County of Sonoma Agenda Item Summary Report

Transcription

1 County of Sonoma Agenda Item Summary Report Agenda Item Number: 68A (This Section for use by Clerk of the Board Only.) Clerk of the Board 575 Administration Drive Santa Rosa, CA To: Board of Supervisors Board Agenda Date: December 13, 2016 Vote Requirement: 4/5 Department or Agency Name(s): Auditor-Controller-Treasurer-Tax Collector (ACTTC) and County Counsel Staff Name and Phone Number: Donna Dunk Bruce Goldstein Title: IRS Appeal and Sonoma County Payroll Process Audit Recommended Actions: Supervisorial District(s): All 1. Direct County Counsel to take all steps necessary to continue to challenge and favorably resolve the inappropriate tax levy by the Internal Revenue Service including any related penalties and interest. (Majority) 2. Review and accept the Sonoma County Payroll Process Internal Audit Report for the period July 1, 2011 through June 30, 2015, which includes a significant subsequent event regarding the discovery of penalties and interest assessed by the IRS. (Majority) 3. Adopt a FY budget resolution totaling $4.7 million to authorize the Auditor-Controller- Treasurer-Tax Collector (ACTTC) and County Administrator (CAO) to record a general fund payable to the IRS at June 30, 2016, and make payments to the IRS in amounts not to exceed $4.0 million to preserve appeal rights and safe guard County credit rating and financial status, and record a general fund payable at June 30, 2016, to reimburse to the Unemployment Insurance Internal Service Fund for penalties and interest payments made to the Employment Development Department (EDD) in an amount of $674,000. (4/5 Vote) 4. Adopt a FY budget resolution totaling $525,000 to authorize the ACTTC and CAO to make payments to the IRS in amounts not to exceed $300,000 for additional penalties that may have accrued to IRS accounts and encumber a legal services agreement in an amount not to exceed $225,000. (4/5 Vote) 5. Authorize County Counsel to enter into agreements with the Hanson Bridgett LLP law firm and/or other lawyers for legal services to represent the ACTTC and the County regarding the tax dispute in an aggregate total not to exceed $225,000. (4/5 Vote) Executive Summary: This item authorizes County Counsel to continue to challenge inappropriate tax levies and potential related penalties and interest with regard to the IRS failure to properly allocate past tax payments

2 among separate legal entities. In addition to engaging outside counsel to assist in the effort, approval of the proposed Resolution would also authorize payment to address the IRS disputed November 17, 2016 payment demand. Authorization of a payment not to exceed $4.3 million is requested to preserve appeal rights, prevent a lien, and/or otherwise protect the County s financial status. The item also requests acceptance of the Payroll Process Audit Report and the ability to make corresponding accounting adjustments. Discussion: Background In January 2016, a draft of an internal audit made the ACTTC s Office aware of an accounting error by ACTTC staff that resulted in a number of employment tax issues during the period from January 2011 through December 2015 as follows: 1. All federal employment taxes were paid timely during that period but were credited to the wrong IRS accounts. The County maintained three accounts during that time one for the County, one for the Community Development Commission (CDC), and one for the Sonoma Marin Area Rail Transit (SMART). Payments made for all three entities by the ACTTC were timely paid but were miscoded. The miscoding resulted in these payments primarily credited to the County account, creating an overpayment in the County s account and underpayment in the other accounts. The IRS has demanded penalties and interest on these phantom underpayments. 2. Several State and federal employment tax returns were filed late due to obstacles in the County implementing a new payroll system and difficulty in reporting features functions. 3. State employment tax penalties and interest payments were also made to the EDD during this period of time. The amounts paid are currently under appeal. Starting in February, 2016, ACTTC staff met with an IRS Representative (Representative) to discuss the resolution of the County s employment tax accounts. During that meeting, staff provided the Representative with copies of bank statements and amounts demonstrating that the required tax payments were transmitted timely every two weeks. At the conclusion of the meeting, the Representative indicated that she understood that payments had been transmitted timely to the wrong accounts and that she would process paperwork to properly credit the payments. At that time, she indicated that penalties and interest should be abated. ACTTC staff also discussed the issue of tax returns filed late and the need to amend some returns. The Representative agreed that problems associated with implementation of a new payroll system in January 2011 constituted good cause for filing late tax returns and that she anticipated those penalties and interest charges could also be abated. Based on the Representative s statements, staff proceeded to provide the IRS with the information requested so that the IRS could make the account adjustments to resolve the claim. On March 15, 2016, the ACTTC s Office reported to your Board issues with state employment taxes that had come to light in January 2016 and sought approval from your Board to work with Counsel to appeal any payments of penalties and interest. (An appeal hearing with the EDD has not yet been scheduled.) Although it was mentioned in the Report, at that time, the IRS issue was not deemed significant as no penalty and interest payments had been made, all employment taxes were transmitted timely, and the Representative had recently acknowledged the accounting error and had committed the IRS to work in good faith to resolve the County, CDC and SMART account imbalances.

3 Over the next several months the IRS inexplicably reneged on its commitment. ACTTC staff has provided all information requested and offered its own technical assistance to insure that the transfers between the accounts were properly made. During this time, the Representative became increasingly erratic and difficult to work with, cancelled meetings, and ultimately was unresponsive. At the end of June 2016, ACTTC staff became concerned that the requested and agreed upon transfers were not made. On June 29, 2016, without warning, the Representative informed staff that her supervisor instructed her to place a lien on the County s bank accounts if the County did not pay a still undetermined liability by October Due to the seriousness of the lien threat, ACTTC immediately reached out to County Counsel for assistance. County Counsel retained outside tax counsel to facilitate resolution of this matter. Outside counsel contacted the Representative to discuss the County s employment tax issue. During a phone conference with outside counsel on August 4, 2016, the Representative again indicated that the requested adjustments could be made and applied to avoid penalties and interest. On September 9, 2016, outside counsel submitted a letter of instruction to the Representative that not only established the legal basis for applying credits and refunds but provided detailed instructions to implement the County s requests. Outside counsel also arranged an in-person meeting with the Representative and her supervisor for September 21, As previously, this meetings was cancelled at the last minute by the Representative. Rather than reschedule the meeting, on September 26, 2016 the Representative requested that the previously submitted information now be provided in a different format. On October 4, 2016, outside counsel communicated to the Representative that it was crucial to reschedule the September 21, 2016 meeting and expressed a willingness to be available any time during the week of October 4, 2016, or the following week. The Representative stated that earliest they could be available was by phone on October 19, Outside counsel met by conference call with the Representative and her supervisor on that date, and during that call, the supervisor suddenly and unexpectedly stated that the IRS will take action in two days, on October 21, 2016, to lien and levy the County s bank accounts effective Monday, October 24, 2016, unless the County immediately paid $2 million or filed for a lien appeal hearing. During this call, outside counsel requested additional time to obtain Board approval to make a payment. The IRS supervisor refused this request. On October 20, 2016, the County filed a lien appeal which was granted. The reviewer found that the tax lien violated the County s due process on two grounds: (i) the IRS failed to provide the County sufficient notice and (ii) the lien failed to provide certainty as to the actual amount owed. Undaunted, on November 17, 2016, the IRS sent a new demand totaling over $4 million and again threatened to file a new lien on the County s accounts if payment was not made by December 14, Although the County vigorously disputes the liability, it is with this threat in place that the ACTTC seeks authority to make this disputed payment if another stay of the lien cannot be achieved in a timely manner or payment is necessary to best preserve the County s position on appeal.

4 Discussion Since February 2016, the County has dealt with the IRS in good faith and has been led to believe that the requested adjustments would be made and applicable penalties and interest abated. The autocratic actions by the Collections Unit has led the County to engage with the IRS Taxpayer Advocacy Service (TAS) which appears to agree that the Collection s Unit has applied the wrong methodology and ignored that another government agency made payments on time and in good faith. In addition, Congressman Mike Thompson s Office has assisted in asking that the IRS follow its own guidelines and act in a responsible manner. On November 14, 2016, IRS Collections filed an assessment against the County of Sonoma, the Sonoma County Community Development Commission (CDC) and the Sonoma-Marin Area Rail Transit (SMART) for alleged employment tax liability, as well as related penalties and interest, for tax year 2011 through the third quarter of On November 17, 2016, the Collections Unit adjusted the total amount of the assessment to $3,973,559. As detailed above, this action was preceded by months of interaction between the IRS Collections Office and the County in which the County attempted to insure payments received by the IRS from the County had been properly applied. On November 17, 2016, the County, CDC and SMART jointly filed a collections due process hearing with IRS Appeals challenging the outstanding employment tax liability calculation, as well as the assessment of penalties and interest, that is shown on the current IRS assessment. The County, CDC and SMART believe that had the IRS properly handled the crediting of the payments made by the County, the outstanding tax liability, if any, would be significantly less, and that the IRS should waive most of the assessed penalties and interest in this situation. Unfortunately, the Collections Unit continues to assert that it will file a lien against the County, CDC and SMART if the full amount assessed is not paid by December 14, even though there is an appeal pending on these issues. The County, CDC and SMART have made the Collections Unit aware that the filing of a lien would cause significant hardship. County staff an outside counsel believe the County, CDC, and SMART will prevail on the merits of their appeal. However, the appeals process does not prevent the Collections Unit from filing a lien. Without assurance from the Collections Unit that it will not file a lien during the period of appeal, the County feels it must seek authorization from the Board of Supervisors now to pay the disputed amounts if necessary in order to stop the lien process. If the full amount claimed by the IRS is paid, the County, CDC and SMART will immediately take appropriate further action to seek a refund of the amounts the County, CDC and SMART believe are erroneously being collected. While we maintain our position, the County simply cannot allow its bank accounts to be frozen. Such an action would prevent the County from performing vital services could negatively impact our ability to receive grant funds and reduce our credit rating. If the County appeal is successful, the IRS will be forced to return funds wrongly collected. This Board action also requests the acceptance of the Payroll Process Audit for the period January 2011 through June 30, The Payroll Process Audit has a number of observations and recommendations which management intends to implement or has already implemented. That audit is attached for your review.

5 FY budget adjustments totaling $4.7 million are necessary to record a general fund payable to the IRS as if June 30, 2016, in accordance with generally accepted accounting principal (GAAP) and make payments to the IRS in amounts not to exceed $4.0 million, and to record a general fund payable to reimburse the Unemployment Insurance ISF for EDD penalties and interest payments of $700,000. The FY unanticipated expenditures will be financed by a release of $3.5 million from the Malpractice Insurance ISF originally established for County Hospital claims which is no longer needed due to statutory claim limits and an early payment of $1.15 million from the Human Resources Management System (HRMS) associated with the general fund advance for system implementation. FY budget adjustments are requested to pay additional IRS penalties up to $300,000 that may be due and payable as of December 14, 2016, but to-date have not posted to IRS accounts and for the outside legal services agreement for tax disputes in an amount not to exceed $225,000. FY budget adjustments will be financed with an additional HRMS early repayment to the general fund. Since this issue was discovered in January 2016, ACTTC staff have worked extensively to identify the cause of and remedies to this issue. As a result, the ACTTC s office has made significant numbers of changes and improvements in the bi-weekly payroll processing and tax filing areas. Additional controls have been put into place, which will prevent this issue from occurring again such as assigned new management to the Payroll Division, implemented bi-weekly reporting on the payroll process including all remittances and tax return filings, redirected all mail to be opened and distributed centrally, and separated remittances to the IRS into the appropriate accounts. Contract for Legal Services: In August 2016, the Hanson Bridgett law firm was retained for $50,000 to assist the County in resolving these employment tax issues with the EDD and the IRS. A new contract is needed for Hanson Bridgett to continue to support the County throughout the appeal process. Staff requests the approval of legal services contract(s) with Hanson Bridgett, and other counsel if necessary to represent the County and the ACTTC regarding the tax dispute in total contract amounts not to exceed $225,000 for legal services. Prior Board Actions: March 15, 2016: Item to ratify the ACTTC s decision to seek administrative relief for reasonable cause from penalties associated with late payroll tax filings. Strategic Plan Alignment Not Applicable

6 Fiscal Summary Expenditures Funding Sources Budgeted Expenses FY Adopted Additional Appropriation Requested $525,000 Total Expenditures $525,000 General Fund/WA GF State/Federal Fees/Other $525,000 Use of Fund Balance Contingencies Total Sources $525,000 FY Projected FY Projected Narrative Explanation of Fiscal Impacts: FY budget adjustments totaling $4.7M (not included in the table above) increases expenditure appropriations in the Non-Departmental General Fund budget to cover the IRS payment and to reimburse the Unemployment Insurance ISF for EDD penalty and interest payments. The unanticipated expenditure will be financed as follows: 1) Release of $3.5M in the Malpractice Insurance Internal Service Fund originally established to cover County Hospital claims which is no longer needed as given statutory claim limits; and 2) Receive $1.2M early payment from the Human Resources Management System (HRMS) associated with the General Fund advanced for system implementation. FY budget adjustment totaling $525,000 to cover additional IRS accrued amounts and increased legal services agreement will be financed with additional HRMS repayment to the General Fund. Staffing Impacts Position Title (Payroll Classification) Monthly Salary Range (A I Step) Additions (Number) Deletions (Number) Narrative Explanation of Staffing Impacts (If Required): Attachments: Internal Audit: Sonoma County Payroll Process

7 Resolutions Related Items On File with the Clerk of the Board: Agreement for Legal Services with Hanson Bridgett