ASK THE CALIFORNIA EMPLOYMENT TAX AND PAYROLL TAX ATTORNEY – IS IT POSSIBLE TO CHALLENGE THE LEGALITY OF A CALIFORNIA TAX WITHOUT FIRST HAVING TO PAY IT? – PART 1
By Robert S. Schriebman
This is Part 1 of a 2-Part series that will discuss the “pay first, litigate later” doctrine when challenging California tax assessments.
If you wish to challenge a tax assessment issued by the EDD, FTB, or the CDTFA, you are allowed to do so without first having to pay the proposed assessment. For example, if the EDD issues a Notice of Assessment (NA) you have a right to file an administrative petition before the CUIAB without first having to pay anything. If you do not file the petition on time, and the proposed assessment becomes final, you have the right to file a claim for refund, and if denied, you are allowed to file a refund petition before the CUIAB. These matters involve challenging the accuracy of the proposed assessment. In these actions you are not questioning the legality or constitutionality of a specific statute. The CUIAB is an administrative tribunal. It is not a court of law such as the Superior Court.
On the other hand, if you want to challenge the legality or constitutionality of a specific statute in the Unemployment Insurance Code (UI) or the Revenue and Taxation Code (RTC) in the Superior Court, are you allowed to do so without first having to pay the assessed tax associated with the questionable statute? Does the California Constitution require you to pay first, and litigate later?
On May 7, 2020, the California Court of Appeal for the Second Circuit issued a decision addressing this very issue (CDTFA v. Superior Court). In this case, Jeremy D. Kinter attempted to challenge the constitutionality of a Policy and Regulation taxing him personally for unpaid sales taxes assessed against HK Architectural Supply, Inc. (HK). HK was suspended by the FTB for failing to pay annual franchise taxes and the failure to file returns. Even though suspended, HK continued to operate. Unpaid sales taxes were initially assessed against HK. The Policy and Regulation adopted by the then SBE, allowed personal assessment for taxes assessed against a suspended corporation. Kinter believed the Policy and Regulation was unconstitutional. He filed a lawsuit in Superior Court without first paying the proposed assessment.
In this article I will discuss the requirement that assessed taxes must be paid first before their legality can be challenged.
I will also discuss an issue that has been on my mind for a long time. The issue involves the EDD procedures for filing refund claims, specifically whether the full assessment must be paid before a refund claim can be considered legally filed.
The Case of CDTFA vs. Superior Court
Is it possible to litigate the legality or constitutionality of a tax assessed by any California agency without first having to pay that tax? Article XIII, § 32 of the California Constitution (section 32) requires taxpayers to pay a tax before they can challenge its assessment. (Cal. Const., art XIII, § 32; Loeffler v. Target Corp. (2014) 58 Cal. 4th 1081, 1107 (Loeffler).) Government Code § 11350 (§ 11350) provides that “[a]ny interested person” may sue for declaratory relief “as to the validity of any regulation.” This rule is known as the “pay first, litigate later” rule or more colorfully known as the “pay up or shut up” rule. Andal v. City of Stockton (2006) 137 Cal. App. 4th 86.
In looking at these two laws, there seems to be some inconsistency. The Government Code says that you are allowed to have a judge determine if a tax law or regulation is legal, but the California Constitution says you must first pay the tax. Is this a chicken-egg riddle? What trumps what?
The origin of this “pay first, litigate second” rule is § 32:
“No legal or equitable process shall issue in any proceeding in any court against this State or any officer thereof to prevent or enjoin the collection of any tax. After payment of a tax claimed to be illegal, an action may be maintained to recover the tax paid, with interest, in such manner as may be prohibited by the Legislature.”
A constitutional provision trumps a state statute, regulation or policy. What the Constitution says goes.
Note: the only court in the land that will allow you to challenge an assessment without first having to pay it is the United States Tax Court.
Bottom line: Kinter had to pay the tax first and go through the refund process administratively before he could set foot inside a courtroom.
How Much of the Assessment Do You Have to Pay Before You Can Litigate?
Let’s look at the EDD. The usual NA consists of several parts. The tax portion, the penalty portion, and the interest accruing on the taxes and penalties. If you want to file a claim for refund, and have your case heard by an ALJ first, and a trial judge second, how much of the proposed assessment do you have to pay? There is no clear answer.
The Principle of Exhaustion of Administrative Remedies
EDD assessments are administrative. As such, administrative procedures must be followed and must be exhausted before you are allowed to file a refund suit in the Superior Court. First, there must be a payment. After the payment is made, a timely claim for refund must be filed. After the claim is filed, and denied, you must file a petition with the CUIAB. Only after all of this are you allowed to file a refund suit in the Superior Court.
In Part 2, I will discuss the nature of EDD assessments and the full payment rule. Do you have to pay the entire amount of the NA before your refund claim is considered valid?
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 40 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.
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