Taxable Talk

For Californians, there's no sign of a budget compromise. The Democrats are proposing massive tax increases; the Republicans won't consider a penny in new taxes; and Governor Schwarzenegger wants a solution but isn't putting any pressure on anyone.

The latest:

1. The Wall Street Journal ran an op-ed piece that proclaimed California is #1. But it's not number one in a good way; rather, it's leading the country in the tax rate. The Journal noted:

California faces a $15 billion budget deficit and Democrats who rule the state Legislature have proposed closing the gap with a $9.7 billion tax hike on business and "the rich." There's a movie that describes this idea: Clueless...

This latest tax gambit was unveiled, ironically enough, within days of two very large California employers announcing they are saying, in the famous words of Governor Arnold Schwarzenegger, "hasta la vista, baby" to the state. First, the AAA auto club declared it will close its call centers in California, meaning that 900 jobs will move to other states. "It costs more to do business in California," said a AAA press release, in the understatement of the year.

2. The Contra Costa Times published an op-ed piece from the "Proposition 13 Reform Tax Force" that advocates a split-roll property tax scheme. The op-ed doesn't mention that a split-roll has been defeated by the voters of California before. And that relatively low property taxes is about the only favorable tax factor in California.

3. Governor Schwarzenegger on Thursday broached the idea of a sales tax increase to balance the budget.

4. The Los Angeles Times published an article noting that economists are unsure of whether the Democrats' proposed income tax increase would actually bring in the revenue that the Democrats forecast. Patrick Fleenor, chief economist for the Tax Foundation, is quoted as stating, "But what is often missed is the firm that would have popped up in L.A. but is instead popping up outside Las Vegas. People on the cusp of moving to California or leaving California would certainly be affected by this [proposed tax increase]."

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Meanwhile, Democrats in the legislature are stating that there are no cuts to be made in programs and that only revenue increases will be considered. Republicans state the only thing they'll look at are cuts in programs. I'm leaving on vacation tomorrow. I'm very confident that California won't have a budget when I return on August 4th.

I don't watch soap operas on television. I should add the caveat that I don't watch much television, period. But all Californians are going to get to watch the annual installment of As the Budget Churns.

California has a statutory deadline of June 30th for enactment of a budget. As usual, that deadline has come and gone. California's constitution requires a 2/3 vote in order for passage of a budget. That means that Democrats must get Republican support for a budget or it can't pass.

Democrats proposed last week to increase taxes (shock, shock). Two new brackets would be added: a 10% bracket and an 11% bracket. They also proposed a hike in California's corporation tax (from 8.8% to 9.3%). They also defeated Governor Schwarzenegger's proposed budget cuts. Republicans vowed that the Democrats' proposals are doa.

The North County Times (of San Diego County) has an excellent editorial on the subject.

[Assembly Speaker Karen] Bass spoke after the Democrats presented their plan to fix the deficit: $8.2 billion in new money, primarily through tax increases. Bass said, in essence, "no more cuts" and fell back onto the controlling Democrats' long-standing line that California does not have a spending problem; "it has a revenue problem." (Republicans are holding firm to a no-tax-increase stance.)

And, in hyperbole at its lowest extreme, Bass asserted there was nothing left to cut except the pay of elementary school teachers, high school principals or firefighters.

Hogwash.

Any private business knows that one does not simply raise prices when facing a new year with projections of less income than anticipated. Instead, a business finds ways to maintain the core of its operations by cutting costs, doing without some things and, if need be, shrinking the work force, either by attrition, buyouts or layoffs.

Is that too much to ask our highly paid, full-time Legislature (now in another weeklong recess) to do, and on time?

Meanwhile, the economic development authorities in Las Vegas, Phoenix, and Denver may have yet another opportunity to snag ex-California businesses in the near future.

Question 1.

"Good afternoon Russ,

"I am a regular [poker] player online and I was wondering the policy in the state of California? Is there a certain amount and above that needs to be reported on your taxes? Since the money comes in overseas is there even a policy?"

The US Tax Code is quite explicit about gambling income: it's taxable. And whatever the source--US or foreign--all income is taxable unless Congress explicitly exempts it.

California taxes start with the Adjusted Gross Income from your US tax return. The only gambling income exempted on a California tax return is California lottery winnings.

Either report it or you are committing tax evasion.

Question 2.

"Hello, sir:

I AM 73 YEARS OLD AND WON A $1700.00 $1.00 TRIFECTA. I RECEIVED A W2-G FORM from Churchill Downs Racetrack but i don't know what or where to go with it.

The Form shows that no money has been withdrawn yet from the Winings. i understand that the Law states that in horseracing, a person owes taxes if the winnings are 300 times the wager. Therefore, if I played a $1.00 Trifectsa( I bet $36.00) i am liable. Right?

If so, my friend, what do I do now? I pay NO TAXES currently. The only money taken out of my check is a $93 amount for Medicare.

Can you please tell me how to proceed? I DO appreciate your help."

First, you owe tax on all gambling winnings whether or not you receive a W-2G. Your gambling winnings go on line 21 of Form 1040 (other income). You can deduct losses up to the amount of your winnings as an itemized deduction on Schedule A.

It sounds like your only other income is Social Security. Assuming that the $1700 is your only gambling winnings of 2008, you almost certainly won't have to pay income tax on your winnings--your Social Security won't be taxed and with just $1700 of income you won't owe any income tax. However, if you have other significant gambling winnings your Social Security could be taxed.

Question 3.

"I reside in New York City, and am planning on moving to Thailand at year-end and will be a professional gambler. I understand that if I'm out of the US for 330 days out of 365 I'm eligible for the Earned Income Exclusion."

So far so good....

"My question is how can I avoid New York taxes? How can New York tax me when I'm going to be a resident of Bangkok?"

At this point, cue Murray Head and One Night in Bangkok. Now that we have the appropriate theme in the background, here's the answer: Because they can.

Seriously, every US citizen is considered a resident of a US state or territory. You have a domicile (residency) in that state. Until you establish a domicile in another US state or territory you are considered a resident of whatever state you currently reside in. The toughest states in enforcing this are New York and California; both routinely conduct residency audits.

You may wish to consider first establishing residency in a state with no income tax, such as Texas, Florida, or Nevada, before moving to Thailand. You would need to sever your ties with New York and establish ties with your new state. You should stay in your new state for several months so that you truly become a resident of your new state.

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Just a reminder: This opinion is limited to the one or more Federal tax issues addressed in the opinion. Additional issues may exist that could affect the Federal tax treatment of the transaction or matter that is the subject of this opinion and the opinion does not consider or provide a conclusion with respect to any additional issues. With respect to any significant Federal tax issues outside the limited scope of this opinion, the article was not written, and cannot be used by the taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.

Proposition 13, the initiative that limited property tax increases, is blamed by liberals as one of the root causes of California's current budget problems. It's not.

The San Diego Union ran an editorial detailing what has happened to property tax revenues to the state since the passage of Proposition 13:

From fiscal 1980-81 – the year Proposition 13 took effect – through 2005-06, property tax revenue skyrocketed from $6.4 billion to $38.3 billion. That is an increase of more than 500 percent. So much for talk that the measure turned off the property tax spigot.

Remember this when our legislature complains that they don't have enough money, or that they need to increase taxes to balance the budget. They don't. They need to cut spending, and eliminate programs that California neither needs nor should have. The time for smoke and mirror has past; it's time to cut politically expedient and popular programs.

If you've ever driven from Southern California to Las Vegas, the first exit on Interstate-15 when you cross into Nevada is for Primm, site of three casinos. These casinos used to be owned by the Primm family but were sold to MGM (now MGM/Mirage) in 1998. (I believe that the Primm Casinos were later divested to Herbst Gaming.)

The family patriarch, Gary Primm, bought a yacht, the Prima Donna. It's a big yacht, 145 feet in length. The yacht is registered in the Cayman Islands and, according to Alexander Druft, attorney for Mr. Primm, was normally docked in Baja California.

The Orange County, California assessor believes that the yacht was docked part of the time during 2002 and 2006 in nearby Newport Beach, and Mr. Primm thus owes the county nearly $380,000 in property taxes (for 2003 and 2007, the years following the dockings). Mr. Primm has appealed the assessor's office ruling; he previously won an appeal regarding 2006 (based on 2005 dockings).

So is this "harassment" as claimed by Mr. Druft or is Webster Guillory, Orange County Assessor, correct when he states, "If he owns a big boat, even if he lives in Nevada, he's not docking it there." Well, I know Mr. Guillory is correct in that an ocean-going vessel isn't docked in Nevada. Still, given the precarious nature of California's finances it's not surprising that the assessor is looking under every rock (or at every dock) to find anything worth taxing.

News Story: Orange County Register

For Californians it's again time to vote. This coming Tuesday it's the June primary. Normally, that's when citizens of the Golden State get to vote in the presidential primary...but not this year (the presidential primary was back in February). However, votes in Congressional races and for the state legislature do occur on Tuesday.

There are two propositions on the ballot: propositions 98 & 99. Both deal with eminent domain, and based on the ballot title both would prevent eminent domain for taking private property for private uses.

However, the proponents of each initiative think that only their initiative gives the desired result. Proposition 98, according to its proponents, enacts real eminent domain reform while proposition 99 was passed by the legislature only to confuse the voters. If you believe proposition 99's proponents, it's the other way around: proposition 98 would cost local government too much while proposition 99 would bring real reform.

No matter what, come Tuesday exercise your right and vote. You can find your polling here.

Daniel Weintraub of the Sacramento Bee has an excellent article today on California's budget problems, their cause, and why certain areas of the budget will likely have to be cut (and will benefit from increased funding). If you want to know why we're in this situation, this article is a must-read.

The Supreme Court ruled today in Dept. of Revenue v. Davis that states can give preferential treatment to their own municipal bonds (over those of other states). Thus, the practice of paying state income tax on out-of-state municipal bonds will continue. The Supreme Court ruling was fractured, with Justice Souter's opinion, four concurring opinions, and two dissenting opinions.

The main impact of this decision is that municipal bonds will tend to be purchased by individuals who reside in that state, so that they can obtain the largest tax impact. The decision is good news for California, as a decision that would have invalidated preferential treatment would have likely cost the state millions of dollars in additional interest.


Link to previous coverage of this case on Taxable Talk

Governor Arnold Schwarzenegger announced his revised budget today. California is now looking at a $15.2 billion deficit, which the Governator is hoping to close by (a) selling bonds backed by expanding the California Lottery (raising $5 billion), (b) and cutting an additional $12.2 billion in additional spending cuts. If the lottery bonds don't happen Schwarzenegger proposes a "temporary" one cent increase in California's sales tax.

Both Republicans and Democrats in the legislature reacted negatively to the Governator's proposal. Bill Lockyer (D), Treasurer: "[This is a] sizable bet that Californians will double their current level of lottery participation within a few years." He doesn't think it's realistic.

President Pro Tem of the State Senate, Don Perata (D-Oakland) told Reuters: "Democrats are not going to accept this budget...I reject its defeatism."

Mike Villines, Assembly Minority Leader (R-Clovis), told AP: "The idea that we use the lottery to pay down debt is a good one. Tying it to borrowing is, I think, a mistake, and tying it to a tax is a mistake."

With Democrats still proposing to create new taxes to balance the budget and Republicans promising not to approve any new taxes, it still looks to me like the unstoppable force meeting the immovable object. A budget requires a 2/3 approval in both houses of the state legislature, so Democrats and Republicans will eventually have to come to an agreement. Expect the emphasis this year to be on "eventually" as I expect the budget to drag on well past the constitutional deadline for passage of June.

Press Coverage:
Associated Press
Reuters
San Jose Mercury

As California continues looking at a massive budget deficit (somewhere between $8 billion and $20 billion) some in the state legislature are looking to implement a tax on the Adult Entertainment Industry. A 25% tax on film production, strip, er, adult entertainment clubs, and pornographic videos.

Larry Kaplan, head of the California Branch of the Association of Club Executives, said that this proposed legislation would "...devastate the San Fernando Valley...[I]t would take $3.5 billion out of California." Matt Grey, a lobbyist for the Adult Entertainment Film Industry, told Reuters that it's cheaper to fly performers to Bucharest, Romania than to drive them to the Valley.

Meanwhile, Republicans are still promising to block all tax increases so it's likely that this porn tax is doa.

One of my favorite weekly reads is the Leonard Letter. Bill Leonard is one of the elected members of the Board of Equalization. Mr. Leonard notes,

"Late last year an article entitled "Why Is Buying Hot Chocolate So Confusing?"appeared in a tax journal. It was bandied about as an example of how difficult it is for California retailers to comply with the state's sales tax law. I asked the Board of Equalization staff to respond to the article and have now reviewed a 3 ½ page letter attempting to explain when hot chocolate is taxable. That it takes 3 ½ pages to answer what should be a simple yes-or-no question gives you a window into the absurdity that is state tax law."

The letter that Mr. Leonard references is here. The question arises as sales tax was collected on hot chocolate sold at a Starbucks inside a Target store but not inside a Safeway (grocery) store nor in the lobby of the Bank of America building in downtown San Francisco. From the letter:

"Sales and Use Tax Regulation 1602, Food Products, (copy enclosed), provides that generally tax does not apply to sales of food products for human consumption except as provided in Regulation 1503, 1574 and 1603. “Food products” include among other items, coffee, tea, noncarbonated and nonalcoholic beverages, breads, bakery products, pizzas, candy, confectionery, chewing gum and cookies. Generally, tax does not apply to sales of the above items except when they are sold under circumstances as provided in Regulations 1503, 1574 and 1603."

After nearly three pages of legalese the author of the letter notes, "Based on the information presented in the article, it is not clear why sales tax was collected by Starbucks on the sale of the hot chocolate."

And some legislators want to extend sales tax to services. Oh, joy....

The city of Vallejo, in Northern California, will declare bankruptcy sometime in the next few days. Why?

Vallejo has a declining industrial base. That's not a surprise—all of California has that problem. Companies that can move do (or don't add to their existing facilities in California).

Vallejo had a huge employer—the Navy. However, the Navy left Vallejo several years ago and no one replaced them.

Vallejo (and many other cities in California) have huge labor costs for public employees. The public employee unions wouldn't accept the cuts that the city asked. It's certain that during bankruptcy that the city will ask for the contracts to abrogated.

Is Vallejo a harbinger of what impacts all of California? For some cities, perhaps. Cities in California that are dependent on a single employer, and have high fixed costs need to be watchful. It will be interesting how this plays out with the background of California's huge budget deficit playing out.

The Los Angeles Times today editorializes that the way for California to escape the budget crisis is to tax services: "Lawmakers cannot act in a fit of panic, but the scope of this year's challenge should encourage new solutions, including service taxes."

On the contrary, instead of looking for new taxes California should really look outside of the box and cut or eliminate current taxes. I can just imagine the Times reading this and thinking I'm nuts. I'm not.

California has spent itself into this problem; we're going to have to drastically cut spending. Some state employees are going to lose their jobs but they really should never have been hired in the first place.

What will happen if the state imposes a service tax? It will cost small employers--more bureaucratic paperwork to deal with. I'll have to increase my fees to cover the costs. That will lead to fewer sales--if price increases and demand is steady, the quantity sold will drop (basic economics). The amount of money raised by the new service tax will be less than what will be projected.

As of today Republican leaders in the State Legislature are holding firm on no new taxes. It figures to be a long summer of the press and Democrats (and possibly the Governator) asking for new taxes and Republicans shooting those proposals down. At least I hope that's the scenario that plays out.

The Franchise Tax Board will now begin to send out some refunds on LLC Fees paid. These fees have been challenged in three court cases. Two of these cases are still in litigation. The one case that's been resolved is Northwest Energetic Services (NES), LLC v. Franchise Tax Board.

The NES case related specifically to a foreign (out-of-state) LLC that had registered in California with the Secretary of State but had no business in California. If you've filed a claim with the FTB and the FTB can determine that the LLC meets the NES criteria, then the refund(s) will be issued.

However, if the FTB can't determine whether an LLC meets the NES criteria no refund will be issued. So if your LLC or your client's LLC meets that criteria, then you should send the FTB the following:

* The LLC's name, address, and the name and phone number of the managing member or designated contact person.
* The LLC's Secretary of State file number or Franchise Tax Board temporary LLC number (for unregistered entities), and Federal Employer Identification Number.
* Taxable Year(s) involved.
* A statement that the LLC did no business in California for each of the taxable years for which the claim is being filed.

If your client hasn’t filed a claim for refund but wants to, include the above information in a letter along with the statement, "This letter constitutes a claim for refund for (taxpayer's name) – No income attributable to California," and the amount of claim per year. Any claim for refund must be signed by a representative with power of attorney (POA) or signed by the LLC's managing partner.

You can fax the information to the FTB at 916.845.9796. You can also mail the information to the FTB to:

ABS 389 MS: F340
Franchise Tax Board
PO Box 942867
Sacramento, CA 94267-8888

If you use FedEx or another private courier, then send it to:

ABS 389 MS: F340
Franchise Tax Board
C/O FTB Notice 2008-2
9465 Butterfield Way
Sacramento, CA 95827

The FTB has issued a notice here.

The Franchise Tax Board has posted its six month revision of its 250 biggest scofflaws. The largest debtors from October are gone, and a new name leads the list: Pinehill Investment of Rye, New York owes the FTB $6.133 million. The largest individual debt is Michael S. Fitzsimmons of New York City; according to the FTB his debt is $4.436 million.

There is still at least one celebrity on that list. Orenthal Simpson probably has more to worry about than his $1.528 million debt.

It took $195,994.96 to make the list. And five taxpayers have paid in full (collecting $604,395.31 to California). Others are obviously on payment plans or in negotiations as the top tax delinquent is no longer on the list. What we don't know is whether or not these taxpayers were shamed into paying or just happened to get around to it.

Back in February California's legislature passed legislation that helped cut $8 billion from the projected $16 billion budget deficit. That's good. Unfortunately, the deficit is growing as the state's revenues aren't. The San Francisco Chronicle has a story on the issue, and they think the deficit might now be as high as $14 billion.

Democrats are pushing for tax hikes while Republicans are now saying they may allow some fee increases. I know I'll be a voice in the wilderness but what California really needs are tax cuts.

Are you nuts, Russ, suggesting tax cuts when California is in dire financial straits? No. California cannot get out of this mess by increasing taxes. The state must fundamentally reform spending, and this will be painful. Cuts will have to be made—significant cuts in programs that many legislators will consider their "pet projects."

But as the Democrats state this might not be enough. So instead of increasing tax rates we should cut them. Cutting tax rates leads to increased tax revenues. This has been shown time and time again (the Laffer curve). California needs to do everything in its power to cause businesses to relocate to the Golden State. If the Democrats in Sacramento had their way every business that could would relocate.

It is time for a change.

If you're a Californian don't forget that the second installment of property taxes is due tomorrow, Thursday, April 10th. That's a postmark deadline. Most California tax collector offices have online payment systems set up, too.

Earlier this week I posted an advertisement from the Nevada Development Authority. The Los Angeles Times had an article today noting that Democrats in Sacramento are unhappy with the advertisements that portray California as a tax-happy state. Of course, Democrats in Sacramento are arguing for more taxes.

Somer Hollingsworth, President of the Authority, told the Times, "We can see what is going on in California as far as businesses are concerned...They've got workers' comp issues, a $16.5-billion deficit, employee retirement funds that are out of whack."

State Senator Mark Ridley-Thomas (D-Los Angeles) told the Times, "Businesses are here because they appreciate the powers of this economy...I suspect Nevada wishes it could be ranked as among one of the top economies in the world."

Perhaps the Democrats in the Legislature would like to talk with some of my corporate clients who are again contemplating leaving the Bronze Golden State because of high taxes and too many regulations. Maybe Nevada won't be the destination, but if California tries to close the deficit on the back of businesses other states will benefit. State Senator Ridley-Thomas is naive if he believes that taxes can increase forever without businesses reacting.

With California having a $16 billion deficit, and the Democrats in California's Legislature saying that the only solution to the problem is to increase taxes, it was only a matter of time until the Nevada Development Authority struck. Here's their latest print advertisement:



My advice to the Democrats (and Republicans) in the Legislature: Increasing taxes will increase the Nevada Development Authority's business.

Political theater occurred last night in Sacramento. The Assembly held a rare evening session, and the Democrats' oil tax fell to defeat 45-30 (it needed a 2/3 vote to pass). The vote was party line, except for one. Assemblywoman Nicole Parra (D-Bakersfield) voted no.

The Democrats framed the issue as "Save our children, tax the rich low-taxed oil companies." Republicans called it political theater. Democrats want to increase taxes; there's no room in the budget to cut spending. Republicans want to cut spending; there's no room in taxpayers' pockectbooks to pay for additional taxes.

I think it's well worth remembering these two themes as we vote this year. Over the last four years spending increased 44% while revenues increased 40%. I think that's food for thought.