Archive for the ‘California’ Category

The California Pension Crisis

Sunday, July 31st, 2016

Last week, the California Public Employees’ Retirement System (CALPERS) released its rate of return for the past year. CALPERS budgets based on a 7.5% return per year. In a “Missed it by that much” moment, they came in at 0.61%. Oops.

But for California taxpayers it’s a real issue: California taxpayers will have to make up the shortfall. California State Senator John Moorlach (R-Costa Mesa) has the right idea: “Now we’re in Peter Pan territory. ‘You’ve just got to believe’… the stock market will rise more than 7.5 percent per year. You’ve just got to believe that interest rates will stay at zero indefinitely. You’ve just got to believe that real estate prices will continue to rise.”

Here’s the reality: Taxes must massively increase or state payrolls must massively decrease. Let’s add more taxes to the most heavily taxed state in the country; I’m sure that will go over well…especially just to pay pensions. Might even more of the middle class do what I did? (Hint: The answer is yes.)

Actually, the idea of cutting California government by 30% is wonderful. It also has a 0% chance of happening in California. A repeal of Proposition 13 would require approval by California voters; there’s a chance (albeit small) that could pass; if it did, it would guarantee more middle class departures from the state. On this year’s California ballot is an initiative to extend the “temporary” California tax hikes.

I hope no one wonders why I call California the Bronze State.

Dotting the I’s and Crossing the T’s

Sunday, July 17th, 2016

Assume there’s a California LLC filing its final tax return, and it is owed a refund of (say) $900. You timely file the return and are surprised when you receive a check for $100 rather than $900. What happened?

Years ago this occurred with one of my clients, and I discovered that the Franchise Tax Board (California’s income tax agency) will automatically deduct $800 from a business refund and apply it to the following year’s mandatory $800 tax (if that has not been paid). But that was a final return, so that shouldn’t happen, right?

Checking the box “Final Return” is just one of the steps a California entity must do when filing a return; it must also close the business with the California Secretary of State. When this happened to my client, the Secretary of State’s office hadn’t processed the LLC withdrawal paperwork (they were running about 90 days behind then). About 30 days later the FTB sent a second check for $800 (once they were notified by the Secretary of State’s office that the entity had closed).

Spidell Publishing highlighted this issue in its weekly podcast on California taxation. I do recommend this podcast for any tax professional dealing with California taxation.

Is Cost of Goods Sold Included in the Calculation of the LLC Fee for a California LLC in Real Estate?

Thursday, July 14th, 2016

The Franchise Tax Board, California’s income tax agency, today issued a legal opinion on how to calculate the Limited Liability Company (LLC) fee for a real estate company selling real property. This is an important issue because if Cost of Goods Sold is included the LLC fee would be significantly higher.

California charges LLCs two fees. The first is an $800 a year tax that any California LLC (or a foreign LLC doing business in California) must pay. The second is a gross receipts fee. Gross receipts is calculated by taking gross income and adding back cost of goods sold. So for an LLC selling real estate is COGS added back to determine the basis for the fee?

The FTB ruled that it should be added back.
The FTB looked at the history of the law, and whether COGS (which must be included in the calculation of the LLC fee) includes real property or not.

Accordingly, the term “cost of goods sold” as used by RTC section 17942, subdivision (b)(1)(A), includes real property held for sale to customers in the ordinary course of a trade or business. Therefore, LLCs that are dealers in real property must add the cost of goods sold (based on real property) back to gross income in calculating the LLC fee.

Do note that this is just the FTB’s opinion; courts could rule otherwise. However, a plain reading of the law would seem that the FTB is likely interpreting this correctly. This means an LLC may not always be the best choice of legal entity in California. (Do note that an LLC that elects a corporate form of taxation in California is treated as a corporation—either an S-Corp or a C-Corp—for tax purposes.)

A Train to Nowhere

Wednesday, June 22nd, 2016

I haven’t posted on California’s bullet train in some time (I’m no longer a resident of the Bronze Golden State), but it’s time to once more post about the train to nowhere. In theory, this train will connect Los Angeles and San Francisco. The first part of the route being built is between Shafter and Merced. Shafter is about 18 miles northwest of Bakersfield. How many riders do you think are interested in taking that segment when (or better put, if) it opens?

The whole idea of the train makes little sense given that airlines fly regularly between Southern and Northern California. The price-tag of the train has gone from about $10 billion to over $60 billion; meanwhile, funding from the federal government has dried up.

Yesterday the Los Angeles Times released a story that notes that almost every high-speed rail line needs taxpayer subsidies, a direct contradiction of what the high speed rail authority has stated. And this gem was noted from an April hearing:

Assemblyman Jim Patterson (R-Fresno) asked [rail authority Chairman Dan] Richard, “Do you know of any high-speed rail operations around the world that make substantial profit?”

Richard answered, “Actually all of them, virtually all of them, make operating profit.” He defined that as being able to cover costs after the expenditure of capital to build the systems.

“Ha, OK,” Patterson said.

The Spanish study showed that 3 of 111 high speed rail lines cover their costs, or 2.7%. Or better put, 97.3% do not cover their costs.

I’m glad I’m no longer a California taxpayer.

Withholding Notice Snafu in California

Wednesday, June 8th, 2016

The Franchise Tax Board, California’s income tax agency, apparently issued a boatload of withholding mismatch notices. Some (but not all) of those notices appear to be in error; additionally, the FTB’s phone and chat lines have been swamped.

The FTB is taking two actions. First, they are giving all taxpayers who received these notices two additional weeks to respond. Second, those impacted by the erroneous notices will receive a “notice of this action” that will be mailed on Monday, June 13th.

Here is the text of the FTB’s announcement:

FTB facing high call, chat volumes, many questions about withholding

The number of calls to FTB’s call centers, as well as its LiveChat program, has spiked in recent weeks. We also saw a corresponding increase in district office foot traffic.

During the same time, the department has collected and investigated a number of complaints about withholding adjustment notices. To accommodate taxpayers with questions, FTB is allowing two additional weeks for taxpayers to respond to the notices. No action (including collections) will be taken during that time.

We apologize for any inconvenience this has caused, and we are taking steps to reduce wait times for our customer service channels.

We have identified a population of taxpayers whose returns were affected by late withholding reports from employers. Some wage and retirement withholding data was not provided to the State of California before FTB processed and validated the associated taxpayers’ returns.

To remedy this, FTB is re-validating those returns to allow the original withholding amounts claimed. Impacted taxpayers will receive a notice of this action, which will go in the mail by Monday, June 13.

A sample copy of the letter is available at

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.