Wertin v. Franchise Tax Bd.

• Decision Date: 21 December 1998
• Docket Number: Nos. B114114,B117076,s. B114114
• Citation: 80 Cal.Rptr.2d 644,68 Cal.App.4th 961
• Court: California Court of Appeals Court of Appeals
• Parties: , 99 Cal. Daily Op. Serv. 9268, 98 Daily Journal D.A.R. 12,917 John E. WERTIN et al., Plaintiffs and Respondents, v. FRANCHISE TAX BOARD, Defendant and Appellant.

Page 644

80 Cal.Rptr.2d 644

68 Cal.App.4th 961, 99 Cal. Daily Op. Serv. 9268,

98 Daily Journal D.A.R. 12,917

John E. WERTIN et al., Plaintiffs and Respondents, v. FRANCHISE TAX BOARD, Defendant and Appellant.

Nos. B114114, B117076.

Court of Appeal, Second District, Division 7, California.

Dec. 21, 1998.

Review Denied March 31, 1999.

Daniel E. Lungren, Attorney General, David S. Chaney, Supervising Deputy Attorney General, and Felix E. Leatherwood, Deputy Attorney General, for Defendant and Appellant.

Voss, Cook & Thel, James G. Damon and M. Edward Mishow, Newport Beach, for Plaintiffs and Respondents.

LILLIE, P.J.

The Franchise Tax Board (FTB) appeals from an adverse judgment after a court trial The Franchise Tax Board also appeals from a post-judgment order awarding the Wertins their attorneys' fees under Revenue & Taxation Code section 19717. The trial court found under Revenue & Taxation Code section 19717 the Franchise Tax Board's position in the Wertins' tax refund case was not "substantially justified," thus entitling the Wertins to an award of fees. The trial court also awarded fees in excess of the statutory rate of $75.00 per hour on the grounds of the limited availability of qualified attorneys for the issue litigated. On appeal, the Franchise Tax Board contends its position had a reasonable basis in both law and fact and was thus "substantially justified," and the Wertins failed to demonstrate they were entitled to enhanced attorneys' fees.

in an action brought by John and Barbara Wertin (the Wertins) for a refund of assessed delinquent taxes and interest thereon. The trial court found the Franchise Tax Board's issuance of a notice of proposed assessment of a tax deficiency without reviewing the Wertins' tax returns for the relevant year rendered the Franchise Tax Board's assessment invalid. On appeal, the Franchise Tax Board argues the trial court erred in applying federal case law and standards to a question of California tax law, under which it asserts it was not required to review the taxpayers' actual returns before issuing the notice of proposed deficiency. The Franchise Tax Board also contends the trial court improperly awarded interest to the Wertins because they failed to file a claim for interest and thus failed to exhaust their administrative remedies.

FACTUAL BACKGROUND AND PROCEDURAL HISTORY

In 1983, plaintiff John E. Wertin was a partner in a California general partnership known as Pacific Securities (Pacific) and a shareholder in two Subchapter "S" corporations known as TNPC, Inc., and Christina Securities (the corporations). ¹ These entities timely filed their 1983 federal and California tax returns for the tax year ending December 31, 1983. The Internal Revenue Service (IRS) later issued to Pacific a notice of Final Partnership Administrative Adjustments in which the IRS disallowed certain of Pacific's losses and deductions. As a result, the IRS claimed additional taxes and interest were due.

Pacific disputed the IRS's disallowance, and filed a proceeding in the United States Tax Court seeking a readjustment of the disallowed items. The Tax Court denied any relief, and on October 26, 1992, the IRS notified plaintiffs certain changes and adjustments were being made to their Joint Federal 1983 tax returns on account of their interests in the entities. The IRS enclosed form 1092C explaining the calculation of the adjustments. Plaintiffs then notified appellant (FTB) by letter dated December 18, 1992, of the IRS adjustments to their federal return, and enclosed with their letter to the FTB a copy of the IRS's form 1092C.

On January 12, 1993, the FTB sent a form letter to the Wertins advising them of its receipt of their December 18, 1992, letter and requesting copies of (1) the initial federal audit report detailing the initial federal computations, (2) the settlement federal audit report detailing the final federal computations, and (3) the Wertins' complete state tax returns for the years audited. The Wertins responded by letter dated January 27, 1993, and advised the FTB that items Nos. 1 and 2 requested by the FTB had never been provided to the Wertins by the IRS. The Wertins advised the FTB that instead of the "audit reports" requested by the FTB, the IRS had sent the Wertins the form 1092C explaining the IRS's position on the necessary tax adjustments. With respect to item No. 3, the Wertins advised the FTB their 1983 state return had been timely filed and was therefore in the FTB's possession. The Wertins advised the FTB if the FTB did not have a copy of their return, they would be able to retrieve it from storage with sufficient advance notice.

On May 4, 1993, the FTB sent the Wertins a letter advising them their response to its January 12, 1993, letter was incomplete. In spite of the enclosure of the IRS form 1092C, the FTB advised the Wertins "your letter [of January 27, 1993] did not provide us with any information on the changes made by the IRS." Although the IRS form 1092C specifically referred to tax year 1983, the FTB claimed it did not know which tax year the Wertins referred to in their letter because their letter did not specifically refer to tax year 1983. The FTB also advised the Wertins that although their 1983 returns had been timely filed with the FTB, the FTB did not keep old tax returns and requested a copy of the return.

The Wertins responded on May 20, 1993, objecting to the FTB's letter and advised the FTB that the Wertins' December 18, 1992, letter had advised the IRS adjustments set forth in the IRS's October 26, 1992, notice were final, the form 1092C provided by the Wertins was sufficient compliance with the FTB's request for IRS "audit reports" and that the Wertins would attempt to locate their 1983 state tax return, which was in storage.

On June 11, 1993, the FTB issued a notice of proposed assessment. The notice stated, "notice is hereby given that [the FTB] propose[s] to assess a deficiency for the taxable year shown below." The notice estimated the Wertins' 1983 income, made adjustments, and assessed an additional $147,262 against plaintiffs for tax year 1983 and interest thereon of $230,369.69. The notice further informed plaintiffs the assessment notice was then being issued because of the impending expiration of the statute of limitations. The FTB stated the adjustment was based upon the "federal audit report submitted by the taxpayer" and the income on the notice had been calculated based upon "your net tax liability since we did not receive a copy of your return as requested."

Because the FTB had issued the assessment without reviewing plaintiffs' tax returns, plaintiffs filed a Protest with the FTB on August 6, 1993. The Wertins asserted the statute of limitations within which the FTB could issue a proposed assessment based on the federal audit had expired because the FTB had failed to mail a valid notice of assessment within six months of their December 18, 1992, letter. The Wertins protested both the tax assessed and the interest accrued thereon. In September, 1994, the FTB corrected the amounts claimed to be owed, and advised plaintiffs $87,786 of additional taxes, plus $158,310.26 of interest, were owed.

On November 21, 1994, plaintiffs paid the additional taxes to the FTB under protest and commenced the within action on June 2, 1995. Their November 21, 1994, letter to the FTB clearly stated "this letter constitutes a claim for refund" of the amount of taxes the Wertins were paying under protest. The Wertins further incorporated by reference into their letter of November 21, 1994, their communication of August 6, 1993 (the Protest). In protest, the Wertins stated they objected both to the taxes and interest sought to be assessed by the FTB.

The matter was tried to the court on November 26 and 27, 1996. The Wertins argued the FTB failed to issue a valid notice of assessment because the FTB had not reviewed the Wertins' tax return prior to issuing the assessment and thus had not validly "determined" the amount of tax due as required by statute. (Rev. & Tax Code, § 18583; Scar v. C.I.R. (9th Cir.1987) 814 F.2d 1363.) As a corollary argument, they also contended because the assessment was not valid, it was not served within the six-month statutory period and was therefore time-barred. (Rev. & Tax.Code, § 18586.3.)

The trial court issued a statement of decision in which it held pursuant to Revenue and Taxation Code sections 18451 and 18586.3, a taxpayer had 90 days to report to the FTB after the IRS had made a final determination changing or correcting the taxpayer's tax liability for a prior year; after that, the FTB had six months within which to send the taxpayer a notice of proposed deficiency adjustment. Therefore, if the FTB did not mail a valid notice of proposed assessment to the Wertins within six months, the statute of limitations of Revenue and Taxation Code section 18586.3 expired and the FTB could not collect the taxes.

The trial court found the key factor in resolving whether the notice of proposed assessment was valid was whether the FTB had validly determined there was a deficiency due. (See Rev. & Tax Code, § 19033; Int.Rev.Code. § 6212(a).) The trial court concluded the FTB's notice of proposed assessment was invalid because a deficiency could not be "determined" without a review of the Wertins' tax return, and the notice of proposed assessment disclosed on its face it had been prepared without such a review. (Scar v. C.I. R., supra, 814 F.2d 1363; see also Kong v. Commissioner (1990) 60 T.C.M. 696.) Finally, the trial court disagreed with the FTB it was the taxpayers' duty to maintain and produce a copy of their return for the tax year in question because no statutory authority imposed such a duty on the taxpayer. The trial court ordered the FTB refund to the Wertins the taxes and interest previously paid by the Wertins, and also awarded the Wertins prejudgment interest at the rate of 10 percent...