(Un)intended consequences? California's 2005 tax amnesty program.

While most associate "amnesty" with the idea of sanctuary, the word derives from the Greek root for "amnesia," a forgetting. For taxpayers who owe state taxes, California is willing to forgive and forget through its own sanctuary: the 2005 tax amnesty program.

Spurred by last year's tax shelter amnesty program that added $1.4 billion to the state's coffers, California is providing a general tax amnesty to individuals, businesses, fiduciaries, estates and trusts for tax years 2002 and prior.

The program--which began Feb. 1 and runs through March 31--is a last chance for taxpayers to pay past-due income, franchise, sales or use tax and the related interest without penalties and criminal prosecution. The Board of Equalization is administering the sales and use tax portion of the program, while the FTB is handling the personal and corporate income and franchise tax portion.

The program, however, contains a few pitfalls that are causing a concern for taxpayers. The lack of an appeals process, harsh new penalties, indiscriminate assessments and information sharing are just some of the concerns CPAs need to be aware of as they advise their clients regarding tax amnesty.

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NO RIGHT TO REFUND IN FTB PROGRAM

The BOE's amnesty program will allow taxpayers making sales tax payments to seek refunds of amounts paid due to the amnesty program participation. However, taxpayers who participate in the FTB program give up that right to appeal and won't be able to claim a refund for any income tax amnesty-related payments.

The taxpayer will be permitted, however, to claim a refund for income tax amounts paid via withholding or estimated tax; paid with the original return; or paid subsequent to the filing of the original return, but before the taxpayer applied for amnesty.

This could create some liability exposure for the CPA. If your client has an existing income tax protest, appeal or amended return in process, consider whether the benefits associated with participation in the amnesty program are worth the risk of losing the appeal and refund rights.

If the client has a reasonable expectation that the income tax protest or appeal will be successful or the amended return will be accepted, it may be best to have the client pay the expected income tax, interest and penalties outside of the covenants of the amnesty program to preserve their refund rights.

ACCURACY-RELATED AMNESTY PENALTIES

Taxpayers who are eligible, but choose not to participate in the amnesty program will be subject to accuracy-related and amnesty penalties. For income and franchise tax purposes, the new penalties include:

* A doubling of the accuracy-related penalty from 20 percent to 40 percent for new deficiency assessments on pre-2003 taxable years;

* A penalty equal to 50 percent of the interest due through March 31, 2005 for amnesty-eligible amounts that are due and payable as of said date; and

* A penalty equal to 50 percent of the interest from the original due date through March 31, 2005 for amounts that become due and payable after March 31, 2005.

For sales and use tax purposes, penalties will be doubled and imposed for deficiency determinations that have been based on a return filed under the amnesty program or upon any other non-reporting or underreporting that would have been eligible for amnesty.

The BOE will issue deficiency notices for any amnesty-eligible period within 10 years from the last day of the calendar month following the quarterly period for which the amount is proposed to be determined. Historically, the statute of limitations on sales and use tax audits was three years, but the tax amnesty legislation has extended it to 10 years.

The BOE and FTB also may impose penalties for all periods for which amnesty was available, including periods for which the statute of limitations is otherwise closed.

Given the potential for increased penalties, it's important for practitioners to advise their clients of their right to participate in the program and the consequences if they don't. If a tax practitioner is aware of a tax error and the client chooses not to participate, the practitioner should document the client's decision to not participate and should also consider contacting their risk management adviser for any further steps.

INDISCRIMINATE ASSESSMENTS

This program differs from the state's 2004 tax shelter amnesty program in several ways.

For example, the tax shelter legislation targeted specific unlawful acts and provided taxpayers the opportunity to bypass penalties by proving the "substantial evidence" behind a questionable transaction.

But the state's 2005 amnesty program applies to all taxpayers for all tax years 2002 and prior and lacks the kind of "safe harbor" provisions found in last year's tax shelter program. Also, unlike the tax shelter amnesty, the 2005 amnesty program dictates that applicants timely file their returns and stay current on taxes owed for 2005 and 2006.

INFORMATION SHARED

CPAs with clients wishing to participate in the program should be aware that while the IRS is not providing any amnesty provisions and other states may or may not be providing an amnesty program, participation in the program will likely result in the client's information being shared with the IRS and possibly other states.

MORE INFORMATION

For more details on the FTB's amnesty program, and to download an application, visit www.ftb.ca.gov/amnesty.

If you are a CAMICO policyholder, CAMICO has sample letter language on its website for policyholders to use to inform their clients of the program. Visit www.camico.com, sign in, click on "LP Alert Documents," then "California Tax Issues," and then "California Tax Amnesty Program."

RELATED ARTICLE: TIMELINE KEY DATES

> Aug. 16, 2004

Gov. Schwarzenegger signs SB 1100 into law, instituting the amnesty program.

> Feb. 1, 2005

2005 tax amnesty program begins; applications for amnesty accepted.

> March 31, 2005

Deadline to apply for amnesty.

> May 31, 2005

* Deadline to file missing income or franchise tax returns for amnesty years (2002 and prior)

* Deadline to file amended income or franchise tax returns for any years you underreported your tax.

* Deadline to pay all outstanding tax liabilities and interest.

> June 30, 2006

Deadline for final payment of installment agreement.

BY RIC ROSARIO, CPA

Ric Rosario, CPA, is vice president of risk management at Redwood City-based CAMICO, the mutual liability insurance company for CPAs. You can reach him at [e-mail].