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 2
By Robert S. Schriebman
This is Part 2 of a 2-Part series that will discuss the “pay first, litigate later” doctrine when challenging California tax assessments. Most tax assessments have three parts, the tax portion, the penalty portion and the interest portion. In this article I will discuss how much of the tax, penalty, and interest portions need to be paid before you can administratively challenge the assessment in a refund proceeding or in Superior Court.
The Right to Administratively Challenge a California Tax Assessment Without First Having to Pay it.
Before discussing the rules relating to paying any portion of the assessment, let’s look at contesting the proposed assessment without first paying anything.
If you wish to administratively 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 not the legality of the underlying statute. 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.
Challenging the Legality of the Underlying Law
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.
Take a Look at Part 1
In Part 1, I discussed the origin of the “pay first, litigate second rule” set forth in the California Constitution. I also discussed the requirement for the exhaustion of administrative remedies before you are allowed to file a suit for refund in the Superior Court.
How Much Do You Have to Pay?
If you wish to file an administrative claim for refund, do you have to pay the tax, penalty, and interest portions of your assessment in full for a specific tax year(s) or calendar quarter(s)? Is it possible to pay less?
As I mentioned above, most California tax assessments consist of three portions: the tax portion, the penalty portion, and the interest portion. Most of the time, when the word “tax” is used, it was understood that it encompassed all three portions of the assessment. When considering the “pay first, litigate second” rule, how much of the “tax” must be paid before you can file a claim for refund, or get your day in court? The answer is far from clear. This is especially true when it comes to refunds and the litigation of payroll taxes. Employment and withholding taxes are different than income taxes and sales taxes. Income tax is for a specific year, and a sales tax applies to a specific quarter. The US Supreme Court in the Flora case made a distinction when it came to payroll taxes.
U.S. v. Flora
In 1960, the U.S. Supreme Court decided the case of U.S. v. Flora, 60-1 USTC § 9347, 362 U.S. 145, 80 SCt 630 (1960). The Supreme Court held that employment taxes were “divisible taxes,” meaning that each employee and each period involved is a separate matter. In other words, to litigate your case, you need only prepay the employment taxes for one employee for one quarter. This person can be the lowest paid employee. A rule of thumb, the payment of $500 per each quarter in issue is deemed a sufficient payment. Under federal rules, one refund claim form (843) must be filed for each quarter in issue. The EDD and the CUIAB do not have such a rule. There is no Superior Court policy that I have found on this requirement.
The EDD Full Payment Rule
In 1992, the California Court of Appeals decided the Masi case. An employer wishing to have his/her day in court must pay the EDD assessment in full, before filing a claim for refund. This means that all three portions of the EDD assessment, regardless of how many quarters, must be paid in full. The Masi case paid no attention to the Supreme Court Flora case. (CUIC §1178 and Masi v. Nagle, 5 Cal. App. 4th 608 (1992)).
The Agnew Case
In 1999, the California Supreme Court decided the Agnew case. Agnew v. State Board of Equalization (21 Cal 4th 310, 320). The Supreme Court ultimately held in Agnew that Section 32 of the California Constitution’s pay first requirement applies only to the tax liability itself and not associated interest. The Agnew case should have overruled the Masi case.
The above “pay first” cases should also apply to refund suits in the Superior Court. To be conservative, and to play it safe, payment of all three portions of any tax assessment is advisable before filing a claim for refund and proceeding to an administrative hearing and eventually your day in court.
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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