Archive for the ‘California’ Category

While I Was Out: The BOE Is In Deep Trouble

Wednesday, April 26th, 2017

California has not one but three tax agencies. The Franchise Tax Board (FTB) administers income tax. The Employment Development Department (EDD) administers payroll taxes. And the Board of Equalization (BOE) administers sales tax (and a few other miscellaneous taxes and fees); the BOE also hears appeals from the Franchise Tax Board. Most states have one tax agency but as Scott would say, “California.” Until this year the most notoriety the BOE has received was over its building. That changed last month when the California Department of Finance released a scathing audit report on the BOE.

The Executive Summary notes,

…Specifically, certain board member practices have intervened in administrative activities and created inconsistencies in operations, breakdowns in centralized processes, and in certain instances result in activities contrary to state law and budgetary and legislative directives.

During our evaluation, BOE had difficulty providing complete and accurate documentation in response to our evaluation inquiries and in some instances various levels of management were not aware of and could not speak to certain district activities for which they held oversight responsibilities. Specific examples include the informal establishment of a call center, creating an unofficial office location, and inconsistent use of community liaisons.

This sounds bad. It looks like the BOE is ignoring its budget, violating the law, and ignoring the legislature. Continuing:

In addition, staff resource utilization practices have negatively impacted personnel and accounting records. These records do not accurately depict current operational activities. Despite having dedicated staff and operating budgets of $1.5 million, some board members routinely supplement their staff by redirecting revenue generating staff to perform non-revenue generating board member activities, including outreach activities. These redirections violate Provision 1 of the Budget Act. Additionally, BOE is unable to accurately reflect revenue and cost impacts in its accounting records and Annual Report on Sales and Use Tax Audit and Collection Activities, Statewide Compliance and Outreach Program and Audit Selection Improvements (supplemental annual report).

Yikes! They’re spending money when they’re not authorized to. But I’m sure they’re handling their core function, collecting sales tax, just fine. Right?

Lastly, BOE provided 11 different versions of its proposed sales and use tax allocation adjustment and with each version, Finance continued to find errors and omissions. Since the proposed adjustment continues to change and BOE has not prepared a comprehensive explanation of its assumptions and methodologies, further review of the proposed allocation adjustment is imperative.

The report is devastating, and the reactions have been uniform across both sides of the aisle in Sacramento. Governor Brown has sanctioned the agency. Democrats and Republicans in the legislature are asking tough questions.

This isn’t the first time the BOE had a problem with money. As the San Francisco Chronicle noted in an editorial, the BOE mishandled $47.8 million in sales tax money back in 2015.

Several years ago (when I resided in California) I suggested that the FTB and BOE should merge. I wouldn’t be surprised if that now becomes reality.

Bozo Tax Tip #7: Nevada Corporations

Wednesday, April 5th, 2017

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.

FTB Not Appealing Swart Decision

Wednesday, February 22nd, 2017

Last month a California appellate court ruled that California’s Franchise Tax Board was wrong in trying to assess an Iowa corporation with a 0.2% ownership in an LLC that invested in California the California minimum Franchise Tax. It was announced today that the FTB will not appeal the decision. The court’s conclusion was,

We conclude Swart was not doing business in California based solely on its minority ownership interest in Cypress LLC. The Attorney General’s conclusion that a taxation election could transmute Swart into a general partner for purposes of the franchise tax, and that the business activities of Cypress can therefore be imputed to Swart, is not supported by citation to appropriate legal authority and, in our view, defies a commonsense understanding of what it means to be “doing business.”

This is good news for passive business entity investors who happen to be investing in California. It’s likely that other cases that are winding way through the courts will now be settled and that the FTB will adopt a common-sense approach on this issue. Chris Smith, the FTB’s Trade Media Liaison, sent an email noting that, “[The] FTB is working on providing information to taxpayers in light of the decision which it expects to release soon.” I will link to that information when it becomes available.

San Francisco Supervisors Want a Local Income Tax

Sunday, February 19th, 2017

California is not a low-tax state. Thankfully for Californians, there are no local income taxes. However, that soon may change.

Seven of the eleven members of the San Francisco Board of Supervisors [1] are sponsoring a measure that will ask California lawmakers to allow a local income tax to fund “sanctuary city” policies. The measure was supposed to come up for a vote last Tuesday; however, the vote has been postponed for two weeks.

If you’re a middle class resident of California or San Francisco, your government is telling you that your wallet will be far better off elsewhere.

[1] San Francisco is both a city and county; instead of a city council, there’s a Board of Supervisors (the county equivalent).

Train to Nowhere is Significantly Overbudget

Saturday, January 14th, 2017

The Los Angeles Times has a report today that California’s bullet train may cost 50% more than initially thought…and that’s in the “easy” section to build (in California’s flat Central Valley). It’s now estimated to cost somewhere between $9.5 to $10 billion (rather than the initially budgeted $6.4 billion).

I’ve written about this train before. The train makes no sense; if the train is completed (a dubious assumption), how many people will use it when you can fly between Los Angeles and San Francisco for less than $100 in one hour?

Meanwhile, Governor Jerry Brown is telling Californians that the state is likely running a budget deficit. An obvious solution—but one that will not happen in the Bronze Golden State—is to end the train to nowhere.

I remain quite happy to no longer be a taxpayer in California.

Swart Wins Appeal; Not Liable for California Minimum Tax

Thursday, January 12th, 2017

Good news for non-California businesses that are passive investors in an investment that invests in a California entity. The Franchise Tax Board (California’s income tax agency) has been ruling that business entities that have no active business in California but make an investment in another entity that invests in California must pay California’s mandatory $800 annual franchise tax. Today, a California Court of Appeal upheld the lower court judgment that Swart Enterprises, Inc., one such entity, is not doing business in California.

The facts of the case were not disputed. Swart is a small family-owned Iowa corporation, with a farm in Kansas; occasionally they make sales to Nebraska. Swart has no physical presence in California, no property of any kind (or employees) in California. It does not sell to California. Yet the FTB said it owed the California minimum franchise tax. Why? As the Court noted,

In 2007, Swart invested $50,000 in Cypress Equipment Fund XII, LLC (Cypress LLC or the Fund) and became a member of the LLC. Swart’s investment amounted to a 0.2 percent ownership interest. This is Swart’s sole connection with California.

Cypress was simply an investment fund. But the FTB said, “A foreign business entity (partnership, LLC, or corporation) is considered doing business in California if it is a member of an LLC that is doing business in California,” and owed the minimum $800 franchise tax. Swart paid the tax but filed a claim for refund. The FTB denied the claim. Swart filed a lawsuit which they won; the FTB appealed.

The Court of Appeals noted,

Although this matter calls for our independent judgment, our views are substantially consistent with the trial court’s ruling, which we find to be logical and well-reasoned. We are not persuaded Swart may be deemed to be doing business in California because it owns a 0.2 percent interest in a manager-managed LLC doing business in California. Swart’s only connection to California was a mere 0.2 percent ownership interest it passively held during the tax year the franchise tax was imposed. This interest closely resembled that of a limited, rather than general, partnership as evinced by the fact Swart had no interest in the specific property of Cypress LLC, it was not personally liable for the obligations of Cypress LLC, it had no right to act on behalf of or to bind Cypress LLC and, most importantly, it had no ability to participate in the management and control of Cypress LLC. Because 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. [citations omitted]

There’s more. The FTB tried to hold that because Cypress LLC is being taxed as a partnership, all partners are general partners, and Swart must pay the $800 minimum tax. The Court disagreed.

Like the limited partners in Amman & Schmid, Swart had no interest in the specific property of Cypress LLC (Corp. Code, former § 17300), it was not personally liable for the obligations of Cypress LLC (id., former § 17101, subd. (a)), it had no right to act on behalf of or bind Cypress LLC (id., former § 17157, subd. (b)(1), (2)), and Swart was prohibited from participating in the management and control of Cypress LLC…

We conclude Swart was not doing business in California based solely on its minority ownership interest in Cypress LLC. The Attorney General’s conclusion that a taxation election could transmute Swart into a general partner for purposes of the franchise tax, and that the business activities of Cypress can therefore be imputed to Swart, is not supported by citation to appropriate legal authority and, in our view, defies a commonsense understanding of what it means to be “doing business.”

There are many other similar cases working through the appeals process and the California court system. (There is a case of a corporation that invested in another entity that invested in another entity that made a California investment, and California is attempting to impose the $800 minimum tax on the corporation. That’s a passive investor in another passive investor that has made an investment in California.) It appears that California courts are taking a dim view of the idea that a passive investor with no ties to California can be made into an entity liable for California tax simply making an investment in California. Incidentally, the Court awarded legal costs to Swart.

The bad news is that I fully expect the Franchise Tax Board to appeal this decision to the California Supreme Court. Still, we appear to be reaching the point where California will likely cease this practice.

California Cities Eye Netflix as a Revenue Source

Sunday, September 25th, 2016

“Don’t tax you, don’t tax me. Tax that fellow behind the tree.” — Russell B. Long

The city of Pasadena, California (home of the Rose Bowl and annual Rose Parade) voted to expand their telecommunications tax to include streaming video services such as Netflix. The tax rate is 9.4%; the tax will begin on January 1, 2017.

The Pasadena Star-News noted,

Councilman Tyron Hampton called the decision “ridiculous” on Friday and said he hopes the council will take up the topic.

“Cable has been a hardship for many families and now we’re going to add a hardship to them,” Hampton said. “Next we’ll be taxing you for streaming music on Pandora. This is ridiculous.”

There is absolutely no truth to the rumor that Pasadena will be bringing up a tax on Pandora at their next city council meeting. (Seriously, I made that up.) But it does show the desperation of California cities to balance their budgets. And the biggest culprit are pension costs.

The crisis dates back to the late 1990s, and the dot-com bubble. California tax revenues were increasing rapidly thanks to the stock market, so everyone drew straight lines going up, up, and up. California legislators and the then Governor Grey Davis forgot this song:

But I digress….

The Howard Jarvis Taxpayer Association isn’t enamored by the new tax, and I suspect a lawsuit is in the future. Still, there’s no doubt in my mind that Californians need to watch their wallets (which is nothing new, and one of the reasons I now reside in Nevada).

Kiplinger’s Tax Friendly and Tax Unfriendly States: No Surprises

Saturday, August 27th, 2016

Kiplinger released its list of the tax friendly and least tax-friendly states in the US. There really aren’t any surprises:

Here are the bottom ten:

1. California
2. Hawaii
3. Connecticut
4. New York
5. New Jersey
6. Minnesota
7. Maine
8. Vermont
9. Illinois
10. Rhode Island

And the top ten:

1. Wyoming
2. Alaska
3. Florida
4. Nevada
5. Arizona
6. Louisiana
7. South Carolina
8. South Dakota
9. Mississippi
10. Delaware

Let’s look at my former state (California) and my current state (Nevada) as to the differences. “The Golden State is home to movie stars, beautiful beaches and the highest income tax rates in the U.S., putting it at the top of our list of Kiplinger’s top ten least tax-friendly states. Californians pay lower property taxes than residents of other high-tax states, but, in a state with some of the highest real estate prices in the U.S., they’re no bargain.” There’s not much to add: California is a very high-tax, high-regulation state.

Now let’s look at Nevada. “Another no-income-tax haven, Nevada is one of Kiplinger’s top ten most tax-friendly states. Where does it get its money? Sales tax: the average combined state and local tax rate is 7.98%.” Kiplinger missed another huge source of funding for Nevada: casinos. No matter, Nevada is a low-tax, low-regulation, business friendly environment. I’m happy I’m here.

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.