BEFORE THE CALIFORNIA STATE BOARD OF EQUALIZATION 450 N Street, Room 121 Sacramento, California REPORTER'S TRANSCRIPT FEBRUARY 3, 2009 ITEM P2 OTHER ADMINISTRATIVE MATTERS CHIEF COUNSEL REPORT REPORT FROM GEOFF WAY, CHIEF COUNSEL, FRANCHISE TAX BOARD Reported by: Beverly D. Toms No. CSR 1662 1 1 2 P R E S E N T 3 4 For the Board Betty Yee of Equalization: Chair 5 Judy Chu 6 Vice-Chair 7 Bill Leonard Member 8 Michelle Steel 9 Member 10 Marcy Jo Mandel Appearing for John 11 Chiang, State Controller (per Government Code 12 Section 7.9) 13 Diane Olson Chief, Board 14 Proceedings Division 15 Board of Equalization Kristine Cazadd Staff: Chief Counsel 16 17 18 ---oOo--- 19 20 21 22 23 24 25 26 27 28 2 1 Sacramento, California 2 February 3, 2009 3 ---oOO--- 4 MS. OLSON: Our next item on the agenda is P2, 5 Chief Counsel Report, Report from Geoff Way, Chief 6 Counsel, Franchise Tax Board. 7 MS. YEE: Okay. 8 MR. LEONARD: Do you have any land for sale? 9 MS. YEE: Actually, while this -- 10 MR. WAY: We can make some more space 11 available. 12 MS. YEE: -- while Mr. Way is -- 13 MR. LEONARD: You've already been generous up 14 here. 15 MS. YEE: Yeah, I was just going to say, 16 Mr. Leonard, I want to express the Board's gratitude for 17 accommodating our staff who are located out at the 18 Franchise Tax Board. 19 Ms. Cazadd, you want to introduce this item? 20 MS. CAZADD: Yes, Madam Chair, Board Members, 21 it's a privilege today to have Chief Counsel of the 22 Franchise Tax Board, Geoff Way. He's here to give a 23 report about the case load; types of cases that will be 24 coming before you; where we are current status. And 25 what we're looking at in the next year or so. 26 Geoff. 27 MS. YEE: Very well 28 MR. WAY: Madam Chairwoman and Members, thank 3 1 you for letting me be here. I am Geoff Way, Chief 2 Counsel of the Franchise Tax Board. 3 Let me first make a few general comments. We 4 really do appreciate all your efforts to increase 5 communication and collaboration between our two 6 departments. We've had some really good meetings on 7 processing efficiencies, sharing information and data, 8 strategic meetings on such as reducing the tax gap. I 9 think it's really good for all of California when we can 10 leverage our resources and expertise. So thank you very 11 much for continuing those efforts. We appreciate 12 joining those with you. 13 And then let me say generally in the Legal 14 Division about our appeals activity; our goal on this is 15 to provide you all the information you need to make your 16 appeals decisions. And we appreciate the fact that you 17 did make some changes in your appeals rules. 18 We enjoy the opportunity now to provide 19 additional either briefing or evidence as requested. I 20 think there's a great procedure in place for us to go 21 through your Board Proceedings so that everybody has 22 that information. So I think that's helped us a great 23 deal. 24 And we also think your new procedure for 25 prehearing conferences is an area that we would like to 26 explore. I think you see your cases are becoming more 27 factually intensive. They're more complicated. We 28 think the prehearing process is a way to explore dealing 4 1 with some of those issues and we look forward to doing 2 that. 3 You'll also note we have made some changes in 4 our appeals procedures. We have two attorneys sitting 5 at the chair now. I believe that will provide a -- a 6 better response to the questions you have. 7 We've instituted mock hearings that have 8 hearings performed by people outside of the individual 9 areas of expertise. I think lots of times when we deal 10 with specific areas we get so used to being in that area 11 we don't think of other issues. So it's -- I think it 12 made it a little bit more robust dialogue at your 13 hearings. 14 And we would like to thank Marcy, who came over 15 about a year ago and provided some training for all of 16 our lawyers. So, again, we just appreciate the 17 opportunity to dialogue with you in the future on this. 18 If there's other things you'd like to see, we're more 19 than happy to -- to make changes there. But thank you. 20 I'm going to start with the document entitled, 21 "Franchise Tax Board Disputes." 22 MS. YEE: Do we -- do we have those documents? 23 MS. CAZADD: We didn't get them. 24 MR. WAY: I put them on -- put them on your 25 chair back in the building on Sunday morning. 26 MS. MANDEL: Uh-oh. Oops. 27 How would you like to do this? 28 MS. OLSON: Would you like us to make copies? 5 1 MR. WAY: I could come back. You want me to 2 come back after about 20 minutes, maybe? 3 MS. YEE: Yeah, let -- let's take up a 4 couple -- a couple other items, and then if you want to 5 come back. 6 MR. WAY: Okay. Let's do that. Okay, and we 7 have copies for you. 8 MS. YEE: And if we -- 9 MR. WAY: Sorry about that. I should have -- 10 MS. YEE: We'll give Mr. Way some assistance 11 and -- 12 MS. CAZADD: No, I apologize, as well. 13 MS. YEE: -- obvious. Okay. Very well, thank 14 you. 15 (Whereupon other matters were heard.) 16 MS. YEE. Okay, next item. 17 MS. OLSON: I believe we -- we have our 18 documents from -- 19 MS. YEE: Oh, great. 20 MS. OLSON: -- Mr. Way. 21 MS. YEE: Let's have Mr. Way come back forward. 22 MS. CAZADD: Thank you. 23 Madam Chair, Honorable Board Members, Kris 24 Cazadd. Geoff Way is here to present his report. And 25 I -- I do apologize. We realize that we missed each 26 other. He dropped the hard copies off on my -- in my 27 cubicle at FTB on Friday, and I was there Thursday and 28 not Friday and not Monday. 6 1 So, we apologize for this mix-up. 2 MS. YEE: Okay. 3 MS. CAZADD: We do have some things for you 4 now. 5 MS. YEE: Great. Thank you. 6 MR. WAY: I'm all in favor of having you in the 7 same building. I think if it's possible I think that 8 will be great for all of us. 9 You do not have the complete set of documents. 10 They didn't all get e-mailed. I will substitute -- 11 MS. YEE: Okay. 12 MR. WAY: -- those for you. So we'll walk 13 through some of these, but I have other information. 14 There is an additional page summarizing all FTB 15 disputes, and I think I just wanted to highlight when 16 John Davies was here last time, he mentioned that we'd 17 received 15 million personal income tax returns. Last 18 year that number jumped to 17 and half million. So, the 19 potential inventory of taxpayers for your work is 20 increasing. 21 Also, for -- our business entity returns are up 22 about 19 percent over 2005. So, we are seeing a gradual 23 increase in the number of -- of returns that we do have. 24 The -- the ratios for NPAs to protest to 25 appeals remains about the same. For PIT taxpayers about 26 4 percent of NPAs end up being protested. About two and 27 a half percent of those end up being appealed to you. 28 So we do really have a winnowing of the issues down 7 1 before they get to you. 2 On the business entity side it's about 8 3 percent of the NPAs that get protested, and about 11 4 percent that get appealed. So that's a little higher. 5 And let me just -- what you don't have -- you 6 have, obviously, your appeal statistics. What you don't 7 have is our protest statistics. So please go to the 8 first page on the graphs. And, again, I will -- I will 9 supplement these with the proper pages. 10 But the ending inventory here shows an increase 11 in 2008 up to 363. That's an increase of about 12 12 percent. Our intent was not to have our protest 13 inventory increase. You may remember John Davies talked 14 about a re-engineering of our protest process to 12, 18 15 and 24 months. It has not worked as well as we have 16 liked. 17 Part of that problem I think is we do have a -- 18 a phenomenon lately where there's a large number of 19 protests coming in that immediately have a -- has a 20 claim filed in addition to the protested amount, which 21 really creates a dual workload for us. So that's 22 increasing the complexity for you, also, because instead 23 of just having to deal with the audit issues you now 24 have a new claim issue. 25 But, frankly, we have not done as good a job as 26 we can on managing this re-engineered process. We have 27 a new process in place for ticklers that we've 28 established last week. We're going to be coming up with 8 1 new procedures. 2 Our hope is that that inventory will in fact 3 begin to decrease along these lines so that you will see 4 an influx potentially in the number of appeals resulting 5 from our workload activities. 6 2007, the inventory was about $1.8 billion. 7 And 2008 the inventory is about $2 billion. So the 8 dollar amount remains the same. 9 You will see a spike in here of GTLB issues. 10 That is one of the complexity issues we are seeing. 11 Part of that's a result of the shelter workload. But I 12 think the types of appeals that are coming to you 13 because of this GTLB spike are more complex than the 14 appeals. 15 MS. YEE: Geoff, why don't you describe what 16 MTB, GTLB and TAPB are. 17 MR. WAY: Okay. 18 MS. YEE: Yeah. 19 MR. WAY: This -- on this it's the Multi-State 20 Tax Bureau, which are the multi-state cases, obviously. 21 General Tax Law Bureau is kind of the garden 22 patch, your credence, Federal types of actions and 23 things like that. 24 The TAP Bureau is the TAPB. Those are their 25 procedural issues, head of household, HRA, those types 26 of -- of issues. 27 So, that's -- that's the graph, the breakdown 28 on here. So the cases -- GTLB has seen a spike. The 9 1 other ones have remained relatively constant. 2 My next page is cases transferred to 3 settlement. I hope that's yours, too. And I just -- I 4 just want to show you the magnitude of these things. 5 Our cases going to settlement, they vary a little bit, 6 but they're not making a large dent in your workload. 7 So our settlements are -- are efficient in resolving 8 issues, but it's really not that efficient in reducing 9 the amount of cases that are coming to you. 10 The docketed protest chart talks about 11 acknowledged by organization by year. These are new 12 protests that came in during the last year. If you look 13 at this universe, 68 of these are out of GTLB. 30 of 14 those are shelters. So about half the GTLB cases that 15 we received last year in docketed protests, our new 16 inventory, were shelters. 17 Of the multi-State, about half of them were 18 divided between treasury function issues, business and 19 non-business issues. 20 The one interesting thing to me about this 21 chart is if you go back to 2006, the number of protests 22 acknowledged was only 60, or about half. This is -- 23 this is -- it says "Acknowledged by Organization" on top 24 and again I'm sorry because it's not stapled in there. 25 You know, we had an interesting phenomena after 26 the amnesty program with the protective claim filings. 27 A lot of audit activity was -- was really siphoned off 28 under validating protective claims. We made a decision 10 1 to do that in a year's time. I think it reduced the 2 number of protests filed as a result of that, and I'm 3 just going to put that in your brain because we're going 4 to talk about new issues in this large corporate 5 understatement penalty as a potential. 6 And then closed protest cases, again it's been 7 fairly constant. It -- it's down a little bit. I mean, 8 I have a sheet that's called "Closed Settlements," which 9 is not in your form and it's -- all that's saying is 10 that our settlement closings have been fairly constant. 11 So, again, that's not a big impact in your workload. 12 Okay, what's not reflected on these sheets 13 are -- are current inventory and audit. So I just want 14 to go through this with you and get a magnitude of what 15 we're dealing with. 16 Let's talk first about shelter or abuse of 17 shelter workload. There's approximately 1200 cases in 18 audit on tax shelters. And this amount has -- has been 19 fairly constant for a while. It takes a long time to go 20 through a tax shelter case. 21 As far as shelters outside of audit, either 22 into appeals or docketed protest, we have about 235 23 cases. And, again, these are difficult to work, 24 factually intensive. They don't -- we've tried various 25 initiatives to deal with these. Our most recent one was 26 the Becka, the Bob and the Aesop initiative, but about 27 34 taxpayers came into that. 28 So we are not making a dent in this workload 11 1 through our initiatives. It's kind of staying there. I 2 think you're going to have a significant number of these 3 coming up in the future. 4 Another trend we see are IRC 1031, which are 5 like kind exchange cases. I've got six in appeals, 13 6 in protest and about 185 in audit. Again, those are 7 fairly factually specific cases. They're difficult to 8 deal with. We're not seeing those go away. I think 9 you're going to see a significant number of those. 10 And as far as our Native American inventory, it 11 is kind of cutting edge. There's lots of issues but we 12 currently have 16 appeals, 13 protests and another 40 13 cases or so in audit. So, I think you're going to see 14 that group of cases. 15 As far as our program -- we call them our 16 program claim cases. These are ones that are generally 17 filed on amended returns and done by various types of 18 representatives. 19 The easy credit cases I think are on the 20 decline. We have HCD regulations that we feel have 21 cleaned up a lot of the vouchering activities. We are 22 working very hard to resolve these cases before they get 23 to you. At least the ones in the current inventory. I 24 think going forward it -- the program should be in good 25 fitting -- footing. I think those will be okay. 26 We also have a significant number of R & D 27 cases that again are very factually specific. Those 28 don't seem to be decreasing. 12 1 And I always like to mention our FAN or 2 Frivolous Activity Non-filer workload. We're working 3 very hard on our website to provide additional 4 information to taxpayers. I think a lot of this is 5 misguided information to folks that are sold a bill of 6 goods that you don't need to pay taxes. We think we can 7 do a better job on our website of pointing people to the 8 law in this area and hopefully that will reduce some of 9 these issues in the future. 10 And I'm a little hesitant to mention new 11 trends. Those -- those are what we actually have in our 12 inventory. But I think for your planning purposes, you 13 know, we -- we have several years here of majority vote 14 tax increases that have really just been tax penalties. 15 Obviously they're on the books. We get a lot of 16 training on what's the appropriate method and manner for 17 asserting a penalty, but I think you're going to end up 18 seeing a lot of penalty cases because it just -- penalty 19 cases are difficult. People don't like them. And there 20 are some of these cases that do have appeal rights. So 21 you may be seeing that. 22 And then the -- the big unknown is the large 23 corporate understatement penalty, the SBX 128. It's 24 been in the press a little bit lately. I know people 25 are not excited about it, but the reality is, is in -- 26 in this penalty if the understatement of taxes is in 27 excess of a million dollars, and understatement is based 28 upon your original return and the actual tax due, you're 13 1 going to be assessed a 20 percent penalty. The bill 2 has a provision in it to allow people to file between 3 2003 and 2007 by May 31, 2009. It's probably a universe 4 of about 300 taxpayers we think that would be impacted. 5 There's a potential then of -- for five years of about 6 1500 amended returns coming in. I don't know that it 7 will be that high but, you know, we're back in some ways 8 to this protective claim workload, what we saw audit 9 resources being siphoned off to do that. It may impact 10 some of the other cases, although we're trying not to do 11 that. But that is a big unknown. 12 But going forward, we anticipate these 13 taxpayers file a conservative return and then filing an 14 amended return as a claim for refund for all of these 15 300 cases. And that -- that would be a large workload 16 for us. 17 And then I just -- what you don't have is -- I 18 will give you, there is an appeals graph that we did 19 prepare. The 2008 appeals number was 1358. It's about 20 a 44 percent increase from the number of appeals in 21 2007. Our -- our inventory shows that you have a 22 current inventory of about 1500 appeals cases. 23 I think it is significant in this, is that HRA 24 comprised about 587 appeals in 2008. The Governor's 25 budget does not have any funding for HRA in '09 and '10. 26 We are anticipating this program going away. 27 I -- it's not a 587 appeal reduction in your 28 inventory, however. We disposed say last year of 337 of 14 1 those appeals. So it left about 250 HRA appeals. So 2 we -- we have been resolving about 60 percent of these 3 appeals, but you will see a decrease in your inventory. 4 An individual will be allowed to file a claim 5 using the Statute of Limitations for incapacity. So you 6 may see some of those cases in the future. But we 7 expect those cases to go down in your inventory. 8 However, those aren't the complex cases, you know, 9 typically. But you should see a reduction in there. 10 And then another -- you know, the only other 11 thing we noted on here is your decisions I think were 12 down last year, the number of decisions you made. I 13 think that has to do partly with the complexity. 14 These -- you know, these appeals used to take 15 15 minutes. They're taking a lot longer. I think you as a 16 Board have spent a lot more time asking questions and -- 17 and analyzing these cases than other Boards. It 18 takes -- it's just longer to do these complex appeals. 19 And we anticipate that will go on in the future. 20 So, I -- I think your plate is full. Our -- 21 our plate is full. And I think you're going to see 22 probably a steady increase both in the numbers and 23 complexity of the appeals that come to you. 24 But with that I'm happy to answer any 25 questions. And, again, I apologize for the information. 26 I'll send you the complete document so you have that. 27 MS. YEE: Right. Thank you very much, Mr. Way. 28 Questions? 15 1 MS. STEEL: Comment. 2 MS. YEE: Yes, Ms. Steel. 3 MS. STEEL: Questions. Thank you very much for 4 coming out here. But I don't know this is the right 5 question or not but, you know, we have few cases that 6 FTB assessment made based on IRS deficiencies or 7 sometimes it's very old. And it seems like FTB to issue 8 an assessment takes a long time after that, too. So is 9 it any way to implement the process, make it shorter so 10 it's going to help taxpayers and tax agencies to collect 11 enough -- I mean, you know, right amount of taxes? 12 MR. WAY: That -- that's frustrating for us. I 13 think in addition to taxpayers -- especially with IRS 14 deficiencies, we have a lot of cases, especially the 15 shelter cases, that are deferred pending Federal action. 16 So our hands are kind of tied. It just goes in and 17 sits. We wait for the IRS to resolve the issue. We get 18 tapes run, you know, usually in batches at the end of 19 the year and things like that of the determinations they 20 made and our hands are unfortunately tied until we 21 actually find out what's going on. 22 Then depending on what action was taken, you 23 often have to dig in to figure out what did they really 24 do in making the adjustment. And it just -- it makes 25 what is probably a long process even longer because we 26 have to piggyback off the Feds. 27 Again, that's part of the issue with 28 conformity, when our -- when our law is based on the 16 1 Federal law. And a lot of these cases we end up having 2 to wait. When they come in, we're trying -- you know, 3 whatever we can. 4 Audit -- audit is very, very good and very 5 cognizant of the fact that the longer you wait the 6 harder it is for taxpayers to have records and things 7 like that. And they do everything they can to expedite 8 this. But some of this stuff is -- we are just waiting 9 what seems to be a very, very long time for IRS activity 10 in a lot of cases. It is difficult. 11 I wish I had a better solution. You know, we 12 work these things as fast as we can. 13 MS. STEEL: Everything seems like computerized. 14 Is it any way possible that we can just pick it up 15 before they report to FTB or -- 16 MR. WAY: Well -- 17 MS. STEEL: -- you can just -- you know, you 18 know that, you know, which case has been done and -- 19 MR. WAY: We know when something's pending 20 Feds. We flag -- we flag the case. But unfortunately, 21 you know, unless it really is just a computer adjustment 22 done at the Federal level that we pick up, it requires 23 somebody at the Federal level doing an examination of 24 the issue. And that's what ends up taking the long 25 time. So, it -- it's difficult. 26 MS. YEE: Thank you. Mr. Leonard. 27 MR. LEONARD: Just -- just on that point, I -- 28 I recognize the -- the virtue in waiting for the Federal 17 1 Government to -- to close out a case, and I also 2 recognize that the IRS is not real good at telling us -- 3 MR. WAY: Yeah 4 MR. LEONARD: -- why they did what they did. 5 But there seems to be a large number of the protests we 6 get where after waiting all these years for the Federal 7 action, Franchise Tax Board isn't going along with it, 8 doesn't exactly know how to explain what IRS did, nor 9 does the taxpayer. It's a settlement. It's some kind 10 of compromise, and it's -- it would seem to me if we're 11 going to wait for Federal action that the bias should be 12 we accept whatever the IRS does, we conform in that way, 13 even if we have to just figure out a percentage of tax 14 remaining versus what was claimed and apply the same 15 percentage at the State level. 16 Because I -- I share your frustration on that 17 to have all this time waited -- you know, waiting for 18 IRS and then not learn anything. 19 MR. WAY: There's nothing definitive. No, 20 it's -- we had -- you know, we had a conversation with 21 them two months ago on the phone and we were expressing 22 some of these things. We seem to get an understanding 23 on the phone of the problem and at least some discussion 24 on what they can do, but we don't often see results in 25 the back side. 26 And I really -- you know, absent looking at 27 each one that comes down -- some of them are very 28 definitive. And some of them are very easy to tell. It 18 1 just -- you never know what they're going to look 2 like -- 3 MR. LEONARD: Right. 4 MR. WAY: -- you know, until you actually get 5 one of these. So, I'd -- it -- it's something we can -- 6 I mean, we can go back and talk about it and see some 7 other ways to do things because it is frustrating for 8 taxpayers and interest is accruing and it's just -- it 9 doesn't seem be the efficient way that we like to 10 conduct business out here. It is -- it ends up being 11 frustrating. 12 MR. LEONARD: You know, whatever you can do to 13 speed that up or to -- or to more -- more closely follow 14 IRS and offer the same settlement -- 15 MR. WAY: I mean, you feel like in cases where 16 our law is the same that there's -- there's times when 17 we're ignoring that or -- 18 MR. LEONARD: Yeah. 19 MR. WAY: Okay. Well, let me -- let me go back 20 and look at that. 21 MR. LEONARD: Thank you. 22 MS. YEE: Thank you. Dr. Chu and then Ms. 23 Mandel. 24 DR. CHU: I just want to commend you for -- for 25 changing the procedures of the way that the cases are 26 being presented with having two attorneys -- 27 MR. WAY: Sure. 28 DR. CHU: -- and having the mock trials. I 19 1 have noticed -- 2 MR. WAY: Good. Thank you. 3 DR. CHU: -- a great improvement and it's -- 4 it's much appreciated. 5 MR. WAY: Thank you very much for saying that. 6 MS. YEE: Ms. Mandel. 7 MS. MANDEL: I think that sometimes on the 8 Federal adjustments what happens is the people have 9 entered into some kind of stipulation in Tax Court or 10 they've reached -- 11 MR. WAY: Right. 12 MS. MANDEL: -- some kind of accommodation on 13 an Offer in Compromise or a -- or a -- 14 MR. WAY: Right. 15 MS. MANDEL: -- some other type of settlement 16 where if you look at the individual master file there's 17 no adjustment -- 18 MR. WAY: Right. 19 MS. MANDEL: -- to tax or a penalty is being 20 cut somehow, but there's no -- there's nothing in the 21 IMF that indicates -- 22 MR. WAY: Right. 23 MS. MANDEL: -- it was for reasonable cause or 24 something else. 25 MR. WAY: Correct. 26 MS. MANDEL: And that -- I mean, whatever the 27 correct way of process is, that turns out to be 28 confusing and frustrating to taxpayers. But that's -- 20 1 that's the way I remember those cases being presented. 2 MR. LEONARD: That's a good example. 3 MR. WAY: And we -- we frankly have had 4 discussions and say we don't hold back when we're making 5 adjustments with the IRS. We feel like that -- you 6 know, it's -- it's in their best interest that we tell 7 exactly what we did and what we found. It's just 8 there's not a cross -- or reciprocity in the -- the type 9 of information that's shared in a lot of these and it is 10 frustrating. 11 But we do have ongoing dialogues. We'll 12 continue to do that. 13 MS. YEE: All right. Thank you. 14 MR. LEONARD: Who plays me in the mock trial? 15 MR. WAY: We're not trying -- 16 MS. MANDEL: It's a closely held secret, I'm 17 sure. 18 MR. LEONARD: Well, I might want to brief them 19 on how -- 20 MR. WAY: Love to do that. Thank you very 21 much. 22 MS. YEE: Thank you very much, Mr. Way. Thank 23 you. 24 MR. LEONARD: Thank you. 25 ---oOo--- 26 27 28 21 1 REPORTER'S CERTIFICATE. 2 3 State of California ) 4 ) ss 5 County of Sacramento ) 6 7 I, BEVERLY D. TOMS, Hearing Reporter for the 8 California State Board of Equalization certify that on 9 February 3, 2009 I recorded verbatim, in shorthand, to 10 the best of my ability, the proceedings in the 11 above-entitled hearing; that I transcribed the shorthand 12 writing into typewriting; and that the preceding 21 13 pages constitute a complete and accurate transcription 14 of the shorthand writing. 15 16 Dated: February 23, 2009. 17 18 19 ____________________________ 20 BEVERLY D. TOMS 21 Hearing Reporter 22 23 24 25 26 27 28 22