Archive for the ‘California’ Category

Bozo Tax Tip #9: Nevada Corporations

Tuesday, April 5th, 2016

As we continue with our Bozo Tax Tips–things you absolutely, positively shouldn’t do but somewhere someone will try anyway–it’s time for an old favorite. Given the business and regulatory climate in California, lots of businesses are trying to escape taxes by becoming a Nevada business entity. While I’m focusing on California and Nevada, the principle applies to any pair of states.

Nevada is doing everything it can to draw businesses from California. Frankly, California is doing a lot to draw businesses away from the Bronze Golden State. But just like last year you need to beware if you’re going to incorporate in Nevada.

If the corporation operates in California it will need to file a California tax return. Period. It doesn’t matter if the corporation is a California corporation, a Delaware corporation, or a Nevada corporation.

Now, if you’re planning on moving to Nevada forming a business entity in the Silver State can be a very good idea (as I know). But thinking you’re going to avoid California taxes just because you’re a Nevada entity is, well, bozo.

Where I Became the “Messenger of Doom” (My Final Comments on Turf Rebates)

Sunday, February 21st, 2016

One of my friends coined my current nickname, the “Messenger of Doom.” It had to do with a year where he made a lot money, and then I gave him the bad news that he had only made about half that after taxes (including state and local taxes). He wasn’t happy, but I’m not the individual who made him move from South Dakota (which has no income tax) to New York City (which had, at the time, the highest income tax rate in the country). But I digress….

I am getting lots of comments in regards to the two posts I wrote about turf rebates. And several correspondents are blaming me for the fact that the money they received is taxable income.

To my correspondents: I’m just the messenger. The US Tax Code is, at its heart, amazingly simple: Everything is taxable unless Congress has exempted it; nothing is deductible unless Congress allows it. Congress has not exempted turf rebates from taxation.

“But Russ, rebates are tax exempt.” True rebates are a refund of money you get from the seller of a product. A good example is an automobile rebate. You buy a new car, and the dealer gives you back $500. That’s a rebate. Turf rebates are nothing like that. You’re purchasing some sort of xeriscape and removing your lawn. That’s done through a landscaper (or others). Meanwhile, the water district is giving you money because of this. Yes, the two actions are tied together but the “rebate” isn’t coming from the company you’re buying from. It’s not a rebate in the tax definition of a rebate.

In tax, it’s substance over form. The Metropolitan Water District is free to call this a rebate (we do live in a free country), but in tax substance this isn’t a rebate. The money you’re getting is taxable income.

“But Russ, California has exempted rebates, and for California purposes they are rebates.” No argument: California has exempted this from state taxation. California is free to exempt anything it wishes from state taxes; Congress is free to exempt anything it wishes from federal taxation. There are numerous differences between California taxes and federal taxes. For example, California lottery winnings are taxable to the United States but not taxable to California. Unemployment compensation is taxable to the IRS but not the Franchise Tax Board. On the other hand, the Section 179 deduction is limited to $25,000 for California purposes but is $500,000 federally. You can have a deduction for contributions to HSAs on the federal level but not California. I could go on and on about the differences.

“But Russ, shouldn’t the water agencies have known these rebates were taxable?” That’s an excellent question. Had they consulted with their tax advisors, they should have reached the same conclusion I quickly did. There’s clearly some error here, and I definitely think that people should have been told the rebates were taxable on the federal level.

“But Russ, this is unfair!” I hate to tell you, but life isn’t fair. If you think this is wrong, contact your Congresscritters and Senators. The only way that turf rebates will become tax exempt is if Congress passes a new law. I’m just the messenger here.

Board of Equalization Excoriated for Ignoring the Law and Binding Precedents

Tuesday, February 16th, 2016

My thanks to Dan Walters of the Sacramento Bee for pointing out a California case where the California Board of Equalization (yet another California tax agency; this agency administers sales and use tax) was rightly excoriated. Dan Walters begins:

However, [the state] cannot tax services and other “intangibles.” And while there is a strong case for including services in the sales tax – particularly were it to mean an offsetting decrease in tax rates – until that moment comes, they are exempt.

One might assume that the folks at the state Board of Equalization who collect sales taxes would know that.

One also assumes they know that, under long-standing court decisions, when tangibles and intangibles are included in one transaction but easily separated, only the tangibles may be taxed.

However, the board’s tax collectors repeatedly have attempted to impose sales taxes on intangible portions of transactions and repeatedly failed when taxpayers have taken them to court.

This is the case of Lucent Technologies and AT&T. Last October, a California appellate court unanimously ruled against the BOE, and finding its position was not justified awarded $2.6 million to Lucent to cover its legal fees. (Lucent and AT&T will actually get more money, as I’ll discuss below.) The California Supreme Court refused to hear the case, so the judgment is now final. Here are two excerpts from the appellate court decision:

The trial court did not abuse its discretion in finding that the Board’s position was not “substantially justified.” A litigant’s position is “substantially justified” if it is “‘“justified to a degree that would satisfy a reasonable person, or ‘“‘has a “‘“reasonable basis both in law and fact.”’”’”’”’”…

In this case, each of the Board’s primary arguments was foreclosed by existing precedent, much of which comes from our Supreme Court. The Board’s arguments that placing computer software onto physical media turns the software itself into tangible personal property and that the taxable basis includes the software are irreconcilable with the rationales of Preston, supra, 25 Cal.4th at pages 211-212 and Navistar, supra, 8 Cal.4th at page 878, and with the specific holdings of Microsoft, supra, 212 Cal.App.4th at page 82 and Nortel, supra, 191 Cal.App.4th at pages 1275-1276. And the Board’s argument that the technology transfer agreement statutes do not apply is inconsistent with federal copyright law, with Preston, at page 214, and with our factually and legally indistinguishable decision in Nortel.

I include the actual citations just to show how poor the BOE’s arguments were. But the court’s summation needs to be put on a bulletin board at the BOE’s headquarters:

The Board’s conduct in this litigation falls squarely within the heartland of section 7156, and the core purposes of the Taxpayer’s Bill of Rights of which it is the key part—namely, to “deter[] state[] agents from asserting unreasonable and unfair claims and defenses against private citizens” and thus to “preserve[] the balance between legitimate revenue collection and ‘government oppression.’” The position the Board took in this case had been rejected by the Legislature that enacted the technology transfer agreement statutes, rejected by several courts interpreting those statutes, and specifically rejected by Nortel. Yet the Board continued to oppose AT&T/Lucent’s refund action, countersued for more than $18 million (and ultimately agreed to accept less than $2 million), propounded thousands of discovery requests, and generated a 20,000 page record on appeal. The net result is that AT&T/Lucent incurred more than $2.5 million in litigation costs to receive a tax refund to which it was indisputably entitled under controlling law. It is certainly up to the Board to decide whether to take positions at odds with binding, on-point authority, but section 7156 makes clear that the Board is not free to require taxpayers to bear the cost of a litigation strategy aimed at taking a third, fourth, or fifth bite at the apple. [citation omitted]

Oh yes, Lucent and AT&T were awarded costs for litigating the appeal. Dan Walters asks in his article how a small business would handle “the same imperious demands” of the BOE. They can’t; they almost always have to give in because to win is almost always a Pyrrhic victory. This is just another reason why the business climate in California is so dreadful.

It Was Only a 13.33% Kickback

Sunday, February 7th, 2016

Last year I reported on the case of Ronald Boyd. Mr. Boyd was Chief of Police of the Port of Los Angeles. The ports of Los Angeles and Long Beach are two of the busiest ports in the world, and Mr. Boyd had a nice job. But he saw an opportunity.

In 2011, Mr. Boyd and two other individuals entered into an agreement where Mr. Boyd would receive 13.33% of revenues related to a smartphone app called “Portwatch.” Mr. Boyd guaranteed that the port would adopt the app, and in return for that he got the promise of future revenues. There’s only one problem with that: Mr. Boyd didn’t disclose that. Oops.

Adding to his woes were the future plans of the business: The goal was to take Portwatch and get more money by developing and marketing a similar app called Metrowatch to sell to other government agencies. (The idea of Portwatch is that it would allow ordinary citizens to report crime at the port. In that sense, the app is quite good.) Unfortunately, Mr. Boyd decided that lying to federal investigators was a good idea (it’s not, of course).

Unfortunately, as the investigation into Mr. Boyd continued the government discovered something else:

Boyd also pleaded guilty to tax evasion in relation to his personal income tax return for 2011. In his plea agreement, Boyd admitted receiving income from a security business he operated, At Close Range. The income came from the owner of a company doing business with the Port, American Guard Services, and Boyd admitted that he failed to report that income on his personal income tax returns for years 2007 through 2011.

Mr. Boyd pleaded guilty to making false statements to FBI agents, tax evasion, and a misdemeanor charge of failing to file a tax return (he neglected to file a 2011 tax return for At Close Range). He’ll be sentenced in July.

FTB’s New MyFTB Impresses; Will the IRS Take Heed?

Monday, January 25th, 2016

Submitting a Power of Attorney form to the IRS means I must fax the form to the IRS’s Centralized Authorization File (CAF) unit and hope that the POA is entered in timely. A few years ago authorized e-services providers (which I am) could enter the POAs directly in the IRS system but no more.

Meanwhile, California’s Franchise Tax Board (FTB), the state’s income tax agency, has never allowed California POAs to be entered by practitioners. The procedure was to fax or mail them and wait weeks for them to be entered. No more.

The FTB debuted the new MyFTB on January 4th, and it’s a winner. I signed up, and waited for my PIN to be mailed to me (that took the expected 7-10 days). I then input the PIN, and have access. I can see the accounts I’m authorized for, and the new system allows me to enter a POA.

However, the POA does not immediately go into effect. The FTB requires that a pdf of the POA be attached so that the FTB can review it. The FTB states that within two weeks (well, 15 days) the POA will be in their system.

The FTB’s procedure appears to me to allay the issues that the IRS had with rogue professionals entering POAs without authorization. And consider the time savings here. I’ve entered all the information into the FTB’s computer system. An FTB employee can match the pdf I uploaded to the POA I entered. If it matches, the employee can make my POA go live. He or she doesn’t have to retype the information I entered, saving the FTB time (and money). The POA gets into the FTB’s systems faster, making me happy (and my client). It’s a win-win.

There’s a lot more that’s doable with the FTB’s new MyFTB. I can look at account balances, estimated payments amounts (clients get these wrong all the time), 1099 information on the state level (IRS wage and income transcripts don’t have this information), calculate a balance due for a future date, protest an assessment, view images of notices and correspondence, and more.

If you’re a tax professional who deals with California clients or a California taxpayer, I urge you to enroll in MyFTB. I’m very impressed. I may rag on the FTB (especially in the enforcement area) but from my point of view MyFTB is a model to be emulated by the rest of the country.

Such a system, if implemented by the IRS, would also be a win-win. Unfortunately, my expectations on that end aren’t particularly high. Indeed, I’ll be surprised if we see such a system for the IRS in the next five years.

Lawsuit Filed Over BOE’s Fixer-Upper

Sunday, January 17th, 2016

I’ve reported on California’s Board of Equalization headquarters building in Sacramento on two occasions. It seems some employees of the BOE aren’t happy at all, and have filed a lawsuit against the BOE alleging that the agency has known for years that the building is a health hazard.

While the BOE has publicly stated that the building is safe, there have been a few “minor” problems. Like glass windows randomly falling to the ground. Given the building is 24 stories tall, you may want to walk on the other side of the street if you’re ever near it. There’s also a few pipes that have corroded; back in 2012 that was only in the waste lines. The elevator doors have this tendency to stay closed when you want to exit the elevators. There was also that infestation of bats.

But the big issue for the lawsuit is toxic mold. Those windows that randomly pop out have done so supposedly because of bad seals. That leads also to water entering the building. Sacramento’s summers are very warm, so that water leads to mold. The lawsuit alleges that the BOE knew back in 1995 (two years after the building opened) that mold was an issue leading to all sorts of illnesses.

It will likely be years before the lawsuit makes its way to trial.

FTB Wins Gillette Appeal

Friday, January 1st, 2016

California’s Franchise Tax Board won the appeal of Gillette v. Franchise Tax Board. This opinion covers taxation of multi-state entities in California prior to 2012.

Gillette (and several other companies) argued that the FTB’s weighing of the “sales” factor higher than other factors was discriminatory based on a multi-state compact. (California specifically withdrew from the compact for years after 2011.) The California Supreme Court decided that the FTB’s interpretation of the California legislature is accurate.

Gillette and the other appellants can file a writ of certiorari to the US Supreme Court; however, this does not appear to be the kind of case that the US Supreme Court would take.

My Love/Hate Relationship with the FTB

Tuesday, December 1st, 2015

For those who don’t know, I used to reside in California. I prepare more California tax returns than any other state’s returns (though it is no longer a majority–or even close to a majority–of my clients). I have a lot of experience in dealing with California’s income tax agency, the Franchise Tax Board.

The FTB, like the IRS, has a practitioner priority service. And you actually get through to humans when you call the number. Though not available on the FTB’s practitioner line, several FTB numbers have “call back” service. The recording tells you how long the average wait time is (e.g., between 45 minutes and 72 minutes), and you can elect to wait on hold or enter your phone number and the system will call you back when it’s your turn to be first in the queue. The system has one “flaw”: I’ve been called back faster than the average wait time.

The FTB also has an annual meeting with the California Society of Enrolled Agents (CSEA). The FTB posted in its December Tax News how to deal with partial year dispositions and late partial disposition elections for tax years 2012-2014.

Yet for all the excellence in how the FTB communicates some of the FTB’s practices leave a lot to be desired. Back in 2013, the FTB invented law related to qualified small business stock. The FTB was convicted of committing fraud and intentional infliction of emotional distress in the Gilbert Hyatt matter. This case will be heard for the second time at the US Supreme Court next week. The Hyatt case is just one example of what appears to me to be the normal FTB strategy: Delay cases and make things as expensive as possible for litigants.

And the FTB has also been persnippity and literal at times. You definitely want your paperwork to be exactly right when dealing with them. So you have to take the bad with the good when dealing with the FTB.

The Turf Monster Striketh

Friday, November 20th, 2015

Every so often the turf monster trips a player in a football or baseball game. Here’s one example:

This post deals with a very different kind of turf monster. Back in September I wrote about Southern California’s Metropolitan Water District issuing “rebates” to homeowners for replacing lawns (turf) with xeriscapes. It’s clear that such “rebates” are taxable for federal tax purposes. (California law specifically exempts such “rebates” for California tax purposes.)

Apparently, the Electric and Gas Industries Association (EGIA), which ran the program for the MWD, just discovered this. A correspondent sent me an email he received:

Dear Soon to be Taxed Homeowner:
Our records indicate that you received a rebate that exceeded $600 from SoCal Water$mart in 2015. In order to comply with Internal Revenue Service requirements you must complete and sign a W-9 form with your Social Security number or Tax ID. This form is available within the online application, and may be accessed by logging into your online account at https://mwdturf.conservationrebates.com/ and editing the application with the required tax information changes. The name on the W-9 form submitted for review must match the name that was on the rebate check…

Please log back into your online account at https://mwdturf.conservationrebates.com/, download and complete the W-9 form and upload the completed form back into the application. The W-9 will be reviewed, and a 1099 will be issued to you for tax and accounting purposes. If you have any concerns regarding whether your rebate is considered taxable income, please contact a qualified tax professional.

There are two obvious implications of this. First, the EGIA realizes that they must issue 1099s to any impacted taxpayers. It’s another case of substance over form: These may be called “rebates” but they’re really an economic incentive to remove turf and replace it with something else. And that results in what is clearly taxable income.

Second, there will probably be an issue with some taxpayers ignoring the email. The email notes that you’re going to be issued tax paperwork; how many taxpayers will want that? Of course, whether or not the 1099 is received does not change that the income is taxable (it is). Still, I suspect EGIA will have quite a bit of work on their hands to obtain all the taxpayer identification numbers.

UPDATE: My correspondent told me that the EGIA is requesting that impacted taxpayers email their taxpayer identification numbers to the agency. If you are an impacted taxpayer, do not do this. Email is fast but it is not secure. EGIA is allowing you to mail the Form W-9 to the agency; that is a far more secure means of transmitting your social security number.

To the EGIA, what were you thinking in these days of identity theft?

Yes, Two States Rank Lower than California

Tuesday, November 17th, 2015

It’s not all bad news in the Tax Foundation’s 2016 State Business Tax Climate Index for California. You could always be in New York or New Jersey. Still, it’s better to be elsewhere.

Two excerpts from the article note why states rank at the top of the list or at the bottom:

The absence of a major tax is a common factor among many of the top ten states. Property taxes and unemployment insurance taxes are levied in every state, but there are several states that do without one or more of the major taxes: the corporate income tax, the individual income tax, or the sales tax. Wyoming, Nevada, South Dakota, and Texas have no corporate or individual income tax (though Nevada and Texas both impose gross receipts taxes); Alaska has no individual income or state-level sales tax; Florida has no individual income tax; and New Hampshire and Montana have no sales tax…

The states in the bottom 10 tend to have a number of afflictions in common: complex, non-neutral taxes with comparatively high rates. New Jersey, for example, is hampered by some of the highest property tax burdens in the country, is one of just two states to levy both an inheritance tax and an estate tax, and maintains some of the worst-structured individual income taxes in the country.

So who are the winners and the losers? Here are the top ten states:

1. Wyoming
2. South Dakota
3. Alaska
4. Florida
5. Nevada
6. Montana
7. New Hampshire
8. Indiana
9. Utah
10. Texas

Here are the bottom ten states:

41. Maryland
42. Ohio
43. Wisconsin
44. Connecticut
45. Rhode Island
46. Vermont
47. Minnesota
48. California
49. New York
50. New Jersey

My home state, Nevada, does very well (ranking fifth overall). It ranks first in individual income tax (there isn’t one), fourth in corporate tax (there is no a gross receipts tax on businesses, but only large businesses and the tax rate is low), seventh in property tax, but 39th in sales tax and 42nd in unemployment insurance tax.

Note that it is possible to have every major tax and still rank highly (Indiana and Utah manage that) if the taxes are broad with low rates. Of course, you can be like New Jersey, New York, and California: have broad taxes at high rates. If you do that, you end up on the bottom.

I should point out that it is possible that New York will rise in the rankings. As the Tax Foundation noted, New York enacted corporate tax reform which should improve its standing. Meanwhile, California is apparently considering more and higher taxes for the future. That, combined with the regulatory environment in the Bronze Golden State, should give legislators pause…but probably won’t.