Taxable Talk

In last November's election, voters roundly rejected a proposed light rail system here in Orange County. The CenterLine system would have linked Irvine, John Wayne (Orange County) Airport, and South Coast Plaza in Costa Mesa.

It's back. But only here in Irvine.

Last week, the Irvine City Council approved spending $5.6 million on studying an Irvine mass transit system. The proposed system would run 5.5 miles, exclusively in Irvine.

Apparently, the members of the council have not been listening to the voters—the same voters who keep rejecting light rail systems. It's unfortunate that the $5.6 million has been approved (and will be spent); it's a certainty that yet another ballot measure will happen and the voters of Irvine will, for the fourth time (I believe) say nyet to rail transit.

News Story: Los Angeles Times

In my practice, I see a lot of S Corporations, but very few LLCs (I can count the number on one hand). Yet, according to Christopher Hoyt of the University of Missouri at Kansas City (writing in the TaxProf Blog), this is the opposite of what's being recommended in law school. So why the difference?

Hoyt notes the statistics, and presents a graph showing that S Corps remain twice as popular as LLCs (based on new S's vs. new LLCs). Joe Kristan of Roth Tax Updates then speculates on the reasons behind this. His points on salaries, and the uncertainty of how LLCs are to be treated for self-employment taxes are on point.

Kristan also notes that state issues have a material impact. He notes that in Iowa (his home state), LLCs are tax-disfavored (versus S Corps) for multi-state operations.

In California, there are two major factors working against LLCs. First, all S Corps and LLCs in California must pay a minimum state franchise (income) tax of $800 per year (or 1.5% of net income, whichever is greater). But LLCs also face a gross receipts tax, so LLCs in California are triple-taxed! The current minimum gross receipts tax (called an LLC fee) is $865 per year. Second, some businesses are prohibited from being in an LLC. These include professionals, such as architects and accountants. (They can form LLPs, though).

If you're at all interested in forming an LLC read the articles. They'll enlighten you about some of the tax issues facing LLCs.

Hat Tip: TaxProf Blog & Roth Tax Updates

Over ten years ago, in the nearby City of Orange, a trash magnate was born. His name was Jeffrey Hambarian, and he was a hometown hero.

Mr. Hambarian had an interesting method of operating his business. He told his vendors that they had to make phony invoices and/or pad legitimate ones, and funnel most of the phony profits to him. He then laundered the ill-gotten gains through check cashing outlets.

This scam continued for some time, until an accountant noticed a problem during an audit. The accountant told the city, there was an investigation, and eventually Mr. Hambarian found himself convicted of 47 counts including grand theft and filing false income tax returns.

On Friday he was sentenced to 15 years in state prison and to pay $12 million in restitution. While his attorney complained that, "I don't know what warehousing him in a state prison would do," a prosecutor noted that, "...these are serious crimes." Usually, those found guilty of 47 felonies find themselves behind bars.

News Story: Los Angeles Times

Let's assume you disagree with a decision that the Franchise Tax Board (FTB) makes on your tax return. You go through the FTB appeals process, and get nowhere. California then allows appeals to the Board of Equalization (BOE). Today, let's look at a recent decision by the BOE in Appeal of Costco Wholesale.

Costco took advantage of California's Manufacturers' Investment Credit (MIC) for its in-store bakery and meat departments. Previously, the BOE had rules in Appeal of Save Mart Supermarkets & Subsidiary that supermarkets were eligible for this credit. Costco asked for a refund of taxes paid between 1996 and 2001 because of the MIC. The FTB didn't like this decision, and elected not to follow it. Costco appealed the FTBs disallowance of the MIC to the BOE. The BOE faced three issues: Whether Costco qualifies for the deduction, whether bakery and meat departments qualify, and whether the BOE has authority to invalidate an FTB regulation.

The easy part of the decision was that Costco is a qualified taxpayer. The BOE followed the Save Mart case and found that Costco's bakery and meat departments are just as qualified as Save Mart's to get the MIC. And finally, the BOE believes that the California Legislature has given the BOE the power to invalidate FTB regulations when the BOE determines such regulations are contrary to statutes.

No word yet on whether the FTB will continue to fight such cases.

Coverage: California Enrolled Agent Magazine, January/February 2006 issue (not on the web), CMTA Capitol archive, 10/27/05.

There are two concepts that tax accountants have trouble explaining to clients: basis and nexus. And this leads to two recent items that have as their basis nexus.

First, on December 31st, the New Mexico Supreme Court ruled that a corporation with no physical presence in New Mexico can be forced to pay New Mexico income tax. The case dealt with a subsidiary of Michigan based K-Mart. K-Mart put intellectual property into the subsidiary. The subsidiary had no physical presence in New Mexico. New Mexico claimed that the subsidiary was formed just to lower the corporate parent's tax bill, and served no real business purpose; thus, the subsidiary must pay corporate income tax. (Also argued was whether New Mexico's gross receipts tax applied to the subsidiary. The New Mexico Supreme Court held unanimously that it doesn't.)

Now, this case is interesting, but it likely will not be the last word. I mean, do corporations really structure transactions to avoid taxes? And do states write their tax codes to force businesses to structure deals in bizarre ways just for tax purposes? Well, I should probably tone down my sarcasm....But really, until a case comes up where a corporation has no physical presence in a state, and that state attempts to force the corporation to file and pay that state's corporate income tax, will I be worried about the impact on small companies.

Separately, Business Week recently commented about the coming of a uniform sales tax allowing all Internet transactions to be taxed. The Streamlined Sales Tax Project is a group of states working on a means for a uniform sales tax so that states can get around the famous Quill Corp v. North Dakota decision. Business Week believes that the streamlined sales tax will happen really soon.

I believe the reality, at least for Californians, is that we won't see this for many years. Perhaps other states are working towards a streamlined tax, with few differences in rates. California, though, continues to pass sales tax rate changes for numerous special districts. Consider just Fresno County. Fresno County has one tax rate, while the City of Clovis has another. And both of those rates are different from anywhere else in the state. There are at least two sales tax increases on the June ballot in California. Thus, I don't see sales tax uniformity coming any time soon to the Golden State.

News Story: Santa Fe New Mexican

For taxpayers in Northern California impacted by the recent storms, the Board of Equalization has extended deadlines for filing California sales tax and fees collected by the BOE by one month. Returns (and payments) originally due on January 31st are now due on February 28th for businesses in these counties:

Butte, Del Norte, El Dorado, Humboldt, Lake, Lassen, Marin, Mendocino, Napa, Nevada, Placer, Plumas, Sacramento, San Joaquin, San Mateo, Sierra, Siskiyou, Solano, Sonoma, Sutter, Trinity, Yolo and Yuba.

Impacted businesses must complete BOE Form 468 (Request for Extension) and BOE Form 27 (Penalty and Interest Relief for Disaster Victims). The BOE has indicated that they may allow late filers who do not complete the forms relief if they include a statement signed under penalty of perjury that they were impacted by the storms.

News Story: San Mateo County Times

BOE Notice

Now that we're in 2006, it's time for me to go back to work. First on the agenda will be business information returns/filings, such as W-2s and 1099s. These forms must be distributed by January 31st, but do not have to be sent in to the government until February 28th (if you file the forms electronically, March 31st).

The most common form 1099 sent is the 1099-MISC. This form covers non-employee compensation, rents, payments to attorneys, and royalties. In general, a 1099-MISC must be issued if the payments during 2005 total $600 or more ($10 or more for royalties). Most payments to corporations are exempt from reporting on a 1099.

If you're in California, you must also report this information to the Franchise Tax Board (FTB). If you file using paper returns to the IRS, the IRS will forward the filings to the FTB and you need not file directly with the FTB. However, if you file electronically, you must also file electronically with the FTB. California has stringent penalties regarding non-filings of information returns (far stricter than the federal penalties). We encourage all of our California clients to require that before any payments are made to a supplier/vendor that a W-9 be obtained.

If you're one of our clients and want us to prepare your 1099s, please contact our office when you're ready.