ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – ARE EDD AND FTB AUDITORS ALLOWED TO ESTIMATE? – THE SHANAHAN CASE
By Robert S. Schriebman
2024
Introduction
Are auditors allowed to make estimations of such things as taxable income for income tax purposes and taxable wages for payroll tax purposes? The short answer is yes. This article will take a look at how both the EDD and the FTB make estimations for tax purposes.
EDD Auditor Estimations
EDD auditors make estimations for payroll tax purposes quite frequently. If an employer does not take out what the EDD believes to be reasonable compensation, the auditor is allowed to use both internal and external studies to make an estimation for payroll tax purposes. Administrative law judges will always support these estimations if the judge deems the estimation to be reasonable. The employer has the burden of proving the EDD’s estimation wrong.
FTB Auditor Estimations
In the Matter of the Appeal of J. Shanahan, OTA Case No. 19085136 (2024)
J. Shanahan (JS) is a licensed engineer. He failed to file his 2016 FTB tax return. After several requests from the FTB, he sent only a 1099 reporting $2,600 of income. He informed the FTB that he had no other income because the US Supreme Court ruled that the essential meaning of “income” is profit. He argued that corporations make a profit, but since he is not a corporation and was only compensated for his personal labor, that compensation is not deemed profit and thus is not “income” for tax purposes. This is essentially a tax protester-type argument. It is also legally deemed a frivolous argument.
The FTB, using its internal studies, issued JS an estimated income assessment of $45,631 and proposed a tax liability, a late filing penalty, a demand penalty, and a filing enforcement fee, plus applicable interest. JS protested the estimated assessment and took the matter to the Office of Tax Appeals (OTA).
The FTB is Allowed to Estimate Taxable Income
The issue before the OTA was whether the FTB is permitted to make an assessment based on a pure estimation.
R&TC section 18501 requires every individual subject to the Personal Income Tax Law to make and file a return with FTB “stating specifically the items of the individual’s gross income from all sources and the deductions and credits allowable,” when certain filing thresholds are exceeded. (R&TC § 18501 (a)). If a taxpayer fails to file a return, then FTB, at any time, “may make an estimate of the net income, from any available information, and may propose to assess the amount of tax, interest, and penalties due. (R&TC §19087(a)).
Both the FTB and the EDD are given great latitude in estimating income and payroll tax exposure especially when a taxpayer files to file a return or files a false return. These estimations are presumed correct by judges and the taxpayer has the burden of proving the auditor wrong. (Palmer v. Internal Revenue Service (9th Cir. 1997)116 F3d 1309)). This is known as a rebuttable presumption of correctness.
Conclusion
Shanahan’s contention that being merely compensated for his labor and he makes no profit, and has no income, has been consistently and emphatically rejected by both state and federal courts as frivolous. There are stiff penalties for making these types of frivolous arguments. These penalties cannot be abated based on reasonable cause.
***
Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 50 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD, and he is not employed by the EDD or any other agency of the State of California.
Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.
Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.
Web Site Article 799