Archive for the ‘California’ Category

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Have I Committed Malpractice?

Friday, February 2nd, 2018

Let’s say John Smith is a consultant in Syracuse, New York. His business is conducted fully in Syracuse. He never travels outside of Syracuse. He writes reports on a niche area for businesses. Mr. Smith files and pay New York state income tax (as he’s a resident of New York) in addition to his federal income tax. Has he satisfied his income tax filing requirements? (There are no local income taxes in Syracuse.)

In my view, almost certainly. His activity is conducted solely within Syracuse, New York. He’s filed his tax returns every year. Yet in the view of the State of California he may owe tax to the Bronze Golden State. How, you might ask, might this be the case?

The State of California, in its unending wisdom, enacted legislation for “economic nexus.” If you have sales to California, a portion of your income is, in the view of California, subject to California tax. Here’s an excerpt from the FTB’s website:

Jill, a nonresident of California, owns a web design business that she holds as a sole proprietorship. She works from her home out of state but has customers in various states including California. For the 2013 taxable year, Jill’s sales receipts from California customers are $300,000 out of the total sales receipts everywhere of $1,000,000. Does Jill have a filing requirement in California?

Yes, nonresident individuals are taxed on all California source income. Jill’s sole proprietorship is carrying on a business in and out of California and will be required to apportion its income to California using UDITPA rules. Under market assignment, sales of services are assigned to California if the purchaser of the service received the benefit of the service in California. Accordingly, $300,000 will be assigned to the California sales factor numerator for Jill’s sole proprietorship and Jill would apportion 30% ($300,000 CA sales/$1,000,000 total sales) of its business income from her sole proprietorship to California. [emphasis in original]

In a tax professional’s forum I noted that while the California legislature enacted this law, there is a good chance that it’s unenforceable except for businesses with nexus to California. Consider a partnership with one of the partners a California resident and the other a New York resident. Here, there’s clearly nexus to California and California tax is owed.

However, in the example I give (above) Mr. Smith clearly has no nexus to California and while California thinks he has a filing requirement, he probably doesn’t because of court cases. I noted the following on that forum:

While I understand that’s the Franchise Tax Board’s position, the ability for a state to to force collection of taxes to a nonresident who resides in another state is governed also by Quill Corp. vs. North Dakota, the famous case on states having the ability to force collection of sales tax on nonresident companies. The background for this case is the “dormant commerce clause.” (Interestingly, the Supreme Court recently accepted another case on this same issue: South Dakota vs. Wayfair, so it’s possible Quill will be overturned.)

The principal of this is that California has the absolute right to tax individuals with nexus to the state. But does California have the right to tax me–a resident of Nevada with no nexus to California–on the (say) 10% of income I receive from California residents whose tax returns I prepare? Can California legally go after Jill who never sets foot in California? My suspicion is courts in Nevada and Jill’s home state would today look askance at such requests.

One tax professional said my response bordered on malpractice: advising clients to disobey laws. I don’t think that’s the case at all. What I am advising clients is that the California law is of dubious legality, and it is difficult for California to enforce on businesses without nexus to California (such as the hypothetical Mr. Smith). I am not ignoring what California is stating (and I’m informing clients who may be impacted by this). That said, based on current precedent federal courts would, in my opinion, rule for Mr. Smith. (Since Mr. Smith has no nexus to California, a court case would almost certainly be in federal court in New York–the only place he has nexus to.)

It’s important to realize that the law could change based on the decision in South Dakota vs. Wayfair. (South Dakota enacted a law regarding sales tax that allows for economic nexus to the state. South Dakota courts held the law was unconstitutional based on the Quill decision.) Today, though, the federal supremacy clause (the federal supremacy clause means that state constitutions and laws are subordinate to federal law) governs; current federal law holds that California cannot tax companies without nexus to the state–and today nexus means physical nexus.

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Posted in California, Sales Tax | Comments Closed

IRS & FTB Give Tax Relief to Wildfire and Mudslide Victims in Southern California

Monday, January 22nd, 2018

The IRS announced last week that they are giving tax relief to victims of the Southern California wildfires and mudslides. The IRS extended impacted taxpayers’ deadlines that fell (or will fall) between December 4, 2017 and April 29, 2018 to April 30, 2018. This includes the Form 1040 deadline of April 17th (it will be April 30th for impacted taxpayers). This impacts individuals and businesses who are in Los Angeles, San Diego, Santa Barbara, and Ventura Counties who were impacted by the disasters.

California’s Franchise Tax Board automatically follows federal tax disaster relief, so state tax deadlines will also be postponed on the state level for impacted taxpayers.

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Posted in California, IRS | Comments Closed

Why California’s Attempt to Make State Taxes a Charitable Deduction is Doomed

Monday, January 8th, 2018

When your budget is out of balance there are two ways of getting it in balance: cutting spending or increasing revenue. For California’s Democratic politicians, the only way they want to balance the budget is to increase the revenue. The new tax law puts a crimp on California (and other “Blue” states) by limiting the deduction of state income taxes and property taxes to $10,000. Kevin de Leon, California Senate President Pro Tempore, came up with the idea of having Californians being able to make a charitable donation to the “California Excellence Fund” instead of paying state taxes; that would allow the deduction to be taken on the taxpayer’s tax return and getting around the $10,000 limitation. Senator de Leon’s measure, though, will not pass IRS scrutiny for four reasons.

First, a charitable donation must be voluntary, not mandatory. That the contribution is used for the “California Excellence Fund”–an that fund is used for the general budget–makes this the equivalent of state tax paid. That makes this a mandatory payment, not a voluntary one, and it is, thus, not a charitable donation.

Second, Senator de Leon cites previous state contributions such as in Arizona, where taxpayers made contributions to parochial schools via a state fund as a charitable contribution. There’s a big difference between that and this California proposal: Mr. de Leon’s proposal would be for the general fund, with the money used in normal state revenues. That’s not going to work.

Third, taxpayers cannot obtain any benefit from the contribution. For example, if you donate $100 to a charity and receive (say) a blanket worth $10, your deductible charitable contribution is $90. Since the whole idea of this is to give taxpayers a charitable contribution in return for taxes paid, the amount that is deductible would be a benefit received and not deductible.

Fourth, there’s a doctrine in tax called “Substance Over Form.” This doctrine basically says that the economic substance of a transaction determines how it is treated for tax purposes, even if its labeled as something else. If you label something as a charitable contribution but it’s really a tax payment, under “Substance Over Form” it will be treated as a tax payment.

Thus, I believe that the efforts by Democrats such as Kevin de Leon are doomed to failure. I expect the IRS to rule–if this measure becomes law–that contributions to the California Excellence Fund are only charitable contributions if they exceed the required amounts to be paid for state income tax.

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Posted in California | Comments Closed

The 2017 Tax Offender of the Year

Sunday, December 31st, 2017

It’s once again time for that most prestigious of prestigious awards, the Tax Offender of the Year. To win this award you need to do more than cheat on your taxes; it has to be a Bozo-like action or actions. As usual, we had plenty of nominees.

President Trump received a nomination. Now, I realize many do not like the President’s politics, and the tax reform bill that was signed into law isn’t tax simplification. However, it is tax reform, and it will lower taxes for most Americans. As for Democrats’ charges that it will kill millions and cause the world to end, please. President Trump may deserve criticism over other political issues, but not on taxes (today).

Finishing in third place was Joseph Cervone, CPA, of White Plains, New York. Mr. Cervone saw the tax credits available for energy and coal and thought, “I can get free money for my clients! Let’s just submit $23 million of phony credits!” Mr. Cervone is enjoying 22 months at ClubFed.

Finishing in second place was the California legislature. The Bronze Golden State had a flirting with single-payer health care; luckily for California taxpayers the projected $400 Billion cost caused even the ultra-liberals to get cold feet. California continues to waste money on the train to nowhere. The project originally had a cost of $33 billion; it’s now up to $68 billion. It’s probable, though, that the project will die as further funding from the federal government is unlikely. It would be nice for Sacramento to stop spending money on it; the $3 billion spent could be used for far better things.

I grew up just outside of Chicago. I’m a fan of Chicago sports teams (save the White Sox), and many of my relatives live in or near Chicago. Yet Illinois in general and Chicago in particular is now known for high and increasing taxes and out-migration. A search on Chicago taxes finds stories like, “Chicago Property Tax Bills Going up 10 Percent This Year,” “Increased taxes, fees on phones, ride-hailing and concert tickets approved in 2018 Chicago budget,” and “Chicago’s soda tax is repealed.” You can read an article about fed-up Illinois homeowners debating moving from Chicago.

The question, though, is why are taxes increasing in Illinois and Chicago? Is it just the politicians, or is there an underlying cause? There is an answer: Public Employee Pension Funds. These funds (generally on the state level) are the cause of the problem in Illinois, and are this year’s Tax Offender of the Year.

The Tax Foundation has a map showing the funding in various states. Here are the top ten (best) funded states as of 2015 (latest year that statistics are available):

1. South Dakota, 107%
2. Oregon, 104%
3. Wisconsin, 103%
4. North Carolina, 99%
4 (tie). Tennessee, 99%
6. New York, 98%
7. Idaho, 95%
8. Nebraska, 93%
9. Delaware, 92%
10. Florida, 91%

And here are the ten worst:

40. Arizona, 64%
40 (tie). Colorado, 64%
42. Hawaii, 61%
42 (tie). Rhode Island, 61%
42 (tie). South Carolina, 61%
45. Alaska, 60%
45 (tie) Pennsylvania, 60%
47. Connecticut, 51%
48. New Jersey, 48%
49. Illinois, 41%
49 (tie) Kentucky, 41%

The Tax Foundation’s closing paragraph explains the problem:

Pension obligations must be fulfilled eventually. Policymakers should consider that reform now may be less costly and less painful than coping with a larger crisis later.

As of 2015, both California and Nevada are about average (at 74% funded). Unfortunately, California is now at 64% and falling. So why has this happened and what can be done about it?

Pew has a report on the 2015 analysis, and the problems began in the early 2000s: Liabilities increased at the same basic rate while assets in pension funds didn’t. In many states the pension fund crisis hasn’t come (yet). In a few, it won’t come (pensions are properly funded). In at least one state, Illinois, the crisis exists today; in another, California, it’s coming very soon. Consider that California pensions aren’t well funded yet we’ve had a huge boon in the stock market over the last two years!

Some cities and counties are in even worse shape. A Hoover Institution report shows that both Chicago and Cook County (the county that Chicago is in) have massively underfunded pensions. So Chicago residents have a triple whammy: underfunded state, county, and city pensions.

As for the reasons why this crisis exists, there are a couple.

1. When rates of return increased in the late 1990s, that increase was built into new public employee contracts. The late 1990s featured the dot-com boom in the stock market. Those rates of returns, in the 7% range, aren’t seen today (they’re about 2% to 3%).

2. Politicians ignoring the issue. It’s always easiest to pass the buck to the next mayor, or the next governor, or the next state legislature. That’s what’s been done in Illinois, and the state is in severe crisis. The Democrats who control the state legislature are beholden to the public employee unions who, shockingly, don’t want to see pensions cut. Last time I looked, Illinois is nearly a year behind in paying its bills–all because of the pension crisis. So Democrats are only proposing tax increases rather. Residents who can move are doing so, and they can escape the pension crisis.

So what’s the answer to this crisis? There are a couple:

1. Pension reform is needed nearly everywhere in the US. Yes, pension benefits are going to decrease. That’s going to happen, either through negotiation or when the systems run out of money. It’s a certainty.

2. Reform for civil service/public employee unions. I am reminded of what President Franklin Roosevelt said:

All Government employees should realize that the process of collective bargaining, as usually understood, cannot be transplanted into the public service. It has its distinct and insurmountable limitations when applied to public personnel management. The very nature and purposes of Government make it impossible for administrative officials to represent fully or to bind the employer in mutual discussions with Government employee organizations. The employer is the whole people, who speak by means of laws enacted by their representatives in Congress. Accordingly, administrative officials and employees alike are governed and guided, and in many instances restricted, by laws which establish policies, procedures, or rules in personnel matters.

Meaningful reform means that public employee unions won’t have collective bargaining or massive reform of civil service (or both). Governor Scott Walker of Wisconsin noted this in a speech and implemented reforms. You will note that Wisconsin pensions are fully funded (one of only three such states).

Pain is coming in the world of pensions. Public employee unions can either recognize it, and live with change, or it will be forced upon them. Taxpayers stuck in bad states (e.g. Illinois) and bad cities (e.g. Chicago) will vote with their feet. Chicago politicians can’t tax John and Mary Smith who leave Chicago for places like Florida. Politicians also need to recognize reform is mandatory. Yes, it will be painful but the cost of kicking this can further down the road is even greater.

That’s a wrap on 2017. While I hope that 2018 will not provide me a lengthy list of candidates for Tax Offender of the Year, I suspect (as usual) that I’ll have plenty of choices.

I wish you and yours a happy, healthy, and prosperous New Year!

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Posted in California, Illinois, Pensions, Taxable Talk | Comments Closed

Reason Magazine on Gilbert Hyatt vs. California’s Franchise Tax Board

Thursday, October 26th, 2017

Reason magazine has a superb presentation on Gilbert Hyatt’s battle with California’s Franchise Tax Board. I cannot recommend it highly enough:

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Posted in California | Comments Closed

California Fire Victims Have Extension Until January 31, 2018

Friday, October 13th, 2017

The IRS announced today that California wildfire victims have until January 31, 2018 to file various tax returns (including tax returns on extension due this coming Monday, October 16th). California’s Franchise Tax Board (the state income tax agency) immediately followed suit. (California automatically allows extended time for victims of any presidentially declared disasters, including the recent hurricanes.)

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Posted in California, IRS | Comments Closed

The Train to Nowhere Remains a Boondoggle

Friday, September 22nd, 2017

California’s high speed rail, aka The Train to Nowhere, remains likely to never carry passengers between Northern California and Southern California. Perhaps the segment linking Merced and Shafter (just north of Bakersfield) will run (although unlikely at high speed); more likely, it will never run. So the image that comes into my mind is the following:

via GIPHY

There have been some developments since I last reported on the train. First, the California Supreme Court ruled at the end of July that California law was not preempted by federal law and that a number of environmental suits against the high speed rail authority could continue.

Meanwhile, Quentin Kopp, the man who introduced the rail line, now calls the line foolish. In an interview with reason.com he said,

It is foolish, and it is almost a crime to sell bonds and encumber the taxpayers of California at a time when this is no longer high-speed rail. And the litigation, which is pending, will result, I am confident, in the termination of the High-Speed Rail Authority’s deceiving plan…

[The selling of bonds is] deceit. That’s not a milestone, it’s desperation, because High-Speed Rail Authority is out of money.

Ouch. Baruch Feuigenbaum, assistant director of transportation policy for the Reason Foundation, stated, “The costs of building [high-speed rail] projects usually vastly outweigh the benefits…Rail is more of a nineteenth century technology [and] we don’t have to go through these headaches and cost overruns to build a future transportation system.”

Look on the bright side Californians, the project will likely need subsidies from the state of only $100 million a year. That’s not bad, right?

Or better, I’m sure the 10 Shafterites looking to head to Merced each day will love the train (as will the 20 residents of Merced looking to head to Shafter each day).

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Posted in California | Comments Closed

Gilbert Hyatt (Mostly) Wins at Board of Equalization; What This Teaches Us About Moving from California

Thursday, August 31st, 2017

Remember Gilbert Hyatt? He’s the microprocessor inventor who made a fortune and then moved to no-tax Nevada from high-tax California, but California’s Franchise Tax Board (FTB) said didn’t move. The case has gotten to the US Supreme Court twice, and there’s still a related civil case at the 9th Circuit Court of Appeals. The underlying tax audit–an audit that began in 1993–was (mostly) resolved in Mr. Hyatt’s favor yesterday at California’s Board of Equalization.

Let me first start with the basic history of the case. Gilbert Hyatt invented (and patented) items related to microprocessors in 1990. He realized he would owe 10% of his very large upcoming income to California if he remained in the state, so in October 1991 he moved to Nevada. In 1993, the FTB audited Mr. Hyatt (the FTB is California’s income tax agency), alleging he didn’t move from California until April 1992. The FTB alleged he owed taxes on $5.4 million plus fraud penalties of another $5.4 million.

The FTB, as part of its investigation, skirted the law in Nevada. They rummaged through Mr. Hyatt’s garbage, and (as found by a jury here in Nevada) committed fraud. The first Supreme Court decision, in 2003, allowed Mr. Hyatt to sue the FTB in court in Nevada alleging that the FTB committed a wide range of torts. The FTB argued because the FTB is immune from lawsuits in California it could not be sued in Nevada; the FTB lost that argument.

The case went to trial, and Mr. Hyatt was awarded $400 million (including punitive damages). The FTB appealed, and the Nevada Supreme Court lowered the damages. The FTB appealed again to the US Supreme Court; the Supreme Court ruled that damages are limited to what could be awarded against a Nevada agency (something less than $100,000).

Meanwhile, Mr. Hyatt’s audit results were appealed to the Board of Equalization in the mid 1990s. Yesterday, some twenty years later, the BOE finally heard the case. (The BOE hears appeals from the FTB. However, beginning January 1, 2018 the BOE will no longer hear such appeals.) After a 13-hour hearing, the BOE ruled 4-1 that there was no fraud; the BOE ruled 3-2 that Mr. Hyatt moved to Nevada in October 1991 (as he had said). However, the BOE also ruled that Mr. Hyatt conducted his business primarily out of California after his move to Nevada in 1991. It’s likely Mr. Hyatt owes taxes on somewhere between $1 and $2 million (plus interest and penalties). This decision could be appealed into the California court system by either side.

More interestingly to blog readers, what does this teach us about changing your domicile from one state to another?

1. Really Move. This sounds basic, but tax agencies don’t like it when you say you move from their high-tax jurisdiction to a low-tax one. If you suddenly come into income, you’re far more likely to be audited, and if the tax agency discovers you’re using your friend’s house in your old hometown to conduct business they won’t be happy. If possible, don’t keep an address in your old state; simply have forwarding orders with the post office.

2. Do the Little Things. There are a lot of things involved when you move, but if you may be a subject of a residency audit it pays to do them. Register to vote in your new city. Make sure you register your car(s), and get a new driver’s license. Yes, the DMV isn’t fun but you need to do this. Change your address with your financial institutions. Have utility bills in your name. Find a new house of worship in your new home. The list is lengthy, but the more you do the easier a residency audit will be.

3. Document, Document, Document. One of my favorite sayings is that if you keep good records an audit is an annoyance; if you don’t keep good records an audit is a painful annoyance. You need to double or triple that for a residency audit.

The last residency audit I was involved with was for a couple that moved from New York to Las Vegas. They really moved and had all their documents. New York alleged that because they didn’t buy a new home for six months after they moved to Las Vegas they were still New York residents. However, the couple (and their children) really did move: There was a lease for their rental home, private school receipts from here, voter registration cards, etc. The couple won the residency audit.

4. Stay Around. You need to stay in your new tax home for four months (minimum)–six months or longer is far better–or your old home could say you haven’t changed your domicile (the place you intend to return to). Indeed, if you can avoid your old home for a year that’s far better.

5. California Tries to Exhaust Litigation Opponents. If you end up in a fight with California one component of the state’s strategy is to financially exhaust opponents. Mr. Hyatt’s dispute began in 1993. It is now 2017. I wouldn’t be surprised if there’s still litigation involved with the dispute into the next decade. Most individuals in fights with the FTB don’t have the resources that Gilbert Hyatt has. It’s very easy to have a Pyrrhic victory in a fight with a tax agency.

There’s a lot more involved when you change your residency. Realize if you’re a high-income individual and you move from California to Nevada you’ve painted a target on your back. If you really do move, do the little things and keep good records.

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The Law Isn’t Fair, But You Have to Pay the Tax

Tuesday, August 29th, 2017

A California couple received an Advance Premium Tax Credit (part of the “Affordable Care Act,” aka ObamaCare). Through bureaucratic errors at Covered California, they’re unable to change their plan once they’re both employed to stop the credit, nor do they receive a Form 1095-A. It’s not as if they ever received the credits themselves; they went to insurers. The IRS assesses the repayment of the Advance Premium Tax Credit and assesses an accuracy-related penalty. The dispute ends up in Tax Court; do they have to pay the tax and penalty?

The facts of the case aren’t in dispute. The couple (for 2014) enrolled in a Silver plan based on lower income. When the wife took a job she promptly notified Covered California that their income increased; clearly, the credit needed to be adjusted. Months later, Covered California sent a letter to them…except the letter was never received.

What happened to that letter is unclear. The records from Covered California that were provided in this case are incomplete. But according to the records in evidence, “during Covered California’s first open enrollment period, Covered California was so busy that it was not uncommon that changes were not implemented.” What the record makes clear is that the [couple] made repeated efforts to get Covered California to take into account the change in household income, but it never did so. [footnote omitted]

They also notified Covered California of their address change; Covered California ignored that. They had an administrative hearing with the California Department of Health Care over Covered California’s errors; they lost on procedural grounds: “The Administrative Law Judge lacks jurisdiction to decide an issue involving an error on the part of Covered California for failure to recalculate the appellant’s eligibility for APTC after the appellant reported a change in income in January 2014.” They never received the Form 1095-A. They did note on their 2014 return that they had health insurance but they ignored the Advance Premium Tax Credit. The IRS assessed the tax (in the amount of the disallowed tax credit) and an accuracy-related penalty.

The couple correctly notes the Catch-22 they were caught in:

[The Commissioner argues] that if Petitioners are liable for the deficiency, then they would be no worse off financially than if the APTC had been terminated in early 2014. This is simply untrue and does not alter the fact that it was Covered California’s responsibility to ensure clients only received the Advance Premium Tax Credit for which they qualified. We would never have committed to paying for medical coverage in excess of $14,000 per year. We cannot afford it and would have continued to shop in the private sector to purchase the minimal, least expensive coverage or gone without coverage completely and suffered the penalties. * * *

* * * If we are deemed responsible for paying back this deficiency, it would be devastating and completely unjust. We hope and pray you are convinced that we have made every single effort to get Covered California to make proper adjustments to our reported income and subsequently to the Advance Premium Tax Credit we were qualified to receive without success. The whole purpose of the Affordable Care Act was to provide citizens with just that, affordable healthcare. This has been an absolute nightmare and we hope you will rule fairly and justly today.

Unfortunately, the Tax Court is not a court of equity:

In other words, the [couple] considered themselves to have been trapped in a health plan that they could not afford without the subsidy provided by the ACA. And they ask us to rule “fairly and justly” or, otherwise stated, equitably.

But we are not a court of equity, and we cannot ignore the law to achieve an equitable end. Although we are sympathetic to the [couple’s] situation, the statute is clear; excess advance premium tax credits are treated as an increase in the tax imposed. The [couple] received an advance of a credit to which they ultimately were not entitled. They are liable for the $7,092 deficiency. [citations omitted]

To add insult to injury, the couple were also charged with an accuracy-related penalty. Here, though, the law is on the couple’s side:

On the totality of the facts and circumstances, the [couple] acted reasonably and in good faith with respect to the underpayment of tax on their return. They did not receive a Form 1095-A showing the income they received in the form of an advance premium assistance credit, and they did not directly receive that income. They did not know nor should they have known that they had additional income required to be shown on their return, and consequently they are not liable for the accuracy-related penalty under section 6662(a).

This result is anything but equitable for the couple. They tried to have the credit adjusted but the bureaucracy ignored them. It just goes to show that when Ronald Reagan stated the following in 1986 he was dead-on accurate:

The nine most terrifying words in the English language are: I’m from the government and I’m here to help.

Case: McGuire v. Commissioner, 149 T.C. No. 9

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Posted in California, Tax Court | Comments Closed

California Single-Payer Health Plan Shelved

Sunday, June 25th, 2017

As Samuel Johnson said, “Whatever you have, spend less.” Apparently some Democrats in the California legislature have realized the virtue of this quote.

Assembly Speaker Anthony Rendon shelved the single-payer measure, calling it “woefully incomplete.” The California Senate Appropriations Committee estimated that it would cost only $400 Billion; that’s double California’s current total budget. While progressives (aka the far left) in California still support the measure, apparently Speaker Rendon realized that California can’t print money. Additionally, the gasoline tax increase in California is horribly unpopular; adding a new 15% payroll tax and/or a 2.3% gross receipts tax would not help matters.

While the bill has apparently been tabled for 2016, the California legislative session lasts two years; thus, it is possible that the bill could rise like a phoenix next summer.

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