California – The Gillette Decision and the Large Corporate Understatement Penalty

SALT Report 1781 – Due to the California court of appeal’s decision in Gillette v Franchise Tax Board, the FTB issued a warning for taxpayers that choose to use the Multistate Tax Compact’s three factor formula to apportion their income on their October 15, 2012 return.  These taxpayers run the risk of having the large corporate understatement penalty imposed if the court of appeal’s decision is vacated or modified, or if the California Supreme Court overturns or modifies the decision after October 15, 2012.

Large Corporate Understatement Penalty

The Large Corporate Understatement Penalty will be imposed on corporate taxpayers that have under reported taxes that exceed $1 million.  The LCUP penalty is 20% of the understated tax.  Currently, California law only grants relief from the LCUP if the penalty is imposed on an understatement that results from a change in law that occurs after a return is filed.

The FTB warns that because the Gillette decision was issued on October 1, 2012 and will not become final until November 1, 2012 the decision will not be treated as law until November 1, 2012.  Therefore, if the Gillette decision is vacated, reversed, or modified after October 15, 2012, the FTB’s opinion will be that there was no change in law and the LCUP will be imposed on any taxpayer that under reports their taxes.

Protective Claims for Refund

Although the Franchise Tax Board’s position is that taxpayer’s should not elect to use the MTC’s apportionment method retroactively, the FTB has provided guidance for taxpayer that wish to file a protective claim for refund electing to apply the MTC’s apportionment formula on their website.

For Further Information:

Franchise Tax Board – FTB Notice 2012-01

Franchise Tax Board – Large Corporate Understatement Penalty