State Tax Agency Targets 150 Suspected of Cheating

Bad news is in the mail for a handful of suspected California tax cheats.

The Franchise Tax Board, the state’s tax collection agency, said Tuesday that it is sending audit notices to 150 rich Californians believed to be using suspect tax shelters to reduce their income taxes. Particular attention will be paid to so-called listed transactions -- tax shelters that federal tax authorities have already identified and consider to be abusive.

“California has zero tolerance for people who cheat the system through illegal tax shelters,” state Controller Steve Westly said at a news conference.

The move is just the beginning of what’s expected to be a broader sweep aimed at tax cheating that involves illegal tax shelters. Legal tax shelters use legitimate expenses or economic losses to shelter income from taxes and can be anything from a home mortgage, which produces interest write-offs, to investment losses. Illegal tax shelters provide tax write-offs, but with no real corresponding costs to the taxpayer.

Experts believe a handful of identified illegal shelters, such as offshore securities swaps, “contingent” sales and corporate re-incorporations, are costing California around $600 million a year.

In a re-incorporation, for example, a business owner creates a so-called S corporation in Nevada, which has no state income tax. But the business owner remains a resident of California, and the bulk of the company’s business is done in the Golden State. Although promoters of these schemes maintain that S corporations can be taxed only in the state where they are incorporated, state tax officials maintain that California residents are taxable on income from all sources.

The first round of FTB audits is aimed at people with high six-figure and seven-figure incomes, said Denise Azimi, a spokeswoman for the state tax agency. Another group of audit letters, expected out in the next month or two, will target middle-income filers, she said.

The FTB uses data from the Internal Revenue Service, banks and brokers to identify potential audit targets. If taxpayers are found to have abused the system, the taxpayer would owe the underpaid tax, plus interest and a penalty amounting to 20% of the underpayment.

Pending bills in the state Legislature, which Westly said he strongly supports, would substantially boost those penalties and give the state greater latitude when seeking information about taxpayers. The state also is in the process of signing a deal with the IRS that would have state and federal examiners teaming up to go after tax cheats in a more efficient way.

“We want to send a strong message,” Westly said. “Don’t even think about cheating on your taxes in the state of California.”