California Tax Evasion Penalties Generally
Generally, penalties for fraud or intent to evade are imposed only when tax deficiency determinations are made by the CDTFA and CDTFA must prove evasion to impose tax evasion penalty. The RTC sections that impose evasion penalties are as follows:
- RTC sections 6072 and 6094.5 — misuse of resale certificate to evade tax, 10 percent or $500, whichever is greater.
- RTC section 6485 — fraud or intent to evade tax, 25 percent of determination.
- RTC sections 6485.1 and 6514.1 — registration of a vehicle, vessel, or aircraft outside of California for the purpose of evading tax, 50 percent of tax due.
- RTC section 6514 — fraud or intent to evade tax by failure to file return, 25 percent of tax, in addition to the mandatory RTC section 6511 failure to file penalty of 10 percent.
- RTC section 6597 — failure to remit sales tax reimbursement or use tax collected, 40 percent of amounts representing sales tax reimbursement or use tax collected and not timely remitted to the CDTFA.
- RTC section 7155 — failure to obtain valid permit by due date of first return for the purpose of evading tax, 50 percent of tax due before permit obtained.
“Fraud” is defined as acts with intent to deprive state of taxes due under the law. Intent to evade is intent to escape paying tax through misrepresentation or deception. CDTFA does not really distinguish between fraud and intent to evade, and calls all resulting penalties as “evasion penalties” in either case. Evasion is one step above negligence and occurs when taxpayer acts beyond just failing to exercise proper care and diligence, and if such failure was intentional and for the purpose of tax evasion. CDTFA must prove such deliberate intent by so called “clear and convincing evidence”. However, the standard of proof is not “beyond a reasonable doubt” as in a criminal prosecution (which is higher than clear and convincing evidence). (See Helvering v. Mitchell (1938) 303 U.S. 391). Instead, the standard of proof in civil tax fraud cases is “clear and convincing evidence” (In re Renovizor’s Inc. v. CDTFA (9th Cir. 2002) 282 F.3d 1233). “Clear and convincing evidence” requires evidence so clear as to leave no substantial doubt as to the truth of an evidence of fraud. That is, there is a high probability that the assertion of fraud by CDTFA is true. Taxpayer's intent is the key to impose tax evasion penalties. Intent can be shown, for example, by consistent multiple tax under-reporting by taxpayer. If under-reporting is random, CDTFA will look at other factors, such as falsified records.
The size of the deficiency in relation to the tax reported is always be taken into account. The higher the understatement of tax, the more CDTFA is inclined to consider that there was tax evasion.
Special Issues with Tax Fraud Penalties
In majority of cases CDTFA relies on circumstantial evidence of tax evasion because direct evidence is very difficult to obtain. CDTFA uses following factors in consideration of whether there was tax evasion:
- Falsified records, especially when more than one set of records is maintained.
- Substantial discrepancies between recorded amounts and reported amounts which cannot be explained.
- Willful disregard of specific advice as to applicability of tax to certain transactions.
- Failure to follow the requirements of the law, knowledge of which requirements is evidenced by permits or licenses held by taxpayer in prior periods.
- Tax or tax reimbursement properly charged, evidencing knowledge of the requirements of the law, but not reported.
- Transferring accumulated unreported tax from a tax accrual account to another income account.
Auditors usually recommend the 25 percent penalty when a taxpayer’s agent, partner, or employee has acted with intent to evade tax payment, even though the attempted evasion occurred without the taxpayer’s knowledge or consent. However, this penalty can not be recommended in the cases when agent or employee defrauded the taxpayer too.
Taxpayer also must benefit from acts if fraud or tax evasion is implied before penalty can be imposed. Generally, if a taxpayer has not benefited from the intent to evade, the evasion penalty should not apply.
If tax evasion penalty is approved by CDTFA, agency must issue a memorandum describing in detail evidence to support tax evasion penalty. Taxpayers should keep in mind that even if tax evasion was not discovered during first audit, if it is present and discovered during subsequent audits, all previous periods, even those already audited, can be included by CDTFA when it comes to penalty for tax evasion.
Penalties for Misuse of a Resale Certificates and for Failure to Remit Tax
Revenue and Taxation Code (RTC) section 6072 imposes a penalty of 10 percent or $500, whichever is greater, for each transaction when a purchaser, for personal gain or to evade the payment of tax, knowingly issues a resale certificate while the person is not actively engaged in business as a seller. RTC section 6094.5 imposes the same penalty when the purchaser knowingly issues a resale certificate for personal gain or to evade the payment of tax, for the property which the purchaser knows at the time of the purchase will not be resold in the regular course of business. Various examples of when this penalty applies and does not apply are laid out in CDTFA of Equalization Penalty Manual which can be found here: http://www.CDTFA.ca.gov/sutax/manuals/am-05.pdf
The penalty will apply in those cases where a pattern of intentional misuse of resale certificate is present, regardless of how large or small amount involved. In those instances where a number of small purchases from the same vendor are noted, a single, rather than multiple, penalty of $500 or 10 percent (whichever is greater) generally will be imposed. But if the purchaser has been previously advised of the consequences of misusing a resale certificate, then possibly more than one penalty may be imposed. If the misuse involves large amounts with the intent of evading the tax, the 25 percent fraud penalty under RTC section 6485 for intent to evade the tax will considered by CDTFA if the evidence exists to support the imposition of the penalty.
CDTFA auditors treat investigation of misuse of resale certificates as one of their priority assignments. In such cases Auditor will always investigate purchaser and will verify seller's records. RTC sections 6485.1 and 6514.1 provide a 50 percent penalty on a purchaser who registers a vehicle, vessel, or aircraft outside of California (i.e., in another state or foreign country) for the purpose of evading the tax. The standards of proof for this penalty are similar to those for fraud in general. The penalty will generally be applicable when the purchaser is a California resident who purchased a vehicle, vessel, or aircraft for use in California and is unable to provide convincing evidence for registration out of state.
For reporting periods beginning January 1, 2007, RTC section 6597 imposes a 40 percent penalty on any person who knowingly collects sales tax reimbursement (Regulation 1700, Reimbursement for Sales Tax 2) or knowingly collects use tax, and fails to timely remit that sales tax reimbursement or use tax (tax) to the CDTFA.
The penalty is discretionary and may only be applied when all the conditions listed below are met:
- The unremitted tax averages over $1000 per month for the reporting period.
- The total unremitted tax exceeds five percent of the total tax collected in the same quarterly reporting period in which the tax was due.
- The taxpayer does not provide a credible explanation showing the failure to remit the tax was due to reasonable cause or circumstances beyond the taxpayer’s control (see Regulation 1703(c)(3)(D)) and occurred notwithstanding the exercise of ordinary care and the absence of willful neglect. In this case taxpayer has to explain CDTFA why tax was not remitted and why it was not taxpayer's fault. CDTFA must disprove taxpayers’ explanation, or simply prove taxpayer's fault with “clear and convincing” evidence.