California: Understatement Penalty Held to Be Constitutional: Action Still Required by May 31st!

The California Superior Court has ruled California's Large Corporate 20% Understatement Penalty is Constitutional. The ruling was filed on May 20, 2009 and is in response to the challenge brought by the California Taxpayers' Association. (the case number is 34-2009-80000168).

The Court held the following:

1. The California Taxpayers' Association did not meet its burden to prove that Section 19138 violates Proposition 13. The court held that if the primary function of the exaction is to regulate (punish) conduct, then it is properly characterized as a penalty; but if the primary function is to raise revenue, it is properly characterized as a tax. The court held the understatement penalty is a "penalty" and not a "tax."
2. The Court held that the Legislature substantially complied with the reading requirement by virtue of its non-rollcall vote, and was validly enacted.
3. The Court denied the claim that section 19138 violates the Excessive Fines Clause of the U.S. Constitution.
4. The Court denied the claim that section 19138 violates the substantive due process guarantees of the Fourteenth Amendment. The Court did not find the retroactive application of the penalty to be so harsh and oppressive as to transgress the constitutional limitation of the substantive due process clause.
5. The Court concluded that the statute may be invoked because it provides a constitutionally adequate post-deprivation remedy in the form of a refund action in which a taxpayer may contest the validity of the tax penalty. The Court found it unnecessary to invalidate or reform the statute as long as due process requirements are met. (The interpretation and application of the statute may be cause enough for the legislature to amend the statute.)
6. The Court denied the Commerce clause claim.
7. The Court denied the Equal Protection claim.

Legislature May Amend Statute

In addition to the ruling, some of the "Big 4" accounting firms have reported that the California legislature may amend the statute prior to May 31, 2009 to address some of the concerns raised in the lawsuit and ruling. This makes it difficult for taxpayers to know what to do.

ACTION:

Therefore, at this time, taxpayers may want to continue to follow the statute as required and take action by May 31st, but wait until the last minute to mail the information, just in case California amends the statute.

More analysis to come.

If you have any questions, please contact me at leveragesalt@earthlink.net.