When Can A Taxpayer Be Subject to a Frivolous Appeal Penalty in California?

California Revenue and Taxation Code § 19714 gives the Franchise Tax Board the authority to impose a civil penalty (not in excess of $5,000) if a proceeding has been instituted or maintained by a taxpayer primarily for delay or the taxpayer’s position in the proceedings is frivolous or groundless, or that the taxpayer unreasonably failed to pursue available administrative remedies.

The recent California Office of Tax Appeals (“OTA”) decision, In the Matter of the Appeal of: T. Flores, 2024-OTA-226, demonstrates that California taxing authorities do not look kindly upon those taxpayers they believe are wasting time by advancing frivolous arguments.

What were the facts of In the Appeal of T. Flores?

On July 15, 2020, the taxpayer late-filed his 2019 California personal income tax return, claiming he had $0 income and $0 tax due. He attached “corrected” Forms 1099 with lines 1 through 18 left blank.

The California Franchise Tax Board obtained information that the taxpayer had earned over $28,000 in income from Uber and Postmates – a matter that the taxpayer did not dispute. The FTB treated his tax return as invalid and sent him notices requesting a valid tax return. The Franchise Tax Board imposed a late filing penalty (R&TC § 19131(a)) and a demand penalty (R&TC § 19133) plus interest, all of which the taxpayer protested. Eventually, he filed an appeal to the California Office of Tax Appeals.

What Issues Did the Office of Tax Appeals Address?

On Appeal, the taxpayer challenged the Franchise Tax Board’s imposition of tax and the late filing penalty and demand penalty. However, the most important issue in the Appeal was whether the California Office of Tax Appeals could impose a frivolous appeal penalty on the taxpayer under R&TC, § 19714.

What Did the Office of Tax Appeals Hold?

The Office of Tax Appeals ruled against the taxpayer in full. The OTA affirmed the tax, citing that the taxpayer could not dispute the Franchise Tax Board’s demonstration that he had earned over $28,000 in income from Uber and Postmates.

The OTA affirmed the late filing penalty because the taxpayer had failed to file his tax return before the due date. He did not prove that he lacked an obligation to file or had reasonable cause for failing to file a timely and valid tax return.

The Office of Tax Appeals also upheld the demand penalty, which applies when a taxpayer fails or refuses to file a tax return after receiving notice and demand. The OTA stated that the taxpayer received sufficient notice, which he did not respond to. The OTA also cited that the taxpayer did not contest the penalty and failed to demonstrate reasonable cause, preventing him from responding to the notices.

Finally, the Office of Tax Appeals imposed a frivolous appeal penalty under Rev. & Tax Code § 19714 because the taxpayer raised frivolous arguments before the OTA that have been consistently rejected. He also raised arguments similar to those previously raised, and he had been notified that this penalty may be imposed. Additionally, when the Appeal was filed, he had yet to file a valid income tax return for 2019.

Frivolous Appeal Penalty Factors

The Appeal of Flores provides insight into when the OTA may impose a penalty of up to $5,000 for a frivolous or groundless proceeding by setting forth a non-exclusive list of factors to be considered when determining whether to impose the penalty:

(1) whether the taxpayer is making arguments that have been previously rejected by OTA in a precedential opinion, by BOE in a Formal Opinion,
or by the courts;

(2) whether the taxpayer is repeating arguments that was advanced unsuccessfully in prior appeals;

(3) whether the taxpayer filed the appeal with the intent of delaying legitimate tax proceedings or the legitimate collection of tax owed;

(4) whether the taxpayer has a history of filing frivolous appeals or failing to comply with California’s tax laws; and

(5) whether the taxpayer has been notified, in a current or prior appeal, that a frivolous appeal penalty might apply. (Cal. Code Regs., tit. 18, § 30217(b)(1-5).)

While the fact pattern of the frivolous appeal case was straightforward due to the appellant’s express admission of wrongdoing, when the facts are actually in dispute, some of the cited factors for frivolity can be open to interpretation. Competent tax counsel can help advise a taxpayer to avoid penalties.

Takeaway

Taxpayers looking to avoid finding themselves in a situation similar to that of the taxpayer in this case should, first and foremost, ensure they accurately report their income when filing their taxes. If the Franchise Tax Board disagrees with a return position, a taxpayer can respond to the FTB’s notices and eventually file an administrative appeal. The takeaway is to not raise frivolous arguments on Appeal. It weakens the case, and taxpayers risk being subject to a civil penalty under R&TC 19714.

Stick to the facts of your case and the legal arguments that are the winners, and avoid frivolous or groundless arguments.  Use plain English and clear legal writing. Most of all, do not delay the administrative proceedings with meritless arguments. Hiring competent tax counsel can help by taking the taxpayer out of the mix in the administrative appeal process and ensuring that the briefs are persuasive, objective, and well-written.

Author: Steven L. Walker with Special Thanks to Marissa Hein, a Pre-Law Student

This article provides information for educational purposes, not specific tax or legal advice. Information in this article should be be relied upon or construed as legal advice.