Posted by: Robert Horwitz | May 11, 2020

There’s No Getting Around the Pay First, Litigate Later Rule for California Taxes by Robert Horwitz

Most tax professionals are familiar with the Supreme Court’s Flora decision: a taxpayer has to pay in full a tax assessment plus penalties and interest before you can bring a refund suit.  California has had a similar rule, which has been part of the California Constitution since 1913.  Article XIII, sec. 32 of the California Constitution states:

No legal or equitable process shall issue in any proceeding in any court against this State or any officer thereof to prevent or enjoin the collection of any tax.  After payment of a tax claimed to be illegal, any action may be maintained to recover the tax paid, with interest, in such manner as may be provided by the Legislature.

Jeremy Daniel was an officer of a defunct California corporation that owed sales tax, penalties and interest.  The Board of Equalization assessed him for the unpaid sales tax, penalties and interest under its policy for assessing responsible persons and Reg. sec. 1702 (18 CCR sec. 1702).  Daniel filed a suit challenging the assessment against him without paying or filing a refund claim.  The case was dismissed.

Daniel subsequently filed an amended complaint after failing a portion of the assessment and filing a refund claim. The amended complaint against  the California Department of Tax and Fee Administration (CDTFA), successor to the Board of Equalization.  The amended complaint did not directly challenge the assessment.  Instead, it alleged that policy and regulation for assessing persons for unpaid sales tax was illegal and unconstitutional.  It prayed for a declaration that the policy and regulation were illegal and unconstitutional and any assessment based on the policy and regulation was not a tax under the California constitution.  The CDTFA filed a demurrer on the ground that the complaint was barred by sec. 32.  The superior court denied the demurrer, holding that the action was to determine the validity of a regulation, not to determine the validity of an assessment against an individual taxpayer or for a refund of tax.  Thus, according to the superior court the pay first, litigate later rule did not apply.  The CDTFA petitioned the Court of Appeal for a writ of mandate.  The Court granted the writ in California Department of Tax and Fee Administration v. Superior Court (May 7, 2020) Docket No. B294400

Finding that the writ petition presented a “significant issue” of “great public interest” the Court of Appeal denied a motion to dismiss the writ.  It then addressed the two questions raised by the petition: a) whether sec. 32 (which the Court termed the “pay first, litigate later” or “pay up or shut up” rule) bars the suit and b) whether Government Code sec. 11350, which authorizes declaratory judgment actions to determine the validity or governmental regulations carves out an exception to sec. 32.  The Court answered the first question “yes” and the second question “no.”

With respect to the first, the Court stated that sec. 32 bars a taxpayer from maintaining any action the net effect of which would be to resolve his liability for a disputed tax unless he pays the entire amount owed with penalties.  Because Daniel had not paid the tax in full and followed the procedures established for bringing a refund suit, sec. 32 barred his action for declaratory relief.   It rejected his argument that he could proceed as a member of the general public or as an officer of a new corporation to whom the regulation may apply in the future since allowing a taxpayer to proceed on that basis would make sec. 32 “a dead letter.”

The Court then turned to the second question.  Gov. Code sec. 11350 allows “any interested person” to obtain a declaration as to the validity of any regulation.  The Court held that this declaration does not exempt the action from sec. 32’s reach.  It gave three reasons for its conclusion:

First, under the rules of statutory construction, sec. 11350 does not on its face exempt claims from the reach of sec. 32’s pay first requirement.  Sec. 32 controls tax actions so that an action for declaratory relief that would result in invalidating an assessment cannot be maintained.

Second, the purpose of sec. 11350 is to provide an avenue for relief where none previously existed.  Taxpayers have always had an avenue for relief from a tax assessment: they can pay the tax and then pursue a claim for refund.

Third, the California Supreme Court has “strongly suggested” that sec. 11350 is not meant to be an exception to sec. 32.

The Court rejected two final claims of Daniel: a) that he is not seeking to determine the amount of tax he owes, but to determine whether the assessment is unconstitutional since by its very terms sec. 32 applies where a taxpayer claims a tax is “illegal;” b) that he is not seeking to enjoin collection, since that would be the effect of granting the relief requested.

The Court remanded to case to the superior court with instructions to dismiss the amended complaint without leave to amend.

Tax litigation in California reminds me of an old Chicago saying about politics:  if you wanna play you gotta pay.

Contact Robert S. Horwitz at or 310.281.3200   Mr. Horwitz is a principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending criminal tax investigations and prosecutions.

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