1 - spidell publishing, inc. · disadvantages of being an rdp couple in 2006, sb 1827 (ch. 06-802)...

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Your California Solution Since 1975

California Taxletter®File protective claims for clients with taxable muni bond incomeA lawsuit has been filed to challenge the constitutionality of California’s tax on this income.

By Renée Rodda, J.D.Editor

Marty Dakessian has filed suit in Los Angeles Superior Court, on behalf of his clients Robert and Pamela Mass, challenging California’s law that states tax-exempt government bond interest passed through from a mutual fund invested less than 50% in U.S. government obligations or California municipal obligations is taxable for state purposes.1

The lawsuit means taxpayers who have been paying tax on this income can now file protective refund claims to protect their refund rights if the taxpayers ultimately succeed in this battle.

We have been reporting on this case since the taxpayers initially started the appeal process in November of 2015. For more information on the case, and why the Board couldn’t rule on the constitutionality of the law, see “Taxpayer will go to court over muni bond interest law” in the July 2016 issue of Spidell’s California Taxletter®.

The California lawUnder R&TC §17145, interest can only be excluded if at least 50% of

the assets held by a mutual fund consist of interest-bearing obligations that are tax-free for California purposes. This includes U.S. and California obligations. Thus, if the fund holds less than 50% of these obligations, all distributions are taxable, even though this income is exempt under the U.S. Code and California Constitution.2 If the fund holds 50% or more in qualifying obligations, the flow-through character of the distributions is retained.

California law requires mutual fund firms and brokerage houses that report interest or dividends from bonds issued by another state that are exempt from federal taxation to file information returns with the FTB.3 So taxpayers who fail to report this income properly will likely receive notices from the FTB.

Filing protective claimsIf your clients have paid tax on California-exempt muni bond income, they

could be entitled to refunds when the dust settles in this case. In order to protect those refund rights, file protective refund claims now.

September 2016VOLUME 38.9

File protective claims for clients with taxable muni bond income

Are there still registered domestic partners in California? Page 2

Reasonable minds may differ over meaning of reasonable cause Page 5

Filing property tax assessment appeals Page 6

New hotline for reporting identity theft to FTB Page 9

Don’t forget the Other State Tax Credit Page 10

Installment sale treatment allowed for sale of partnership interest Page 15

FTB keeps $800 of business refunds Page 18

Wisconsin S corp. hit with huge late-filing per-shareholder penalty Page 19

Thumb Tax Page 21

Tax relief available to fire victims in three more counties Page 22

California Contacts Page 23

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This publication is sold with the understanding that the publisher is not engaged in rendering legal, accounting or other professional advice and assumes no liability whatsoever in connection with its use. Since tax laws are constantly changing and are subject to differing interpretations, we urge you to do additional research before acting on the information contained in this publication.

SPIDELL’S CALIFORNIA TAXLETTER® (ISSN No. 0194-8237) is published on the first day of each month by Spidell Publishing, Inc.®, 1134 North Gilbert Street, Anaheim, California 92801-1401. Telephone: (714) 776-7850. Fax: (714) 776-9906. Web site: www.caltax.com. E-mail: [email protected]. The subscription price is $164 for 12 months. Periodicals Postage Paid at Anaheim, CA.© 2016, Spidell Publishing, Inc®. POSTMASTER: Please send address changes to Spidell’s California Taxletter, P. O. Box 61044, Anaheim, California 92803-6144. Federal law prohibits unauthorized reproduction of Spidell’s California Taxletter®. All reproduction must be approved in writing by Spidell Publishing, Inc.® Publisher Emeritus: Robert Spidell. Publisher: Lynn Freer. Editor: Renée Rodda. Senior Editor: Tim Hilger. Contributing Editor: Kathryn Zdan. Contributing Editor: Diane Fuller. Managing Editor: Austin Lewis. Layout: Jeremy Suppes.

California Taxletter®SEPTEMBER 2016

A refund claim must be made prior to the expiration of the later of: ! Four years from the date a return was timely filed, including extensions; ! Four years from the last day prescribed for filing the return, determined without regard to any extensions; or

! One year from the date of overpayment.4

Currently, the FTB has not established any special procedures for accepting these protective refund claims. At this point, they recommend that taxpayers follow the instructions for filing a protective claim on Form 540X, Amended Individual Income Tax Return:

! Write “PROTECTIVE CLAIM” in red ink at the top of the completed form; and ! On Part II, Line 5, specify that the claim is being filed in reference to the pending litigation in Ronald & Pamela Mass v. FTB, Los Angeles Superior Court, Case No. BC627648.

These claims will remain on hold until there is a final resolution of the case. Remember that this could take years, as we have seen with other cases in the past.

1 Ronald & Pamela Mass v. FTB (July 20, 2016) Los Angeles Superior Court, Case No. BC6276482 31 U.S.C. §3124(a); Cal. Const., Art. XIII, §26(b)3 R&TC §18631(c)(8)4 R&TC §19306

Are there still registered domestic partners in California?Is there a benefit to being an RDP?

By Lynn Freer, EAPublisher

With a law change in 2006 and the Supreme Court decision ruling that same-sex married couples are treated the same as opposite-sex couples, many California RDPs either married or ended their domestic partnerships.1

CommentMarty Dakessian is the founder of Dakessian Law, a practice

dedicated to representing California taxpayers. He can be reached at (213) 516-5510 or [email protected].

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While there are reasons to marry now that federal law recognizes same-sex marriage, there are still a few valid reasons to register as RDPs.

Advantages of being RDPsProbably the biggest benefit to being RDPs versus married is that, for federal

purposes, the individuals may file returns as single, including head of household or qualifying widow/widower. With the plethora of marriage penalties, this can be a big benefit. However, for federal purposes, community property law applies and income must be split, but filing as two singles or as single and a head of household will generally result in less tax than the same couple who is married.

Look at the Voss case where the court ruled that two unmarried owners of a residence may each deduct interest on up to $1 million (plus $100,000 each in equity debt).2 While California will force the couple to file as married and limit the maximum loan amount at $1.1 million, for federal tax purposes the interest deduction could be huge.

There may also be couples who, due to religious reasons, do not want to marry but want to make a legal commitment and choose to register.

Disadvantages of being an RDP coupleIn 2006, SB 1827 (Ch. 06-802) changed the law to require RDPs to file

California returns as married taxpayers, a reason many couples initially chose to register rather than get married. This was especially enticing to higher income heterosexual couples who could have a “legal” domestic relationship without filing as a married couple. When the law changed and the IRS announced that community property laws apply to RDPs, many of these couples dissolved their domestic partnerships.

RDPs do not get certain legal benefits afforded to married individuals, whether same-sex or opposite-sex RDPs. These benefits include:

! The unlimited marital exemption or portability at the death of the first RDP; ! The ability of the partner to receive a deceased RDP’s spousal retirement annuity;

! The ability of the partner to receive a spousal Social Security benefit; and ! Filing federal tax returns as married.

EXAMPLE 9-1: Joe and Jeff are RDPs. Their total combined income – all community property – is $500,000. They have a $2 million mortgage on their home, and interest paid on the home is $60,000.

As RDPs, on the federal return they may deduct $30,000 each. At a tax rate of 39.6 percent, their combined tax benefit is $23,760. If they are married, their tax benefit would be $13,068 because they would be limited to deducting interest paid on only $1.1 million.

For California purposes, they are limited to a combined $33,000 deduction based on the $1.1 million limit.

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Each RDP taxpayer must continue to file as a single taxpayer for federal purposes and as a married taxpayer for California.

For federal purposes, an RDP may use the following filing statuses: ! Single; ! Head of household; or ! Surviving spouse (if previously married and the spouse died during either of the two immediately preceding taxable years, and the survivor provides a home for a qualifying dependent child).3

Although they file as single for federal purposes, the community property rules that apply to spouses also apply to RDPs for federal and California purposes.4

For California purposes, an RDP couple will be treated in the same manner as a married couple, including classification of property as separate or community, division of property, support payments, child custody, and division of the couple’s debts.

Completion of the RDP returns entails preparing: ! Federal returns for each single taxpayer who has a filing requirement, splitting community income between the RDPs;

! A dummy federal return prepared as if the taxpayers had been married for federal purposes, which is used to complete the California return; and

! A California return (or returns) as married taxpayers.

1 U.S. v. Windsor (June 26, 2013) 570 U.S. 122 Voss v. Comm. (August 7, 2016) U.S. Court of Appeals, Ninth Circuit, Case Nos. 12-73257 and 12-732613 IRC §2(a)4 CCA 201021050

Reasonable minds may differ over meaning of reasonable causeRecently released BOE decisions shed light on the difficulty of having penalties abated.

By Sandy Weiner, J.D.California Editor

We frequently receive inquiries on our Message Board asking how to establish reasonable cause to have FTB penalties abated. Our standard

Who can be RDPs?In California, RDPs are individuals of the same sex or a heterosexual couple

where at least one individual is age 62 or older. The couple must register as legal domestic partners with California’s Secretary of State. Unmarried couples living together are not RDPs unless they have registered as such.

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response is “good luck.” We do not mean to be flippant, but as you can see from the decisions below, it can be very difficult to establish reasonable cause.

All three taxpayers below filed appeals requesting reasonable cause abatement. All three appeals were denied.

Estimated tax underpayment penaltyThe estimated tax underpayment penalty under R&TC §19136 applied

when an 80-year-old taxpayer sold an apartment building in Canada in December 2012.1 The taxpayer claimed that due to problems with escrow and Canadian withholding, she did not have the funds to make the estimated tax payment until April 2013. However there is no reasonable cause exception for the underpayment of estimated tax penalty (unless she had retired in 2012 and was over age 62). A once-in-a-lifetime sale of property also did not qualify for the “casualty, disaster or other unusual circumstance” exception.2

Accuracy-related penalty Taxpayers were ineligible for relief from the R&TC §19164

accuracy-related penalty even though the taxpayers’ tax preparers were convicted of fraud.3 The Board ruled that the taxpayers should have known that the use of a partnership return to deduct personal expenses and to create large losses was not legal, and they should have questioned their preparers’ competency.

In another case concerning the accuracy-related penalty, a doctor and his “consultant” wife failed to show that they reasonably relied on an attorney’s advice when they set up a corporate structure and defined benefits plan that constituted an abusive tax shelter.4 The taxpayers failed to establish reasonable cause to have the California accuracy-related penalty abated. They failed to show good faith reliance on the attorney by supplying no evidence as to what information they provided to the attorney, what advice the attorney provided, and their reasonable reliance on the advice.

Also, the taxpayers signed a closing agreement with the IRS that included the federal accuracy-related penalty in order to have some of their federal tax liability reduced. The fact that the federal penalty was not abated weighed against the taxpayers.

1 Appeal of Brown (December 18, 2014) Cal. St. Bd. of Equal., Case No. 7850302 R&TC §19136; IRC §66653 Appeal of Costello (December 18, 2014) Cal. St. Bd. of Equal, Case No. 742268; R&TC §191644 Appeal of Jones (December 18, 2014) Cal. St. Bd. of Equal., Case No. 741988; R&TC §19164

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Filing property tax assessment appealsBase-year values may increase more than 2% if the property value declined sharply and then rose again.

By Kathryn Zdan, EAContributing Editor

Property holders may have, or will soon receive, a notice from their county showing assessed values for property tax purposes. In some cases, the assessment value will increase by more than the statutory 2% limit. This frequently happens when the housing market rebounds after a home’s assessed value was previously lowered to reflect declining market values.

Property owners who believe their property is overvalued may seek a reappraisal from their local county assessor’s office. They may not need to file a formal appeal if they talk with their assessor’s staff first. The assessor’s staff can explain how they determined the value and review any additional information provided. If the assessor’s staff agrees with the owner’s documentation, they may be able to reduce the assessed value of the property.

If the property owner still disagrees with the assessed value, then he or she must file an appeal with their local clerk of the Assessment Appeals Board, and the appeal must be filed within a specific period in order to be valid.

Property values: ups and downsUnder Proposition 13, a base-year value is established when a property

changes ownership or is newly constructed. A base-year value may not be increased more than 2% per year, and sometimes the market value of a property on the January 1 lien date has fallen below the adjusted base-year value.

To reflect the decline in value, assessors must use the lesser of the adjusted base-year value or the market value. This is generally referred to as a “Proposition 8” assessment.

A property assessed under Proposition 8 is not restricted to the 2% limit. This means that if values decline and then rebound, taxpayers may see a jump in property tax in excess of 2%. Once the market value increases and is equal to or greater than the base-year value, increased by the annual 2% increase, the base-year value is restored. The annual increases beyond that will again be limited to 2%.

As such, each year the value is the lesser of: ! The Proposition 13 value increased by the 2% annual increase; or ! The FMV of the property.

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Filing periodThe period for appealing California county property tax assessments

began on July 2, 2016, and ends September 15, 2016, if the county assessor mails assessment notices to all property owners by August 1, 2016. This is the filing period for Alameda, Inyo, Kings, Placer, San Francisco, San Luis Obispo, Santa Clara, Sierra, and Ventura counties.

For all other counties, the appeals period ends November 30, 2016.2

You can see the 2016 filing deadlines for each county at:

The BOE has prepared a video to assist taxpayers when filing appeals. The video may be viewed at:

An appeal must be based on the market value of the property as of January 1 of the year in which the taxpayer files the appeal. For example,

www.boe.ca.gov/proptaxes/pdf/filingperiods.pdf

www.boe.ca.gov/info/AssessmentVideo/Index.html

CautionProperty owners must pay assessed property taxes on time — even

if they have filed an appeal. Failure to do so will result in interest and penalties being charged, regardless of the outcome of the appeal.3

EXAMPLE 9-2: Joe purchased his home in Year 1 for $500,000. On January 1, Year 2, the market value of the home was $550,000. Under Proposition 13, however, the increase in his base-year value was limited to 2%. So, for the Year 2–Year 3 roll, his assessed value was $510,000.

In January of Year 3, the market value of his home had dropped to $350,000. As a result, his county assessor dropped the assessed value of his home to $350,000 for Year 3–Year 4.

In January of Year 4, the market value of his home increases to $700,000. His assessed value will now be $541,216 (the lesser of the FMV and his original base value increased by the 2% annual increase). Thus, the assessed value for property tax purposes is more than a 2% increase over the prior year.1

The computation of the maximum increase in Proposition 13 value is as follows:Year 1 $510,000 ($500,000 × 102%)Year 2 $520,200 ($510,000 × 102%)Year 3 $530,604 ($520,200 × 102%)Year 4 $541,216 ($530,604 × 102%)

http://www.boe.ca.gov/proptaxes/pdf/filingperiods.pdf

http://www.boe.ca.gov/info/AssessmentVideo/Index.html

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if the taxpayer files an appeal in 2016, the appeal must be based on the market value of the property as of January 1, 2016.

For general information on filing and presenting an appeal, see BOE Publication 30, Residential Property Assessment Appeals.

For links to county assessors’ offices, visit:

Who can file?An appeal can be filed by the property owner or the owner’s spouse,

registered domestic partner, parents, children, or any person directly responsible for payment of the property taxes. These individuals do not need to be designated as agents of the property owner.

An appeal may also be filed by the authorized agent of the property taxpayer. If an application is filed by an agent — other than a California licensed attorney or a family member — written authorization signed by the property owner is required.

Further appeal rightsA decision by an appeals board is final. Taxpayers who want to challenge

the appeals board’s decision must file a claim for refund with their board of supervisors, unless they’ve already made their appeal application for a claim for refund, in which case the next step is to file an action in Superior Court.

Appealing valuation changes from a disasterTaxpayers may appeal a change in valuation resulting from a disaster to

the Assessment Appeals Board or the county Board of Equalization,4 and can file property tax appeals to either board depending on the appeal process the county has decided to adopt.

1 See County of Orange v. Bezaire (2001) 11 Cal.3d 4782 BOE Letter to County Assessors No. 2015/0223 R&TC §4985.34 R&TC §§62, 170, 201.7, 439.2

New hotline for reporting identity theft to FTBAlso beware of a new scam targeting preparers.

By Kathryn Zdan, EAContributing Editor

Effective July 1, 2016, the FTB has a new Identity Theft Hotline.1 Although the hotline number has changed, the ID theft fax number remains the same

www.boe.ca.gov/proptaxes/assessors.htm

http://www.boe.ca.gov/proptaxes/assessors.htm

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for submission of ID theft correspondence and forms, such as the ID Theft Affidavit, FTB 3552.

The contact numbers to use are:

How to report the theft In general, if a taxpayer knows or even just suspects that he or she is a

victim of identity theft, it’s important to immediately file Form FTB 3552, Identity Theft Affidavit. The taxpayer should also be prepared to send copies of the following documents to the FTB:

! Passport; ! Driver’s license or Department of Motor Vehicles identification card; ! Social Security card; ! Police report; and ! IRS letter of determination, if applicable.

Form FTB 3552 can be filed as a precautionary measure when a taxpayer believes his or her identity has been compromised but has not yet experienced any direct tax ramifications.

How to handle future returnsWe asked the FTB a couple of questions about how they specifically

handle returns for taxpayers affected by identity theft.Q: What happens in the year after a person has been a victim of tax-

related identity theft?A: Because of the “ID Theft status” on the account, the FTB will stop and

review any returns filed under the victim’s name and Social Security number to confirm if the return was filed by the real taxpayer or if it’s fraudulent. The FTB will use information from their files and may also contact the taxpayer for confirmation. If the victim is expecting a refund, the refund could be delayed 60 days due to the high volume of identity theft cases.

Q: Does the taxpayer need to include any special handling requests or instructions when they file a return for a year after the theft took place?

A: No, the return should be filed as normal. The FTB recommends filing early in the season in order to be able to e-file. If the thief e-files a fraudulent return before the taxpayer, the taxpayer will be required to file on paper. When a taxpayer’s account is in “ID theft status,” no returns will be processed without manual review. This process helps the FTB to protect the taxpayer.

Latest phishing scam targets tax preparersTax professionals should be aware of the latest phishing e-mail scam

that imitates communication from tax software providers.2 Recipients are

Phone: (916) 845-7088Fax: (916) 843-0561

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instructed to download and install an “important software update” via a link that redirects to a website prompting the tax pro to download the fraudulent update. The file has a naming convention that uses the actual name of their software followed by an “.exe extension.”

The download is in fact a program designed to track the tax professional’s key strokes, which is a common tactic used by cyber thieves to steal login information, passwords, and other sensitive data. Rather than clicking on links or opening e-mail attachments, preparers should go to the software provider’s main webpage to download all updates.

1 August 2016 FTB Tax News, “New Identity (ID)Theft Hotline”2 FTB Tax News Flash (August 19, 2016); IR-2016-103

Don’t forget the Other State Tax CreditHere are little known facts and problems.


California allows individuals, estates, or trusts to claim a credit for net income taxes imposed and paid to another state only on income that has a source within the other state and is taxed by California and the other state.1

Lately, we have seen new issues, Board decisions, and a few changes. We have also heard from several practitioners whose clients received notices disallowing the credit. So here is a review of how the credit works as well as discussions of:

! Group return withholding disallowance; ! The FTB’s new disallowance of credit for the Revised Texas Franchise Tax;

! Double-taxed income that doesn’t qualify for the credit; and ! Statute of limitations for claiming the credit.

Generally, you take the credit for double-taxed income on the taxpayer’s resident return. However, for certain states, the credit is taken on the nonresident return. If you have income taxed by California and another state, use the chart ”Other State Tax Credit — Where to Take It“ to determine where to take the credit.

Client resourceDownload a copy of Spidell’s Identity Theft Victim Checklist at:

www.caltax.com/spidellweb/public/editorial/IDtheft.pdf

http://www.caltax.com/spidellweb/public/editorial/IDtheft.pdf

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Here are some exceptions to the general rule.

Taxes paid on a group returnIf the tax was paid to certain states on a group nonresident return, the

credit goes on the California resident tax return, even though normally the credit would go on the nonresident return of the other state.2 According to the Schedule S instructions, these are the states where the group return withholding will go on the California resident return:

! Arizona; ! Guam; ! Indiana; ! Oregon; and ! Virginia.

To claim the credit for one of these states on the resident return, attach a statement to the return explaining that the income is part of a group return, the amount of the income, the tax withheld, and the state involved.

FTB incorrectly disallows credits from group returnsThe FTB has been erroneously disallowing the OSTC when a California

resident claimed the credit from a group return for a reverse credit state on their California resident return.

For example, Virginia is typically a reverse credit state, but for a credit from a group nonresident return, the credit is taken on the California resident return. In many cases the FTB disallows the credit even though it was taken correctly. We have talked to the FTB, and they are looking into a way to fix this intermittent problem.

As stated above, the Schedule S instructions say to attach a statement explaining that this is part of a group return. Also, on Part I of Schedule S,

Other State Tax Credit — Where to Take It

Taxpayer is: Income is from: Credit is taken on:

California resident

Arizona, Guam, Indiana, Oregon,* Virginia

Other state nonresident return

Any state or U.S. possession not listed above

California resident tax return

Taxpayer is: Resident of: Credit is taken on:

California nonresident

Arizona, Guam, Indiana, Oregon, Virginia

California nonresident tax return

Any state or U.S. possession not listed above

Other state resident return

* There is an exception for California residents who paid tax to both California and Oregon on wages for services performed in Oregon in connection with a qualifying film production

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don’t lump income and credits from separate states into one line and say “See attached.” This will surely result in a disallowance.

If you have a credit from more than one state, figure the credit by completing a separate schedule for each state. Add the credits from each state’s Schedule S, and enter the total on Form 540.

The FTB is looking into a resolution. We have suggested a box to check, or a separate section to list the group return states. In the meantime, a call to the Tax Practitioner Hotline or a secure chat is your best bet if the credit is incorrectly disallowed.

Certain Oregon wagesGenerally, a California resident must take a credit for tax on

Oregon-source income on the Oregon nonresident return. However, for “qualifying compensation” the credit is taken on the California resident retun.3 Qualifying compensation includes wages paid by an employer to an employee for services performed in Oregon in connection with a qualifying film production.4

Oregon does not allow California residents a credit against Oregon income taxes for taxes paid to California on qualifying compensation. Therefore, the FTB stated that they will generally allow a credit to California residents for income taxes paid to Oregon on qualifying compensation.

Dual residentsA dual resident is any taxpayer who is defined as a California resident

under California law and a Virginia resident under Virginia law. A dual resident of Virginia and California may claim the Other State Tax

Credit on the California return for taxes paid to Virginia on Virginia-source income. Dual residents who are elected or appointed officials and staff (holders of federal elective offices, certain Presidential appointees, and congressional staff members)5 may claim the OSTC for taxes paid to Virginia on all income taxed by Virginia whether or not it has a source in Virginia.6

Dual-resident estates or trustsAn estate or trust may claim the credit for taxes paid to another state if it

is a “resident” of California and also a “resident” of another state. For this purpose, an estate or trust is considered to be a “resident” of any state that taxes all its income regardless of whether the income is derived from sources within that state.7

The credit is limited to: ! The proportion of the tax paid to the other state by the estate or trust that the double-taxed income bears to the entire income of the estate or trust; and

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! The proportion of the estate’s or trust’s California tax that the double-taxed income bears to the total income taxed by California.

Both states taxR&TC §18001 defines double-taxed income for resident taxpayers

claiming the credit to reflect only income that would be sourced to California to a nonresident. In other words, you cannot take the credit if the other state taxes the nonresident on the income, but California would not tax a nonresident on the same income.

Revised Texas Franchise TaxIn January 2014, the FTB withdrew Notice 2010-2, which stated that

whether a taxpayer can claim an OSTC for payment of a Revised Texas Franchise Tax (RTFT) must be made on a case-by-case basis. Late last year, the FTB went one step further and began disallowing the OSTC for all payments of RTFT. After hearing from a number of practitioners whose clients’ credits were disallowed, we asked the FTB for an answer as to why they were disallowing the credits.

In February of 2016, the FTB issued Technical Advice Memorandum 2016-01, which stated that the payment of RTFT is not eligible for the OSTC for any year and that a legal ruling would be issued on the issue. At that time, we were told the FTB would issue the legal ruling “within the next couple of weeks.” Most recently, we were told the advice would be coming out by the end of summer. At press time it had not been released.

What income/tax does not qualify?The OSTC is not allowed for either preference or alternative minimum tax

paid to California or another state.The OSTC may not be claimed for taxes paid to cities, counties, and other

countries or their subdivisions, such as the Canadian provincial tax.However, a portion of the tax paid to Maryland counties is allowed in

computing the credit for Maryland. The maximum amount includable in this credit is 20% of the state tax.8

EXAMPLE 9-3: Joey is a California resident. He sold property in Hawaii and is receiving principal and interest payments on the property sale. Hawaii taxes him on the principal and interest payments. Under Hawaii law, all interest on the sale of property located in Hawaii has a situs there. California allows a credit for tax paid to the other state on the principal payments, but not on the interest payments. This is because, under California law, the interest is sourced to California, not Hawaii, and a Hawaii resident is not required to pay California tax on the interest if it does not have a California situs.

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Statute of limitationsA taxpayer who pays tax to another state has one year from the date the

tax is paid to claim an OSTC with the FTB, even if the statute of limitations has already expired.9

This provision will help taxpayers who do not file tax returns with a nonresident state and are notified after the California statute has expired.

The reverse is not true, however. A taxpayer who incorrectly filed a resident return rather than a nonresident return was held liable for California tax. The taxpayer was not entitled to the OSTC for the increased liability because the statute of limitations to claim an OSTC had lapsed in Pennsylvania. Where a taxpayer fails to take the OSTC in another state to prevent double taxation and then the statute has run, the double tax cannot be recouped under the California statute.10

How to compute the creditBasically, the credit allowed is the lesser of the tax paid to California or the

tax paid to the other state on the income. Here are the steps you use:Step 1: Calculate the amount of income taxable by both California and

the other state. Typically, they will be the same, although they may vary because of depreciation or other laws.

Step 2: Calculate a percentage of the double-taxed income taxable by California divided by the California adjusted gross income. The percentage cannot exceed 100%. This percentage is then multiplied by the California tax liability.

Step 3: Calculate a percentage of the double-taxed income taxable by the other state divided by the other state’s adjusted gross income. The percentage cannot exceed 100%. This percentage is then multiplied by the income tax paid to the other state for the same year the income is taxed by California.

The credit is the lesser of the results of step 2 or step 3.

EXAMPLE 9-4: Opie, a California resident, has income from an oil well in Oklahoma in 2007. He never filed Oklahoma tax returns to report the income. On December 15, 2015, the state of Oklahoma assessed $1,000 tax on $15,000 of Oklahoma income he earned in 2007, which he paid on January 15, 2016.

Even though the 2007 statute of limitations for California expired on April 15, 2012, he may claim a credit for tax paid to Oklahoma on his 2007 amended California return.

To claim the credit, he must file an amended 2007 return on or before January 14, 2017.

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To claim the credit on the California return, complete Schedule S, Other State Tax Credit.

1 R&TC §§18001–180112 R&TC §185353 FTB Information Letter dated July 29, 20104 Oregon Law Ch. 2005-559 §15 R&TC §17014(b)6 Id.7 R&TC §180058 Appeal of Daniel Q. and Janice R. Callister (February 25, 1999) 99-SBE-0039 R&TC §19311.510 Appeal of Calvin (November 19, 2014) Cal. St. Bd. of Equal., Case No. 728341

Installment sale treatment allowed for sale of partnership interestThe FTB argued unsuccessfully that the partnership structure was used for tax avoidance purposes.


Taxpayers who used a complicated related partnership structure as part of their estate plan had a substantial business purpose and were not just attempting to avoid tax.Therefore they were able to use the installment method to report income from the sale of a partnership interest.1

The planThe Khourys used several of their family-owned real estate entities as part

of their estate plan. The transactions at issue involved the installment sale of their children’s partnership interests in one partnership to protect the assets of another partnership for the benefit of their grandchildren.

The FTB disallowed the installment sale treatment of the partnership interest claiming that the transaction lacked any economic substance and was really used to avoid tax on the sale of an asset. As a result, the FTB assessed tax on the full sales price of the partnership interest during the year of the sale. However, the Board found that the transactions did not lack economic substance and therefore allowed the installment sale treatment.

The Board found that the transactions had economic substance because: ! The transactions had substantial nontax motivations and were undertaken as part of an estate plan that ensured that assets were protected for the benefit of the grandchildren; and

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! The management of the entity that purchased the partnership interest provided professional and independent oversight of the partnership assets showing that there was objective economic substance.

The factsThe Khourys were owners of Pacific Scene Family of Companies, a group

of family-owned real estate companies. NBJ Associates, LP and RSD Group, LP were two limited partnerships that were a part of this group.

As part of an estate plan, they arranged for a sale of NBJ‘s interest in RSD to a third partnership, Sundance-K LP. However, during this same period, RSD began negotiating the sale of its major asset, an apartment building.

The sale of the interest in RSD from NBJ to Sundance allowed RSD to make an IRC §754 election and increase the partnership’s basis in the apartment building. The sale was accomplished using an installment sale with minimal cash, lots of debt, and a huge balloon payment due in 30 years.

The FTB alleged that the whole transaction was designed to avoid tax on the sale of the apartments and assessed tax on the sale.

Below is a timetable and description of the transactions at issue in the case.

Timetable of transactions

Date Event

December 6, 2005 RSD contracted to sell the Club Pacifica Apartments

January 3, 2006 NBJ sold its interest in RSD to Sundance-K in return for a $14.75 million installment note and $10,000 in cash

February 1, 2006 Sundance-K paid a $490,000 first installment to NBJ. The remainder of the $14.26 million sale price was due in thirty years on January 3, 2036. Monthly interest payments of $60,000 (5% interest rate) became due beginning March 1, 2006, until principal was paid in full.RSD made an IRC §754 election on behalf of Sundance-K, increasing its partnership’s basis in the property to $17,529,480

February 7, 2006 RSD’s sale of the Club Pacifica Apartments closed, and Sundance-K received $223,558 of the allocated net gain

(continued)

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How the taxpayers prevailedWhen initially looking at the structure of these transactions, you can see

why the FTB made the tax avoidance allegation. The taxpayers, however, were able to present evidence to demonstrate that their main goal was to protect assets for their grandchildren. The Board held that they proved there was a legitimate economic purpose to the transaction, and the installment sale was upheld.

Testimony and other declarations presented by the taxpayers established that the Khourys entered into these transactions for estate planning purposes to ensure that the cash proceeds from the apartment sale would not be squandered by the adult children.

By structuring the partnership interest transaction as an installment sale, the grandparents essentially put their three children on a monthly allowance of $60,000 ($20,000 each), and ensured that the ultimate sale proceeds from the partnership interest were invested for the benefit of the grandchildren.

Because all of the entities involved made the payments required by the various interrelated transactions (e.g., interest payments on the installment note and the loans), the independent entity structures were respected.

In addition, all required tax payments were made by the individual owners, so there was no legitimacy to the FTB’s claim that the transactions were undertaken for tax avoidance purposes.

Finally, it was clear that the ultimate control of the assets was shifted from the adult children to the grandparents and therefore changed the economic realities between the parties.

Timetable of transactions (continued)

Date Event

February 28, 2006 RSD distributed $14,504,490 in proceeds from the Club Pacifica Apartments sale to Sundance-K. Most of the proceeds received by Sundance-K were used to extend interest-bearing loans to other entities, which were owned directly or indirectly by the various Khoury family members

March 1, 2006 Sundance-K began making monthly $60,000 interest payments to NBJ, which were reported by NBJ as taxable income

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By finding that the transactions had economic substance and were not undertaken for the purpose of tax avoidance, the Board also ruled that installment sale treatment was not disallowed under the:

! IRC §453(e) two-year resale prohibition; or ! Treas. Regs. §1.701-2 anti-abuse rules.

1 Appeal of Khoury (May 26, 2016) Cal. St. Bd. of Equal., Case Nos. 867810, 867855, and 867874

FTB keeps $800 of business refundsIt’s in case they don’t dissolve.


Recently one of our subscribers relayed an interesting situation when filing a final entity return with the FTB. From this we learned something new that I want to pass on to you.

A final LLC return was filed with a refund of $3,500. The FTB sent a check for only $2700. The rep called to ask why and was told the $800 was taken to cover 2016 $800 minimum tax.

We checked and here’s what we found out.When a business entity tax return posts to the FTB’s accounting system and

creates a credit balance, the system looks to see if the corporation’s estimate or LLC tax payment for the subsequent tax year has been received. If the payment has not been received and is past due, the system will move the money ($800) forward on behalf of the business entity to help them reduce penalties and interest on the subsequent year. At that point, the remaining credit balance would be refunded to the business entity when a return is filed or as an offset to other tax years with a billable balance due. This applies to both corporations and LLCs.

This scenario would hold true even if the recently filed return was marked “final” because if the entity does not take care of their obligations with the Office of the California Secretary of State to cancel or dissolve, they continue to have a filing requirement going forward. Essentially, until they fully complete the cancellation or dissolution and the FTB receives that information from the SOS, they are still an active entity.

What the FTB is overlooking is that for many years, the final return could be filed prior to dissolving with the SOS. We believe the FTB should revise their procedures and not apply the $800 to the subsequent year if the final box is checked.

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Once the FTB has received information from the SOS that the entity is indeed cancelled or dissolved, the remaining credit would be refunded, provided that the entity did not incur another year’s filing and payment requirement or some other additional balance due.

We were told this has been standard practice for business entities for many years. Exact information about when the practice was implemented is not available. However, from talking with veteran staff, it’s been at least 15 years or more.

Wisconsin S corp. hit with huge late-filing per-shareholder penaltyTaxpayers protected by P.L. 86-272 must still pay the $800 minimum franchise tax.


A Wisconsin S corporation was required to pay $16,200 in a late filing per-shareholder penalty for failing to timely file a California franchise tax return to report and pay its $800 minimum franchise tax liability for the 2010 taxable year.1

The Board rejected the taxpayer’s claims that the penalties should be abated for reasonable cause because:

! It reasonably relied on its tax preparer’s advice that it had no California filing requirement; and

! FTB staff had provided contradictory information concerning the taxpayer’s filing requirements.

BackgroundAmerican Orthodontics Corporation (American) was headquartered in

Wisconsin and manufactured and sold dental and orthodontic equipment around the world. At one time, American was qualified to do business in California but surrendered this right in 1982. Since 2003, it had employees in California, and in 2010 it had six sales people in California.

EXAMPLE 9-5: Done LLC filed a timely tax return and marked the box “final.” Because they had overpaid the annual fee on gross receipts, their refund was supposed to be $3,500. The FTB sent a check for $2,700 and applied the $800 to the 2016 annual tax because they had not yet cancelled their registration with the SOS.

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Although it was required to and did pay California employment taxes on the wages paid to the sales people, American was not required to pay corporate income taxes on its California-sourced income pursuant to the federal Interstate Income Act of 1959 (Public Law 86-272).

Under P.L. 86-272, taxpayers are not subject to corporate income taxes in states where their only activities involve the solicitation of sales of tangible personal property. However, P.L. 86-272 protections do not extend to the minimum franchise tax. Taxpayers who are “doing business” in California must pay the minimum franchise tax even if not required to file a corporate income tax return.2

When American realized that it was required to file and pay the minimum franchise tax for the 2010 taxable year, it voluntarily filed a return on June 15, 2012, before it was even contacted by the FTB. On the return, it indicated that it had 75 shareholders.

Subsequently, the FTB assessed the per-shareholder late-filing penalty under R&TC §19172.5 against American, which imposes a penalty against late-filing S corporations equal to $18 per shareholder per month for a maximum of 12 months. As applied to American, this came to $16,200 (($18 × 75) × 12).

Penalty applies to franchise taxAmerican argued that §19172.5 applies only to the late filing of the

corporate income tax return and not the franchise tax return. It claimed that the purpose of the per-shareholder penalty was to encourage the timely filing of the S corporation return so K-1s could be sent out in a timely fashion and the shareholders would have adequate time to prepare their returns. However, American’s assertion was not supported with any legislative analysis or other documentation. Therefore, the Board held that §19172.5 applied to the late filing of both the corporation income and franchise tax returns.

Reasonable causeAmerican also failed to supply any evidence to support its claim of

reasonable cause for penalty abatement. As the Board has consistently held, ignorance of the law is no excuse for failure to file a return.3

Reliance on improper substantive advice from a professional tax preparer may constitute reasonable cause if the taxpayer reasonably relied on the preparer’s advice, and the advice is based on the taxpayer’s full disclosure of all relevant facts and documents.4 However, American failed to explain or provide any evidence of:

! The information it disclosed to its tax advisor; ! The nature of the advice provided by the advisor; or ! When the advice from the advisor was obtained.

Its claim of equitable estoppel based on contradictory advice supplied by FTB employees was similarly rejected. American failed to provide any evidence

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that FTB representatives made incorrect or inaccurate representations to American with the intention that American would rely on that advice or that American actually detrimentally relied upon such representations. There was no evidence presented of American’s phone calls to the FTB, let alone the nature of the matters discussed or the dates of the calls.

Although American claimed that the late filing penalty is “excessive” and noted that other states impose either a flat penalty or a percentage of tax, the amount of $16,200 was calculated in accordance with California law, and due to American’s failure to demonstrate reasonable cause, was not eligible for abatement.

1 Appeal of American Orthodontics Corp. (August 5, 2014) Cal. St. Bd. of Equal., Case No. 7111532 R&TC §231533 Appeal of Electrochimica Corporation (August 3, 1970) 70-SBE-027 4 United States v. Boyle (1985) 469 U.S. 241, 244

California’s EITC program 2015 results are in — Low-income California workers received $189 million under California’s EITC program, with over $15 million of EITC claims denied as invalid.

These results were reported at the FTB’s July 14, 2016, board meeting. The $189 million figure was far lower than what was anticipated in the 2015–16 budget. The budget analysis had projected that eligible workers would receive up to $380 million in EITC tax benefits.

FTB increases interest rates for first half of 2017 — The FTB has announced that for January 1, 2017, through June 30, 2017, the interest rate on personal income tax overpayments and underpayments and on corporation tax underpayments will increase from 3% to 4% and that the interest rate on corporation tax overpayments will remain at 0%.1

1 “Interest Rates Increase,” FTB Tax News (August 2017)

Economic nexus thresholds and throwback rules addressed — In Chief Counsel Ruling 2016-03, the FTB states that for purposes of determining whether a taxpayer has met the economic nexus threshold, its receipts from California sales

CommentCalifornia’s penalty is similar to the federal failure to file S corporation

return penalty under IRC §6699. The only difference is that the federal penalty is $195 per month and is subject to inflation adjustments.

Thumb Tax

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of tangible personal property (TPP) are aggregated with its California-sourced royalties received from licensing its trademarks. The sales factor throwback rule did not apply because the taxpayer was “doing business” in other states and P.L. 86-272 did not provide immunity from tax because it only applies to sales of TPP.

The Chief Counsel Ruling can be found at:

Keeping records for sales and use tax purposes — In updating BOE Publication 164, Statewide Compliance and Outreach Program, the BOE added a section on “Keeping Records,” which states that it is important to keep records; that California law requires that businesses keep sales and purchase records, receipts, resale certificates, and normal books of account; and that records must be kept for at least four years. Publication 164 covers the Statewide Compliance and Outreach Program (SCOP), under which the BOE visits most of the businesses in the state for routine permit and license verifications. For a schedule of which zip codes are being visited, go to:

www.ftb.ca.gov/law/ccr/2016/03.pdf

www.boe.ca.gov/sutax/SCOP_Overview.htm

Tax relief available to fire victims in three more counties

The Governor has declared states of emergencies in Lake, San Bernardino, and San Luis Obispo counties for the Clayton, Blue Cut, and Chimney fires that occurred in August 2016. As a result of legislation enacted last year,1 taxpayers impacted by the fires may be able to claim a disaster loss throwback election on an amended California 2015 return even though the counties were not declared a disaster area by the President.

EDD reliefEmployers in these counties directly affected by the fires may request

up to a 60-day extension of time from the EDD to file their state payroll reports and/or deposit state payroll taxes without penalty or interest. Written request for extension must be received within 60 days from the original delinquent date of the payment or return to file/pay.

BOE reliefBusiness owners and fee payers directly affected by the fires may

also request relief from the BOE, including extensions of return filing due dates, relief from penalties or interest, or replacement copies of records lost due to the fires.

http://www.ftb.ca.gov/law/ccr/2016/03.pdf

http://www.boe.ca.gov/sutax/SCOP_Overview.htm


California Editor Sandy Weiner, J.D.

Contributing Editor Kathryn Zdan, EA

Contributing Editor Diane Fuller

Managing Editor Austin Lewis

Layout Jeremy Suppes

Editor Renée Rodda, J.D.

Editorial Staff

Publisher Lynn Freer, EA

Senior Editor Tim Hilger, CPA

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California ContactsSee the 2016 property tax assessments filing deadlines for each county at:

www.boe.ca.gov/proptaxes/pdf/filingperiods.pdf

The BOE video to assist taxpayers when filing appeals may be viewed at:

www.boe.ca.gov/info/AssessmentVideo/Index.html

For links to county assessors’ offices, visit:

www.boe.ca.gov/proptaxes/assessors.htm

The new phone number to report identity theft to the FTB is:

Phone (916) 845-7088 fax (916) 843-0561

Download a copy of Spidell’s Identity Theft Victim Checklist at:

www.caltax.com/spidellweb/public/editorial/IDtheft.pdf

The Chief Counsel Ruling 2016-03 can be found at: www.ftb.ca.gov/law/ccr/2016/03.pdf

For a schedule of which zip codes are being visited by the BOE for routine permit and license verifications, go to:

www.boe.ca.gov/sutax/SCOP_Overview.htm

Property tax reliefTaxpayers whose homes were substantially damaged or destroyed

by the fires qualify for reassessment of their property as of the lien date following the event (January 1, 2017).2 Taxpayers may also qualify to transfer the base-year value of their original property to a replacement property of equal or lesser value either within the same county or within another county that has adopted an ordinance allowing such a transfer.3

1 SB 35 (Ch. 15-230)2 R&TC §513 R&TC §§69, 69.3









http://www.ftb.ca.gov/law/ccr/2016/03.pdf



1 - spidell publishing, inc. · disadvantages of being an rdp couple in 2006, sb 1827 (ch. 06-802)...

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