On March 24, Governor Jerry Brown signed into law SB 86 (Committee on Budget and Fiscal Review), a majority-vote bill, which includes a tax amnesty program for taxpayers with underreported income related to abusive tax avoidance transactions and offshore financial arrangements. The amnesty program—which is more stick than carrot—is part of a larger proposal to close the $26 billion gap between spending and revenue in the state budget, and is estimated to raise roughly $200 million due in large part to accelerated revenues. This revenue estimate is as likely to materialize as an Easter bunny carrying a copy of State Taxation (by Jerome and Walter Hellerstein) at your next family picnic.

The tax amnesty program—referred to as Voluntary Compliance Initiative Two (VCI II)—offers a 91-day amnesty period from August 1, 2011, through October 31, 2011, for personal and corporate income taxpayers with liabilities derived from abusive tax avoidance transactions and offshore financial arrangements related to taxable years prior to January 1, 2011, and tax deficiencies that are not final as of July 31, 2011.

The legislation defines an “abusive tax avoidance transaction” as: 

  1. A tax shelter, as defined in Internal Revenue Code (IRC) § 6662(d)(2)(C)
  2. A reportable transaction, as defined in IRC § 6707A(c)(1)
  3. A listed transaction, as defined by IRC § 6707A(c)(2)
  4. A gross misstatement, as defined by IRC § 6404(g)(2)(D); and 
  5. Any transaction to which Revenue and Taxation Code Section 19774 (the Noneconomic Substance Transaction (NEST) Penalty) applies.

An “offshore financial arrangement” is defined as “any transaction involving financial arrangements that in any manner rely on the use of offshore payment cards, including credit, debit, or charge cards, issued by banks in foreign jurisdictions or offshore financial arrangements, including arrangements with foreign banks, financial institutions, corporations, partnerships, trusts, or other entities to avoid or evade income or franchise tax.”

Taxpayers that pay all taxes and interest due during the amnesty period are offered a “carrot” and will “hop” out of harm’s way by receiving a waiver of most penalties (including the 40% NEST penalty, the new VCI II 100% interest penalty, and the 20% accuracy-related penalty). Two penalties that will not be waived are the large corporate understatement penalty under Section 19138 and the 2005 amnesty interest penalty under Section 19777.5. Taxpayers that participate in the program will also avoid criminal prosecution.

Taxpayers that participate in VCI II will forfeit their right to claim a refund of amounts paid in connection with abusive tax avoidance transactions and offshore financial arrangements under the amnesty program. Furthermore, to retain the forgiveness of penalties offered under VCI II, taxpayers must “fully cooperate in an inquiry” regarding the use of abusive tax avoidance transactions or offshore financial arrangements. If the FTB finds a VCI II participant to be a bad bunny (and less than “fully cooperative” with such inquiries), the FTB may assess any applicable penalties.

Taxpayers that do not participate in VCI II and who have liabilities attributable to abusive tax avoidance transactions or offshore financial arrangements will be subject to a 100% interest penalty, in addition to the standard penalties imposed upon such transactions. If a taxpayer files an amended return correcting the deficiency after the amnesty period but before a notice of proposed assessment is issued, the penalty will be reduced to 50% of the interest payable on the additional tax imposed. 

The legislation implementing VCI II also extends the statute of limitations related to abusive tax avoidance transaction deficiencies from eight years to 12 years from the date of filing the return. This extended statute of limitations, which “bugs” many taxpayers, applies to all notices of proposed deficiency assessment mailed to taxpayers on or after August 1, 2011.