California Court of Appeal Upholds Twenty Percent Understatement Penalty

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In 2008, the California Legislature enacted SBX1 28 which added section 19138 to the California Corporation Tax Law. As enacted in 2008, section 19138 imposed a new penalty, as specified, on taxpayers subject to the California Corporation Tax Law equal to twenty percent of the understatement of tax in excess of one million dollars for any taxable year. The penalty applies to taxable years beginning on or after January 1, 2003 for which the statute of limitations has not expired. With rare exceptions, this is a “strict liability penalty” with no discretion given to the California Franchise Tax Board (“FTB”) to forgo the penalty on such traditional grounds for relief as reasonable cause, substantial authority or adequate disclosure. As enacted in 2008, for taxpayers included in a combined report, the one million dollar threshold applies to the aggregate amount of tax liability for all taxpayers included in the combined report. For purposes of computing the twenty percent penalty, “understatement of tax” means the amount by which the tax imposed by the California Corporation Tax Law exceeds the amount of tax shown on an original return or an amended return filed on or before the original or extended due date of the return for any taxable year.

On February 17, 2009, and soon after the penalty’s enactment, the California Taxpayers’ Association (“CalTax”) filed a petition for writ of mandate in Sacramento County Superior Court challenging the constitutionality of section 19138.

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