Archive for the ‘California’ Category

Out With the Fed Mandate; In With State Mandates

Wednesday, November 13th, 2019

Once upon a time there was the federal mandate to have health insurance; per the US Supreme Court, a “tax.” Well, beginning with 2019 tax returns (filed in 2020) the federal mandate is no more. Unfortunately, tax professionals and taxpayers aren’t done with insurance mandates: Several states have implemented their own mandates.

Massachusetts, New Jersey, and the District of Columbia have their own mandates for the 2019 tax year (tax returns filed in 2020); Massachusetts’ mandate began in 2007. California, Rhode Island, and Vermont have implemented mandates for the 2020 tax year (tax returns filed in 2021).

If you are a resident of one of these states, we’ll be asking you about health insurance when we prepare your 2019 returns. Additionally, if you do receive insurance through the Exchange (e.g. healthcare.gov) and receive a Form 1095-A, you must provide a copy of the form to your tax professional.

There’s no reason for tax professionals to be in the health insurance field. But thanks to Obamacare, we are…and will be for the foreseeable future.

Regulations Matter, Too

Tuesday, November 5th, 2019

Last week, KABC (a Los Angeles television station) reported on a couple moving their small business from Canoga Park, California (in the San Fernando Valley area of Los Angeles) to Fort Worth, Texas. There’s nothing new about this story–companies relocate all the time. The reasons, though, state something about doing business in the Bronze Golden State.

“There’s so much regulation, that we really need to be in a place that allows our small business to grow and I feel that Texas will do that for us,” Micki Brizes, one of the owners of Aeromax, told KABC. The owners couldn’t find a building to move into that they could afford near their current location in California.

Consider that they are spending more than $100,000 on moving their business. Those are just the direct costs. There are undoubtedly indirect costs (orders delayed due to the move, disruptions in various things, etc. Yet the owners believe that they will be able to recover the costs of the move very quickly. Is that realistic?

Absolutely. They’ll likely be able to rent a larger space than what they had in California that meets their needs for less than what they paid in California. They’ll save 8.84% or more in taxes. They’ll be in a business-friendly environment instead of a business-hostile environment. I suspect the owners will be asking themselves why they didn’t make this move earlier.

Meanwhile, the Babylon Bee (a satirical website) had a post: “Texas Luring Jobs Away From California With Promises Of Electricity.” Good satire is based on a truth, and extrapolating it out into humor. This post is humorous, but the underlying truth exists. If California doesn’t fix their problems, the high-tech industry will vanish from Silicon Valley. California’s budget over the last several years has been in balance (actually, in surplus) based on Initial Public Offerings in the high-tech industry. Democratic politicians should be asking themselves what they can do to make California a desired destination for businesses, but they likely won’t until it’s too late. The reality is that it’s not just tech businesses that can be at least 300% more effective when they have power.

Does My Business Owe California Tax?

Wednesday, October 30th, 2019

Assume you operate a business as a tax professional in Las Vegas. Or Des Moines. Or Albany. Or anywhere outside of California. You’ve been in business for years, and don’t solicit new clients (other than having a website). Your only trips to California are to visit family members (nothing to do with your business). You do have clients in California, but you prepare all the tax returns in your office. Do you owe California tax?

In the view of the Franchise Tax Board (California’s income tax agency), you likely do. And in a ruling earlier this year, the Office of Tax Appeals upheld the Franchise Tax Board. In that case, a screenwriter who resided in Arizona was ruled to owe California tax because he was paid by California LLCs.

Here, appellant received income for his services as a self-employed screenwriter from Mindbender and Lakeshow, which are both California LLCs. Appellant was a resident of Arizona where he performed his services as a self-employed screenwriter. He also received $40,000 of gross income from his services as a self-employed screenwriter from California customers. Consequently, appellant’s trade or business as a self-employed screenwriter was carried on within and without the state. We find appellant was carrying on a business within and without California.

And using California’s approach, since he was conducting part of his business in California, he owes tax on the sale to Californians:

In sum, pursuant to the provisions of the UDITPA relating to the sale of servicesand the regulations thereunder, appellant’s physical presence does not determine whether he had income derived from California, but rather it is determined by where the benefits of appellant’s services were received.

Based on this decision, my business owes California tax based on having clients who happen to reside in California. However, I strongly suspect this ruling is wrong under federal constitutional precedents (which weren’t raised in the appeal noted above).

In order for a state to tax someone, there must be a minimum level of contacts with the state. See Shaffer v. Heitner, 433 U.S. 186 (1977) and International Shoe Co. v. Washington, 326 U.S. 310 (1945). The FTB and the Office of Tax Appeals believe that simply providing services to California entities even if all work is done outside the state brings sufficient contact to California. It’s possible that is true for a screenwriter (he could have solicited within California, so it’s theoretically possible he has such contacts), but it’s not true for my business (I don’t solicit within California), and I haven’t conducted business within the state since 2011 (when I moved to Nevada).

Consider if you’re a tax professional working in your office in Boston. Someone comes in from off-the-street to have you prepare their return. He or she happens to be from Los Angeles, so you prepare their straightforward return (let’s assume it only has a W-2 and a few investment 1099s), charge the customer $x (let’s assume it’s a relatively small amount, say $300). You may now owe $800 to California because your business entity is considered to be conducting business in the state. That doesn’t sound very reasonable to me–and it’s hard for me to envision any sort of “minimum contacts” with California coming from an unsolicited client who happens to walk into your office.

I strongly suspect that some case like this is headed to federal court (and possibly the US Supreme Court). This sure appears to me yet another example of California overreaching and thinking everyone owes tax to the Bronze Golden State.

Hat Tip: Robert Wood

The 2020 State Business Tax Climate Index: The Usual Laggards, but Some New Faces on Top

Thursday, October 24th, 2019

The Tax Foundation released its annual State Business Tax Climate Index. There weren’t many surprises with the best states:

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

This is the first time I remember Oregon in the top-ten of this list. These states share one of two attributes: the lack of certain taxes (such as individual income taxes) or low tax rates across all taxes (such as in Utah and Indiana). Meanwhile, it’s “Bring me the usual suspects” for the bottom ten:

41. Louisiana
42. Iowa
43. Maryland
44. Vermont
45. Minnesota
46. Arkansas
47. Connecticut
48. California
49. New York
50. New Jersey

As the Tax Foundation says, “The states in the bottom 10 tend to have a number of afflictions in common: complex, nonneutral taxes with comparatively high rates. New Jersey, for example, is hampered by some of the highest property tax burdens in the country, has the second highest-rate corporate income tax in the country and a particularly aggressive treatment of international income, levies an inheritance tax, and maintains some of the nation’s worst-structured individual income taxes.”

I noted Oregon being in the top ten, but the state is likely going to fall out soon. Oregon adopted a gross receipts business tax, and that’s almost certain to send the state out of the top ten next year. Oregon will be one of only two states with both a corporate income tax and a gross receipts tax.

My home state, Nevada, ranks near the top in individual income tax (fifth), which isn’t a surprise since we don’t have that tax. (A few ‘individuals’ will owe the Nevada gross receipts tax on their businesses, which is why the Silver State doesn’t share the top ranking here.) We also rank towards the top (tenth) in property tax. We’re right in the middle for corporate income tax (25th) which shows the impact of the gross receipts tax. We’re towards the bottom (44th) in sales tax (Nevada sales taxes are relatively high; the rate is 8.25% in Clark County) and in unemployment insurance tax (47th). But overall Nevada is a good state for taxation; this is one reason I moved here in 2011.

Contrast that with California. Corporate taxation is actually in the middle (28th) and property tax is in the top half (16th); the property tax ranking is due to Proposition 13 which Democrats in the Golden State are proposing to partially due away with. Unemployment Insurance Tax ranks 22nd, about average. It’s individual income tax which is the major contributor to California’s low ranking. The state ranks 49th. California also fares poorly in sales tax, ranking 45th.

Note that taxation is just one piece of why businesses relocate. It’s an important component, but it’s not everything. Another major factor is regulatory burden, and that’s another place where California ranks at or near the bottom. This is something I’ll be reporting on in the future.

As to individuals who state that businesses don’t move because of taxes, that’s hogwash. Businesses do move because of this, and will continue to do so. It is just one reason, but it’s a very important reason. California lawmakers who look at the map provided by the Tax Foundation (showing California in dark grey (dark grey indicates a bad score) while numerous neighboring states are in blue (indicated a good score) should be worried. But given how I think the Democratic majority in Sacramento thinks, it’s unlikely they’ll do so.

Jolly Good News on the Swart Front

Tuesday, September 10th, 2019

Let’s say you’re the managing member of an LLC headquartered in Seattle (duly registered as an LLC in Washington State). You invest in another LLC (a Delaware LLC) that invests in property throughout the United States. You own between one and five percent of the Delaware LLC each year, and are not involved in any of the decisions of the Delaware LLC. The Delaware LLC invests in California property, and is considered doing business in California (it registers with the California Secretary of State and files a California LLC tax return). Is your Washington State LLC doing business in California?

The California Franchise Tax Board has been holding for years that if you invest in a California LLC–or a foreign LLC doing business in California–your LLC is considered doing business in California. Even an indirect investment (investing in LLC 1 that invests in LLC 2 that invests in a California LLC) is enough to be doing business in California in the view of the FTB. Then came Swart.

As previously discussed on this blog, Swart Enterprises, Inc challenged the FTB regarding its 0.2% interest in a manager-member California LLC. The courts held that such a passive investment is not doing business in California. After Swart, the FTB held that if your passive interest is 0.2% (or less), you’re not doing business in California; greater than that, you are.

Jali, LLC is a Washington State LLC that mirrors the fact pattern in the first paragraph. They invested in Bullseye Capital Real Property Opportunity Fund, LLC and California’s Franchise Tax Board asserted they were doing business in California. Jali, LLC paid the FTB for the years in question and filed a claim for refund; the claim was denied because Jali, LLC owned more than 0.2% of Bullseye. Jali, LLC appealed to the California Board of Tax Appeals.

In what will be a precedential decision, the Board of Tax Appeals noted:

FTB thus takes the position that a 0.2 percent membership interest in an LLC doing business in California is the new, post-Swart bright-line ownership threshold used to determine whether an out-of-state member is also doing business in the state. As applied to the facts of this appeal, FTB concludes that appellant is deemed to be “actively” doing business in California because its membership interest in Bullseye “was well beyond the 0.2% Swart limit.” We disagree.

FTB misconstrues the Swart court’s statement, “We conclude Swart was not doing business in California based solely on its minority ownership interest in Cypress LLC.” The court’s opinion was not “based solely” on Swart’s minority ownership interest. Rather, in making this statement, the court was simply dismissing FTB’s argument that the court should base its decision on that fact alone. When the entire opinion is considered, it becomes abundantly clear the court’s holding was squarely grounded on the relationship between the out-of-state member and the in-state LLC.

But that’s not all. The Board of Tax Appeals realizes that the key questions are, (a) Is the entity a limited or general partner, and (b) Can the limited partner control the activity of the LLC that is doing business in California?

FTB misconstrues the Swart court’s statement, “We conclude Swart was not doing business in California based solely on its minority ownership interest in Cypress LLC.” The court’s opinion was not “based solely” on Swart’s minority ownership interest. Rather, in making this statement, the court was simply dismissing FTB’s argument that the court should base its decision on that fact alone. When the entire opinion is considered, it becomes abundantly clear the court’s holding was squarely grounded on the relationship between the out-of-state member and the in-state LLC…Indeed, in rejecting the same argument FTB advanced there as it does here, the court concluded that “[b]ecause the business activities of a partnership cannot be attributed to limited partners, Swart cannot be deemed to be ‘doing business’ in California solely by virtue of its ownership interest in Cypress LLC.” (Ibid., emphasis added and internal citation omitted.) Accordingly, Swart did not establish a bright-line 0.2 percent ownership threshold for purposes of making nexus determinations for out-of-state members holding interests in in-state LLCs classified as partnerships.

Employing the foregoing legal analysis from Swart, we agree with appellant that it is not subject to California tax. Appellant points to certain relevant facts—none of which FTB contests—that are virtually identical to those in Swart. Under its operating agreement, (1) Bullseye is a manager-managed LLC, (2) it is managed by an elected director(s), not appellant, (3) appellant is not personally liable for any debt, obligation, or liability of Bullseye, (4) appellant has no power to participate in Bullseye’s management, or bind or act on behalf of it in any way, and (5) appellant has no interest in any specific property of Bullseye. And, even though appellant’s percentage interest in Bullseye is greater than that in Swart (between 1.12 to 4.75 percent versus 0.2 percent), both are undisputedly minority interests. Therefore, like Swart’s interest in Cypress, appellant’s interest in Bullseye closely resembles that of a limited, rather than a general, partner, and there is no evidence that appellant had any ability or authority, directly or indirectly, to influence or participate in the management or operation of Bullseye. [footnotes omitted]

The conclusion of the Board of Tax Appeals is clear:

[W]e reject FTB’s 0.2 percent ownership threshold as the new bright-line legal standard for distinguishing between an active and a passive ownership interest in an LLC classified as a partnership.

Unlike the earlier decision in Satview Enterprises (which was not precedential), this decision will soon be precedential. The big question is whether the FTB will appeal into the California court system. There’s a definite possibility they will (it would be consistent with the FTB’s general legal practices). No matter, this decision is excellent news for owners of minority interests in California LLCs.

(It’s also, overall, excellent news for California. You want to encourage investment in the state. The FTB’s policy of demanding the $800 for minority interest in California LLCs discourages California investment.)

If you have a non-California LLC that has been forced to pay California LLC tax for indirect interest in a California LLC (or a foreign LLC doing business in California), you should consider filing a claim for refund–or a protective claim if your statute of limitations is nearing expiration.

Case: In the Matter of the Appeal of Jali, LLC

The Check Is in the Mail, Really!

Sunday, July 14th, 2019

One of the more interesting aspects of being a tax professional is the reliance on the mail, the Post Office. When you timely mail a tax return, it’s considered filed on the date of mailing. There are, as always, some caveats: You should mail the return (or payment) using certified mail. That means going to the Post Office, waiting in line, and using one of those green certified mail receipts. But if you do that your return will be considered timely filed even if it takes a while to get to its destination. It also helps resolve issues if your return gets lost in the mail (that’s happened a couple times to my clients), or if the mail truck makes a right turn while on a bridge over San Francisco Bay (there’s a reason there’s a bridge), or the mail truck goes up in flames.

This morning I received a notice from California’s Franchise Tax Board (the state’s income tax agency):

Due to a significant delay at the Post Office, some June payments arrived via mail up to a month late at the Franchise Tax Board.

However, these payments will be posted with a timely date of June 15, 2019. No action is needed by taxpayers or their representatives.

On Tuesday July 9, FTB received approximately 115,000 estimate and other payments with dates mostly between June 5 and June 20.

If a taxpayer or representative contacts FTB regarding a payment sent in June that has not yet posted, FTB customer service representatives will use all available resources to locate the payment.

FTB is asking taxpayers and representatives to allow some additional time to process and post their payment. It is not necessary to stop payment on a check that was delayed. MyFTB users may log in to their MyFTB account to verify payment.

Kudos to the FTB for being proactive on this issue and letting the public (and the tax professional community) know of the problem, and for taking the appropriate steps to resolve the issue. If you are one of the impacted taxpayers, give the FTB one month to resolve this. Unfortunately, this is clearly something that’s going to be a manual fix, and there are 115,000 fixes to be done.

If your payment posts and isn’t corrected to the June 15th date, then it will be time for you (or your tax professional) to contact the FTB.

Arizona v. California Update

Monday, June 24th, 2019

The State of Arizona has asked the US Supreme Court to stop California’s illegal (in Arizona’s view) scheme of requiring indirect passive owners of LLCs who happen to own other LLCs that invest in California from paying California’s minimum $800 franchise tax. Because this is a dispute between the states, the proper venue for Arizona to challenge this is an original action at the Supreme Court.

Today, the Supreme Court had a one-line order on the case:

The Solicitor General is invited to file a brief in this case expressing the views of the United States.

This can be expected in the next few months. Once that brief is filed, the Supreme Court will again consider whether to hear the case; it’s probable that decision will be late this year. If the case is heard, it would likely be sometime next Spring.

IRS To New York, New Jersey, and California: We Weren’t Kidding

Tuesday, June 11th, 2019

Today the IRS issued rules and guidance on charitable contributions as a workaround to the new limits on state and local taxes. Unsurprisingly, the IRS said exactly what I thought they would: both substance over form and quid pro quo apply.

There’s a fundamental rule in tax: The substance of a transaction determines how it’s taxed, not what it’s labeled. Suppose I pay you to perform services for me, but I send you a Form 1099-INT (for interest income). What I pay you is service income, not interest income, no matter how it’s labeled. Consider state taxes. Suppose a state (say, New York) offers you the ability to contribute to the “Support New York Fund” instead of state taxes. Well, the substance is that you’re paying state taxes by contributing to that fund.

Another issue is “quid pro quo;” that’s Latin for ‘something for something.’ And if you get something for a charitable contribution, that portion isn’t charity. Consider a donation to some foundation for $50 and you receive a blanket worth $10; your charitable contribution (that you can take) is $40. This rule has been around for some time. It applies to these workarounds, too.

Put bluntly, the IRS isn’t amused with the workarounds. The Tax Code is law; until Congress changes it, federal deductions for state and local taxes are limited.

Arizona vs. California Franchise Tax Board

Monday, June 10th, 2019

Legal authorities in the Grand Canyon State are not amused by California’s view that indirect interests in California LLCs mean that the entities are doing business in California. And they’re mad enough to take action, asking leave to sue California in the United States Supreme Court.

The issue involved is not new. California’s Franchise Tax Board believes that indirect ownership of an entity doing business in California, or even indirect ownership of an entity that indirectly owns another entity that does business in California, is enough to make all such entities be considered to do business in California. Arizona calls this an “illegal scheme” and wants it to end. The only way is to ask the Supreme Court for permission to take the case; Arizona filed the request in February. California objects to the characterization and states that impacted business owners have ways of fighting the $800 charge.

The problem is that the charge is $800, and the cost to fight is in the thousands of dollars, so few do. There are cases (such as Swart) where business owners fight back, but they take years, are expensive, and require extraordinary deep pockets. Arizona estimates the damage to Arizona business at $10.6 million a year.

Disputes between the states are subject to judicial review by the Supreme Court; however, the Supreme Court must agree to take the case. The Supreme Court is scheduled to decide whether or not to review this in the coming weeks. If the Supreme Court takes the case, it would likely be heard next winter.

Derailed

Friday, May 17th, 2019

California’s “Train to Nowhere,” the alleged high-speed rail that would link San Francisco and Los Angeles (originally), and, now, the thriving metropolises of Shafter (just north of Bakersfield) and Merced is in deep trouble. Well, it has been in deep trouble since day one of the project but the trouble is now far worse: The US Department of Transportation canceled funding of nearly $929 million. That cancellation stops $929 million of funds from heading to California. Making matters worse, the US is considering asking for $2.5 billion to be returned.

Based on CHSRA’s repeated failure to submit critical required deliverables and its failure to make sufficient progress to complete the Project (as defined in Attachment 2, Section 1 h, of the FY 10 Agreement) hy the close of the performance period, and after careful consideration of the information presented by CHSRA in its March 4, 2019, letters to me and to Ms. Jamie Rennert (CHSRA Response) (included as Ex. C and Ex. D, respectively), FRA has determined that CHSRA has violated the terms of the FY 10 Agreement and has failed to make reasonable progress on the Project.

CHSRA consistently and repeatedly failed in its management and delivery of the Project, and in meeting the terms and conditions of the FY 1O Agreement, all of which constitute violations of the FY lO Agreement. Despite extensive guidance from FRA, CHSRA was unable to prepare and submit fundamental Project delivery documents (e.g., budgets, Funding Contribution Plans (FCPs), and Project Management Plans (PMPs)). CHSRA’s inability to track and report near-term milestones, as described further below, shows that CHSRA is likewise unable to forecast accurately a long-term schedule and costs for the Project. Further, after almost a decade, CHSRA has not demonstrated the ability to complete the Project, let alone to deliver it by the end of 2022, as the FY 10 Agreement requires. As described further below, CHSRA is chronically behind in Project construction activities and has not been able to correct or mitigate its deficiencies. Overall, such critical failures completely undermine FRA’s confidence in CHSRA’s ability to manage the Project effectively. [footnote omitted]

This is what almost every critic of this project has said from day one. The cost has gone from $10 billion to somewhere north of $70 billion (I’ve seen estimates that range from $72 billion to well over $100 billion). The demand for high-speed rail between Bakersfield and Merced isn’t high, so the project is going to have problems breaking even.

California Governor Gavin Newsom said he would fight the decision in court. But for now, I will not be surprised if the California high-speed rail line turns into a brand new bikeway sometime in the future.