CA Tax: Back Taxes, 831(b) Elections and Divorce

California CPA magazine: July2008

by Len Williams, CPA

It is possible to specify how payments to the Employment Development Department for back taxes will be directed.

The situation that helped to clarify this involved a taxpayer who owed back EDD taxes, penalties and interest from 2005 and 2006. The EDD had levies on two of the client’s sources of revenue, and the EDD was getting around $23,000 per month.

A CPA was representing his client in this matter, and asked the EDD if it was permissible for the client to specify how to apply the payments that the EDD received via the levy. The EDD held that it is possible to do so, irrespective of whether the payment is voluntary or involuntary. In addition, the EDD will accept a letter specifying how to direct all future payments, whether voluntary or not.

This is different from the IRS, which will not allow the taxpayer to specify the application of involuntary payments; and for voluntary payments, a statement specifying how it is to be applied must accompany each payment.

The EDD claims this discretion via Unemployment Insurance Code Sec. 1110.1.

There are several reasons why a taxpayer may want to exercise this alternative. Assuming for example, a cash-basis taxpayer, such a designation will help produce a tax  deduction, since the penalties aren’t deductible. On the other hand, if the taxpayer wants to show higher profits, then the choice would be to allocate the payments to penalties first.

83(b) Elections and E-filing
The IRS has received several inquiries about e-file and the 83(b) Election. The current IRS policy on filing the 83(b) Election is as follows: if the election the taxpayer is choosing to make requires a signature and can be filed with the tax return, then that tax return must be filed on paper.

If the election the taxpayer is choosing to make requires that a copy of the original election, which has already been filed with the IRS, be attached to the tax return, even though the original election is signed, the copy does not have to be signed. Therefore, the copy in the latter example can be put into an Election Explanation Record (if software permits) and e-filed.

When Divorcing, When May One File as Single?
A common source of confusion among taxpayers and tax professionals alike is the use of the term “legally separated” when answering the above question.
In addition, the term’s use may vary from one state to another.

Within California, legal separation is a judicial proceeding, an alternative status to divorce. It is rarely used, but is evidenced by a Separation Order, signed by a judge. It is most often used for people who, for religious reasons, don’t want a divorce, but want a spouse out of his or her life. If there are divorce proceedings that are not final, then the person is not “legally separated.”

If one is legally separated, he or she may not remarry without going back to court and dissolving the marriage.

If there are children and if the couple lived apart for at least six months, and has his or her child living with him or her, then the party meeting those qualifications may file as head-of-household. If there are two children, that usually can be worked out amicably. If there is only one child, then the parent with whom the child lived for more than 6 months may file as head-of-household, and the other one is stuck with filing as married filing separately.

EDD Audits
The following sources, account for about 90 percent of the EDD’s audit leads:
•    1099 Forms filed.
•    Internet-based complaints.
•    EDD hot line complaints.
•    Industry specific initiative: surreptitious investigative group, large employers with multiple locations and public works projects.
•    Employer/employee inquiries.
•    IRS audit data.
•    Employer contact.
The remaining 10 percent come from:
•    Obstructed claims-worker files UI claim and EDD has not record of wages. Usually employer has treated the worker as an independent contractor, so the Tax Agency audits the employer.
•    Employer/employee inquiries.
•    Investigation Division.
•    Continuation Audits.
•    Government agency referrals.

E-verification of New Employees (Pending)
AB 2102, currently in the Assembly, would require that certain employers (state agencies and anyone who contracts with state agencies) would have to use E-Verify (an internet-based system that allows employers to electronically verify the employment eligibility of their newly hired employees) to ensure that a new employee is allowed to work in the United States.

Thanks to the following CPAs for their contributions to this column: Barbara Aue, Jim Counts, and Don Yamagishi. 

Leonard W. Williams, CPA is a Sunnyvale-based sole practitioner. A member of CalCPA’s Committee on Taxation, the AICPA Tax Division and a former Peninsula Chapter president, you can reach him at williams@lwwilliamscpa.com.