When a taxpayer files a tax return after its due date (whether the original due date or a valid extension), the taxing authorities generally assess a late-filing penalty of 5% per month, or fraction thereof, up to a maximum of 25% of the unpaid tax shown on the return.
Example:
Assume a return reports a total tax liability of $10,000. The taxpayer had $8,000 of withholding, leaving a $2,000 balance due. If the return is filed 2 1/2 months late, the late-filing penalty is 15% of the balance due, or $300.
The California Franchise Tax Board (FTB) generally follows the same penalty structure as the IRS. However, California has a significant—and often overlooked—exception.
If the FTB issues a “Demand for Tax Return” letter with a stated response deadline, pay attention! If the taxpayer fails to file the return by that date, the penalty calculation changes dramatically. Instead of being based on the unpaid balance due, the penalty is computed on the total tax liability.
Using the same example above, the total tax liability was $10,000. Fifteen percent of that amount equals $1,500. In other words, by failing to file the return on time after receiving the Demand letter, the taxpayer’s late-filing penalty is five times higher than it would have been otherwise.
I am not aware of any other state that applies such a punitive formula for late-filed returns. The takeaway is simple but critical:
If you owe the FTB a return and receive a Demand for Tax Return letter, you should make every effort to file the return on or before the response date.
One final—and equally important—point: if a delinquent return is filed more than three years after its original due date (including extensions), the taxpayer permanently loses the right to claim any refund shown on that return. I have seen clients forfeit thousands of dollars in refunds simply because they delayed filing too long. Losing a refund for this reason is entirely avoidable—and unfortunate.