owe in back taxes until long after the amnesty is over.

But the companies could still get hit with a penalty equal to 50% of the interest due on the unpaid taxes. That could amount to millions of dollars for some.

State Controller Steve Westly, a co-sponsor of the amnesty law, said such concerns are valid. “We don’t want to catch anybody in the net that shouldn’t be there,” he said. “Some people have proactively come forward and said, ‘We think we have an issue here.’ We don’t want time to run out on them.”

Westly’s stance frustrates fellow Democrats. They say the law already allows taxpayers to avoid stiff penalties by paying disputed amounts upfront, and receiving refunds later if they win. Supporters of the program suggest that anyone who has been honest with the tax authorities will not be hurt.

“These guys pay their accountants big bucks to manipulate the system and save them money,” said Lenny Goldberg of the California Tax Reform Assn. “They’re concerned they’re going to be hit with big penalties if they keep playing their games.”

Tax officials estimate the program would raise $280 million in new revenue by enticing people and businesses to come clean if they failed to file returns, underreported their income or exaggerated deductions. They project that the amnesty will hasten collection of another $300 million in taxes that would normally be paid in future years.

It’s a different group of Californians from those the state went after last year, with an amnesty for wealthy individuals and corporations who used complex tax shelters. That effort astounded tax officials by generating $1.4 billion for the state. They had estimated it would bring in $90 million.

Users of the tax shelters had been assured by accountants and attorneys that they were legal. In many cases, the state ruled that they were not.

This year’s amnesty targets taxpayers who have been reporting less income and fewer assets than they have -- or not reporting them at all. The last time the state offered such an amnesty was in December 1984. That program brought in $197 million.

To get the money flowing this year, state tax authorities have launched a publicity campaign. Pamphlets and public service announcements alert scofflaws that they can avoid criminal sanctions and fines if they settle up by the end of next month. “It Was Probably Just An Oversight” is the title of one brochure mailed to 900,000 businesses.

As the advertising blitz intensifies, so does the counter-effort by businesses. Groups involved include the American Electronics Assn., the California Realtors Assn., the California Manufacturers & Technology Assn., the Silicon Valley Manufacturing Group and professional tax lawyers and preparers. Apple Computer Inc., Cisco Systems Inc., General Electric Capital Corp., Intel Corp. and Citigroup Inc. also are involved.

“We need to narrow the width of the stick so that it hits the bad actors” alone, said Christopher Micheli, a Sacramento lobbyist taking the lead for businesses.

Citigroup, in a written statement, said, “Our desire is to better understand the requirements to ensure that the rules are clear and work as intended, and that penalties aren’t imposed in situations that might not have been intended.”

The amnesty program is one of many tax-related initiatives Democrats are working on that may meet resistance from business groups and Republicans. Johan Klehs (D-San Leandro), chairman of the Assembly Revenue and Taxation Committee, said he is producing a list of the industries in which tax evasion is highest and will concentrate on them.

Some of the ideas Democrats are mulling -- such as going after more of the $292 million in tax money that officials say is lost on the sale of cigarettes on the black market -- will be easier to sell than others.

Klehs, for example, would like the state to work harder to force businesses to pay sales taxes on goods they purchase over the Internet. The law requires such payments to be made now, but few companies bother -- much the same way consumers don’t pay the taxes they are technically supposed to when they make online purchases.

That proposal could generate more than $800 million for the state, Klehs said. But it’s uncharted territory, and would probably be seen as a tax increase.

At a hearing in El Monte last month, Chu heard from experts on other ways to boost tax collection. Panelists included an IRS official, the head of California’s Franchise Tax Board -- the state’s version of the IRS -- and a professor of tax law at Stanford University.

They all reached the same conclusion: There isn’t much low-hanging fruit left for the state to pluck. Closing the tax gap further at this point, they said, would have to involve more politically difficult measures.

Joseph Bankman, the Stanford professor, said much tax evasion is done by small cash businesses: mom-and-pop stores, restaurants, baby-sitters. Such businesses account for more than a third of the unpaid taxes in California, according to state reports. In restaurants, for example, state tax officials estimate that most workers report less on their returns than they earned.

Bankman said there are more things the state can do. One of them is to send more auditors after the bigger, more complex cases. Currently, the state demands that every dollar spent on auditors uncover at least $5 in unpaid taxes.

If more auditors were hired, Bankman said, the ratio for each auditor would drop, but more money would come into the state overall.

“We want to get the revenue, “ he said, “but not put Uncle Ned in jail.”