The California FTB recently released a settlement initiative for taxpayers involved in microcaptive or syndicated conservation easement transactions. Taxpayers who enter into the settlement program will not be able to claim any tax benefits associated with the respective transaction. Taxpayers who have not been contacted by the IRS or FTB will not have to pay any penalties. Those who are under audit but have not yet received a Notice of Proposed Partnership Adjustment  (“NOPPA”) will have to pay a 20% penalty. Taxpayers who have already received a NOPPA will have to pay a 20% penalty and interest-based penalty. The settlement initiative closes November 17, 2023, so taxpayers have a small window to agree to the terms.

At first blush the settlement offer does not seem to be much of a concession by the FTB. But considering the draconian penalties imposed by the FTB, taxpayers should at least consider whether the offer makes sense for them. The FTB will often impose non-economic substance, fraud, accuracy, interest, and reportable transaction penalties on conservation easement and microcaptive cases. Unlike the IRS, the FTB actually stacks many of these penalties. This means a taxpayer could face penalties in excess of 60% or 70% of the total tax due. 

The prospect of penalties should not be the sole consideration in determining whether or not to settle. Taxpayers who invest in a syndicated conservation easement transaction will need to consider the quality of the original appraisal commissioned, which will require the help of an experienced appraiser. Unlike with microcaptives, taxpayers have won a number of conservation easement cases in Tax Court and will likely continue to do so. Those who invested in a captive insurance company will need to consider the facts of their arrangement and compare those facts to recent and older captive insurance case law. For example, a captive that offers medical or other stop-loss coverage or subcontractor default insurance could have a very strong case in Court.

It is important to note that the settlement initiative is specific to adjustments to California state tax and will not impact a taxpayer’s federal tax liability due. That means the IRS can still make adjustments to a taxpayer’s federal tax liability (and impose penalties) regardless of whether they settle with the FTB. Taxpayers who settle also run the risk of winning their case in Tax Court but being left to pay tax and penalties to the FTB.

If you have questions about the terms of the initiative or need help in analyzing your case, please reach out to a member of the Tax Controversy group.