Introduction
When we have a client who is faced with a state tax issue versus a federal tax issue, we usually advice the client to pay down the state liability first and or deal with the state tax issue first because often times even though the liabilities are smaller or the amount in controversy is less, there is more at stake with the state tax issue in terms of resources consumed both in time, energy and money.
California state tax issues are confusing because they rules are not quite the same as the federal system and it is not a user friendly as dealing with the IRS (funny as that sounds.) California is one of the most aggressive states in terms of both examinations (audits) and collections and taxpayers often get frustrated by the process. Additionally, there is a general lack of information available to your average taxpayer on how to resolve California tax issues.
Why You Should Think About Hiring a California Tax Attorney
First, let us get this out of the way. We are often surprised at the reaction that we get from the people we meet outside of our tax world who would never of or had not considered hiring a tax attorney to deal with their California tax problem. When probing this, we have found two general responses: 1) Why should I not handle my California tax problem myself or internally within my company? 2) Why shouldn’t my CPA be the person to handle this issue on my behalf?
Why you should not handle your California tax problem on your own?
- Time – California’s administrative tax process is not easy. As mentioned above, the state is aggressive, the system is designed to facilitate tax assessments and collections, there is not a whole lot of information out there to help, and the information out there is not the greatest. Taking it from people who have built a law practice on dealing with California tax issues, the frustration level is often very high in dealing with the California. Whether or not you are “right” on the law, the procedural rigmarole of the process is exhausting and time consuming. And your time is valuable. Hiring us is like taking a hot butter knife through all the red tape, hassle, and headache associated with dealing with the California.
- Money – Wait, lawyers cost money. It would seem that logic dictates that you are saving money by not hiring an experienced California tax attorney to deal with your California state tax issue. In reality, that statement often times could not be further from the truth.
One of the driving principles of our firm is value. We actively screen matters to make sure that the ones we accept will provide value for our clients. This means that whatever your fees are with us will generate a return on investment in terms of tax that we save you or pain that we take away. And we have great track record in that department. The problem with handling your California tax problem internally is that you do not know what you do not know. Particularly in audits, there are lots of little things you can do to substantially reduce the scope of the audit, to drive the bill down to zero, and to even get money back from California.
You do not know what you do not know extends to the amount of pain involved with the process as well. Many prospective clients oversimplify their issue or simply make wrong assumptions about what dealing with California will entail. It is totally false to assume that because you have not done anything wrong that does not mean you do not have anything to worry about.
- Reputation – Do you have a California collections issue? Do you have an audit that may turn into a collections issue? California a lot of weapons in its arsenal and one of the most effective ones is public shame. First, do you know that both the Franchise Tax Board and the California Department of Tax and Fee Administration keep public lists of their most delinquent taxpayers?
https://www.ftb.ca.gov/about-ftb/newsroom/tax-news/may-2018/top-500-delinquents-taxpayers-list.html
https://www.cdtfa.ca.gov/taxes-and-fees/top500.htm
Second, once you move into collections, California can be very disruptive. They file liens that are a matter of public record. They contact employers, vendors, customers, banks, and even will send local agents out to interview neighbors and employees/co-workers. Yes, there are privacy laws, but they only prevent the government from disclosing the exact nature of the problem and those people above are left to their own inferences about why they are being contacted by the government for a matter on your behalf. In certain cases, California can suspend your professional licenses and even your drivers license.
Our point is this: if you are reading this and have a tax issue, we can give you all the general information in the world on this page about California tax issues, but what you really need is specific information about your situation. There is nothing wrong with picking up the phone and consulting with someone who is both knowledgeable and experienced in dealing with these types of California tax problems. Our clients are doctors, lawyers, entrepreneurs, corporate executives, professional athletes, and a host of other widely successful people. Your success and your personal standing is not marred by the fact that you have a tax issue and even less that you seek counsel of someone who can truly help you and/or guide you toward the best outcome possible.
Why Your CPA may not be the best person to handle your California tax issue?
Many people equate accountants to taxes. If this were Family Feud, we guess that answer would be at the top of the board. And why wouldn’t it? After all, your CPA does your taxes every year, if you got a notice from the State of California, why would they not be your first reach out?
Speaking generally about CPAs (whom we are very fond of because they are a big help to our practice), accountants go to school to learn tax compliance. In a very general sense, it is fill the form out, make sure it is done correctly, and make sure the client does not get in trouble because of it. That is what a CPA is in essence. They are certified to prepare certain types of filings, so that the public and the government has trust in what is prepared. They are not aggressive people by nature, they are not trained in advocacy, and, honestly, most prefer it that way.
Tax attorneys on the other hand share the same knowledge of the tax law that a CPA has (arguably CPAs understand certain issues better than we do sometimes), but tax attorneys (specifically tax controversy attorneys) are trained in 1) advocacy, 2) tax procedure. When your CPA sits down with an auditor, unless they have lots of experience in audits or have otherwise been trained, they can certainly hold their own in a conversation about the law. However, the law is not what wins in an audit. When we sit down with an auditor, the following things are running through our head at any given time (in no order):
- The tax law that is involved.
- Who the auditor is? Have we worked with this person before? Do we know their manager? Do we know other auditors in their group? What relationships can we leverage if this person gets out of line?
- The presentation of the materials we have been given. How will these look not only to the auditor, but to their manager, the territory manager, the appeals officers, the appeals team manager, district or area counsel, and/or a tax court/administrative law judge. Note: when we deal with tax issues, we are constantly thinking several levels ahead so we are better prepared to win at those levels and get what we need to on the record.
- The procedural issues involved. How can we use the state of California’s procedure to our advantage? We know their playbook (it’s public record). How do we maneuver for the benefit of the client and to maximize our wins in any given situation,
See, it is just different. We love CPAs and rely on them all the time in our practice, but a CPA is not the most appropriate person for the job in certain situations. It would be like if you came to us and asked us to prepare a tax return. We probably could, but that is not what we do all day long.
Why your CEO/CFO/Controller/Bookkeeper is often even a worse choice to handle your California tax issue?
Speaking again in generalities, equating someone’s skill in dealing with financial matters to their ability is solve complex California tax problems is often a huge mistake. Tax is, in and of itself, a much different thing than the issues that the other members of your financial team deal with. Although the various accounting backgrounds these individuals may have can shorten the learning curve, that alone is not going to eliminate it. Just because someone knows what a general ledger is or what goes into a balance sheet does not mean that they understand what a sales tax auditor will glean from that information and the consequences of submitting those items. As such, one of the biggest mistakes that companies make is assuming that the key financial person in the company is somehow apt to deal with a tax controversy. Someone’s access and understanding of your company’s financial records does not necessarily make them qualified as your tax representative. Would you have your CFO/Controller/Bookkeeper prepare your tax return or send them in to negotiate a major dispute between you and another party in an area that they might be unfamiliar with? Then why would you send them outmatched and unprepared into a tax situation that they might not address the full ramifications of. Although we can mitigate some of the damage done by this person in these situations, often times we cannot eliminate it and it often costs the client thousands, tens, or hundreds of thousands of dollars more than if we had stepped in initially and handled the matter ourselves. Again, you do not know what you do not know.
Think of us as a very specific tool to solve a problem, more specifically a California tax problem. We purposely limit or scope of services to just deal with certain issues and we do that because we want to be the very best at resolving those issues for our clients. Businesses and individuals hire us for our experience in these areas because they want to handle the situation once and do it right. So rather than mess with learning curves, rather than enter a situation at an immediate disadvantage in experience, and burn a bunch of time, money, and reputation by fighting California, perhaps you would much rather turn to an experienced tax law firm designed specifically and trusted to deal with these types of situation. The choice is yours.
California Income Tax – Franchise Tax Board
The Franchise Tax Board can be extremely difficult to deal with from a taxpayer standpoint whether through the examination division (audits) or through the collection division. Taxpayers become easily frustrated by California income tax procedures and the level of service received from the Franchise Tax Board. In addition, California has never been viewed as a particularly taxpayer friendly state. Tax procedures are geared to benefit the state and assist it in the collection of revenue. Additionally, California revenue officers and members of their Complex Account Recovery Team (CART) are known to take difficult stances with taxpayers during collection matters.
Unlike many tax firms, Brotman Law focuses on California state tax resolution specifically and navigates our clients through the most difficult of state tax issues. Neutralizing immediate threats, whether in an audit or during the collections process, is especially important because of the tendency of the Franchise Tax Board to take aggressive action when left unchecked. After the danger has passed, we work with the different levels of the Franchise Tax Board (often who do not communicate with each other) to put a resolution in place that best meets your goals. Our familiarity with the Franchise Tax Board helps us implement expedient resolutions to most California income tax problems.
California Payroll Tax – Employment Development Department
The Employment Development Department is the largest tax agency in California. Although it handles a variety of functions (the Employment Development Department has roughly ten thousand employees and a annual budget of roughly twelve million dollars), one of its primary functions is the administration and collections of payroll tax for the approximately seventeen million workers in California. As with the IRS, failure by employers to make payroll tax deposits is perceived to be a huge problem for California and, as a result, the Employment Development Department can take far-reaching and severe actions against businesses that do not meet their obligations.
Brotman Law recognizes the seriousness of the business being involved in a tax dispute with or being investigated by the Employment Development Department. EDD agents are among the biggest threats to California businesses because of the approach they take toward collecting revenue for the state, often to the detriment of the taxpayer. It is important to walk into any dealing with the Employment Development Department with a strategy to achieve the goals and minimize any potential damage that an agent can cause. We use our “business first” approach to solving problems to neutralize risk and protect the ability of your business to earn and generate income.
California Sales Tax – California Department of Tax and Fee Administration
In our professional experience, the California Department of Tax and Fee Administration is the most aggressive and difficult agency to deal with in California. In audits, sales tax auditors use a myriad of complicated tricks and auditing techniques to trap taxpayers and increase their liabilities to the state of California. Unlike income tax audits, the Board’s calculations for determining unreported sales rely heavily on methods that are heavily variable. On the collections side, CDTFA revenue personnel utilize extremely burdensome collection methods which can stifle a taxpayer’s business. Even more frightening is that CDTFA personnel can and will shut down a taxpayer’s business entirely for unpaid sales tax liability.
Brotman Law takes the fight to the California Department of Tax and Fee Administration. We utilize innovative and sound techniques to defeat liability and to make dealing with the CDTFA as easy as possible. In audits, unlike many attorneys, we are skilled in statistically methods and models and use our advanced knowledge of statistics to defeat the CDTFA procedures for assessing liability. Our proven methods have saved our clients millions in liability. In dealing with collections, we shield business and personal assets from collection officers and work to produce resolutions that mitigate even the toughest of collection agents.
Differences between California’s tax administration and the IRS
Most states are modeled after the federal system and California is one of them. There is not a lot of sense in inventing the wheel twice and the federal structure is usually very clear and easy to understand. However, when a state like California tries to duplicate how things are done on the federal level, not all of it will translate over into how the state does things.
Briefly, I want to talk to you about the differences between the federal tax system and the state tax system. First, you should understand that the states have much more limited resources than the federal government, are usually much more dependent on their tax revenue, and, as such, are usually more aggressive in their collections tactics and in their examination tactics than the federal government. A lot of times, when there is a budget short fall, the state will learn on their sales tax bureau, will lean on the payroll tax bureau and will lean on the income tax collections to help mandate collections priorities and help raise revenues either through collecting past due liabilities or examining returns and finding new ones. California’s laws are designed to facilitate collections and designed to give the state an advantage in making tax assessments and collecting money from those assessments; they are not designed to make things easy or fair on the taxpayer.
California Takes Action Against You From a Distance
In general, because of their limited resources, California will rely more on involuntary collections actions initiated at the state level than field representatives. Field representatives more money than computers taking action, mailing out pieces of paper, or having someone sit in a call center. Therefore, California is much more reliant on actions that are initiated from a remote location.
For example, with the Franchise Tax Board (FTB), the body in California responsible for individual and corporate income tax collections, most action is initiated from Rancho Cordova (Sacramento). From their Sacramento office, the FTB will initiate bank and wage levies, phone calls, contact with taxpayers or any other sort of collection actions. California does have collections presence at the local level and they do like to maintain a presence in the community through their local field offices. However, often times, most things are centralized outside the local field office and the local office is only utilized for situations that require the presence of someone locally to administer (a really intensive audit, field visits by collections to track down taxpayers and/or their assets). In a lot of cases, audits are shifting toward becoming correspondence audits through the mail instead of the traditional face-to-face meeting that you might imagine. So as you can see, the theme here is that limited resources at the local office are used sparingly and headquarters serves as the centralized base of operations for many state actions.
Limited and Inflexible Appeals Process
California’s appeals system for tax matters is also much more limited and inflexible than the one that exists on the federal level and one of the main differences between the federal and California systems exists on the appeals level. In 1998, because of a lot of abuses in the system, the IRS overhauled its system through the IRS Reform and Restructuring Act of 1998.
Think about it conceptually. With the federal system, you have a tax court and a very well defined judicial system at the top. When there are disputes with the IRS, which there often are, the US court system operates as a major check and balance against the IRS. Issues from all fifty states are litigated and litigated frequently through the courts and you have this really nice body of judicial decisions for both the taxpayers and the IRS to use as a framework.
That framework guides the IRS appeals process. IRS appeals is a separate and independent body from the rest of the Service. They are set up and designed to be impartial and are a way of settling disputes between taxpayers and the government prior to reaching tax court. When the law is clear, IRS appeals will kick issues out in favor of one party or the other. When it is not, IRS appeals will use its broad settlement authority to achieve resolution. At least in theory (not withstanding some issues with IRS appeals), it is a really great system and designed to administer a variety of tax controversies very efficiently.
California, on the other hand, does not have that same system. For one, the California judicial system sets a really high bar for even hearing tax cases in the first place. Actions may not be brought in California which impede the collection of tax and to get a case all the way through the California court system can take years and is usually prohibitively expensive. So where as the federal system makes access to the courts relatively easy, California’s system actively pushes most things into an administrative resolution.
This has wide ranging effects on the appeals process. First, less court challenges means less case law for the administrative tax agencies to rely on as guidance for their decision making. Less law also means comparatively less statutes when it comes to tax issues and less challenges to those statutes to parse their meaning (it should not surprise you but legislatures often write things that are ambiguous). So, there is a much looser framework in place that is often subject to interpretation and “subject to interpretation” means that there is often less certainty in the California appeals process than exists at the federal level.
The looser framework is not really a good thing for a variety of reasons. First, although the tax agencies in California do try to be fair and have created some measure of checks and balances, this is driven from the people at the top. What gets driven at the top does not always get translated down to the local levels. At the district office for many California tax agencies, there is a head of audit or head of collections and it is their word that governs by in large how that office is run. When their auditors/collections people are follow protocol from their supervisors, they view that as the final word vs. a well-defined system of written judicial opinions, and they generally have more bravado because they feel like actions that they take are “blessed” by the final word. From an appeals perspective, because those appeals functions are being run by the same agencies that they are meant to police, the frustration with a lot of situation in appeals is that it feels like the inmates are controlling the yard and that there is not a lot of oversight. This is not to suggest that the appeals function in California is not impartial or that the system is somehow deliberately rigged (it is not), but taking into consideration that a lot of the hearing officers and appeals employees are graduates of that system, it sometimes feels there is a lot of deference that is given to the State and the burden of proof on the taxpayer is really high.
Let’s place that into context. You are a hearing officer with the California Department of Tax Administration (CDTFA). You became a hearing officer because you made a job transition in the Department and come from a long and decorated background as a sales tax auditor. You have a lot of experience handling audits and, perhaps, you were a supervisor at one point. However, your experience is largely a product of a career spent in one office where you worked under Jane, your District Principal Auditor. Jane liked things done in a certain way and your experience as an auditor and your training was largely governed by her (after all, she’s your boss).
Now, as an hearing officer, the matter of XYZ company is in front of you. XYZ alleges that the method that California used to assess them more than $300,000 in sales tax liability was improper. Because it is a sales tax audit and no one has the resources to go through an entire three year history of a company’s sales, the auditor has used statistical sampling to arrive at his determination. The company argues that position has no basis in reality. Why would it? $300,000 in liability (at an 8.25% tax rate) would mean that the company underreported nearly $3,000,000 in sales. That simply cannot be true.
You look at your audit manual and see that the auditor followed all of the Department’s approved statistical sampling methods. Deep down, in your heart of hearts, you probably know that the taxpayer did not underreport nearly $3,000,000 in sales. However, on the flip side, the Department did everything that were supposed to according to the manual, there are no court cases or other authority to guide your decision, and, as an appeals officer, you are left to rely on your independent skill and judgement as an appeals officer. What do you do?
You can see how that situation could be resolved in either direction. The lack of formal judicial guidance and the fact that the appeals division of these agencies are designed to dissuade people from entering the court system creates this wishy-washy situation that sometimes taxpayers will feel going into the California appeals process. The appeals officer knows that there word will be fairly final on the issue as there is nothing really in writing that could call it into question, absent direct court precedent on the issue and, as explained, there is less of that in the state appeals process. Although California does have the Office of Tax Appeals, which will hopefully provide more of the tax court structure we see on the federal level (and which we are a big fan of), that body is also not without its own problems. For starters, the agency was started in July 2017 and is in its infancy. Second, the pay scale for administrative law judges in California is not the greatest and, as a result, most of the judges come from a government background.
Much Greater Power Bestowed on Auditors and Collection Agents
This looser administrative driven framework is not only an issue at the appeals level, but impacts the regular examination and collections functions in California as well. Guidelines through the procedural manuals for the various state tax agencies are not as well-defined as the federal system and, as illustrated in the previous example, the lower level auditors can be significantly influenced by their superiors with whom they have to work with every day. However the other issue here is more limited oversight, which is driven by the restrictions to resources given to the auditors and collection agents in California.
Traditionally, our experience has taught us that except with junior personnel, California tax agency managers and supervisors are a lot more hands off on the cases that are in the inventory of their people than with the IRS. To be fair, the IRS has much more rigidity baked into the process than with the state of California. Collections cases, for example, can move states or transfer to different districts depending on the geographical movements of the taxpayer. The IRS is also engaging actively in moving resources from one place to another. If the San Diego IRS office gets too backed up, cases could easily get shifted up to Riverside, Laguna Nigel, or Los Angeles to compensate. This happens all of the time. With appeals, cases can and do move all over the country. All of this constant shifting has created a need for uniformity across the way things are done within the IRS and a constant monitoring that is done with individual agents and their inventory and how things are progressing.
It is not to suggest that there is an absence of this on the state level, but it is just less pronounced and less of an issue. As mentioned, California actively consolidates its base of operations to Sacramento, so less stuff moves around at the state level. In addition, things that do get assigned out will usually move to a district office and will stay there. Payroll and sales/use tax cases will move around much less than IRS federal income tax cases because businesses are less portable than individuals. Things stay in the district office and the complexity of some of these matters means that they can hang around those offices for years and that is not something that is out of the norm.
While pressure still exists for front line collections people and auditors to push cases forward, then manner in which they so just is not as uniform. Again, because of the way the appeals system works in California and the time is takes to cycle through appeals, there is not so much immediate pressure on a district office to remain consistent in their outcomes. Problems with the way things are being handled, particularly in audits, may take years to fully surface. By then, it is entirely possible the original auditor is no longer there or has moved on. Front line collections are given a great amount of discretion in what they will and will not accept in their determinations on ability to pay. The collections guidelines and national standards that exist within the federal system are non-existent on the state level. We have had collections people tell our team the craziest things about taxpayer expenses from “maybe they should think about shopping at Walmart” to our client with a strict halal diet, to suggesting taxpayers should buy clothes at Goodwill, to saying that a client who was a doctor that was unemployed could afford to pay $5000 a month because he was “smart’ and “would just figure these things out.” Yes, these are extremes, but the rate in which we get California collections agents comment on our client’s personal living choices vs. the IRS representatives is exceedingly higher.
This is just the system that we have in California. What I mean by that is the auditor or the collection agent is given a lot more latitude in most cases to handle the cases as they see fit as long as it falls within the administrative guidelines. This particularly has an impact on the examinations process. A lot of the times, the auditors are kind of given free reign to define the scope of what the audit is in sales tax audits, but in particular, they can do a really detailed investigation and go through a number of steps that you may not find in the federal process. Generally, their managers are relatively lax about the process and are not really involved in the nuts and bolts either until the case passes on to get reviewed by “technical review” prior to the decision going file (one of the jobs of the manager is to limit the amount of cases that get kicked back from “technical review”). Long story short, the disposition of your California tax matter can be impacted greatly by the person you are dealing with.
Administrative Delay
Again, as a result of fewer resources and less uniformity, the time to resolve California state tax cases and the administrative delay involved is much greater than at the federal level. That is not to suggest that cases do not drag at the federal level too (oh yes, they do), but delays are much more common with California then in the federal system. Remember “technical review” that I mentioned earlier? It can take several months for a case to get reviewed and turn into a final billing, which in turn lags the client getting into the appeals process formally. Getting to an appeals conference? It can sometimes take up to two years to go through that process depending on backlog of cases. The federal system, although not without its own challenges, tends to run much smoother.
Particularly wi