Taxable Talk

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.

My thanks to Dan Walters of the Sacramento Bee for pointing out a California case where the California Board of Equalization (yet another California tax agency; this agency administers sales and use tax) was rightly excoriated. Dan Walters begins:

However, [the state] cannot tax services and other “intangibles.” And while there is a strong case for including services in the sales tax – particularly were it to mean an offsetting decrease in tax rates – until that moment comes, they are exempt.

One might assume that the folks at the state Board of Equalization who collect sales taxes would know that.

One also assumes they know that, under long-standing court decisions, when tangibles and intangibles are included in one transaction but easily separated, only the tangibles may be taxed.

However, the board’s tax collectors repeatedly have attempted to impose sales taxes on intangible portions of transactions and repeatedly failed when taxpayers have taken them to court.

This is the case of Lucent Technologies and AT&T. Last October, a California appellate court unanimously ruled against the BOE, and finding its position was not justified awarded $2.6 million to Lucent to cover its legal fees. (Lucent and AT&T will actually get more money, as I’ll discuss below.) The California Supreme Court refused to hear the case, so the judgment is now final. Here are two excerpts from the appellate court decision:

The trial court did not abuse its discretion in finding that the Board’s position was not “substantially justified.” A litigant’s position is “substantially justified” if it is “‘“justified to a degree that would satisfy a reasonable person, or ‘“‘has a “‘“reasonable basis both in law and fact.”’”’”’”’”…

In this case, each of the Board’s primary arguments was foreclosed by existing precedent, much of which comes from our Supreme Court. The Board’s arguments that placing computer software onto physical media turns the software itself into tangible personal property and that the taxable basis includes the software are irreconcilable with the rationales of Preston, supra, 25 Cal.4th at pages 211-212 and Navistar, supra, 8 Cal.4th at page 878, and with the specific holdings of Microsoft, supra, 212 Cal.App.4th at page 82 and Nortel, supra, 191 Cal.App.4th at pages 1275-1276. And the Board’s argument that the technology transfer agreement statutes do not apply is inconsistent with federal copyright law, with Preston, at page 214, and with our factually and legally indistinguishable decision in Nortel.

I include the actual citations just to show how poor the BOE’s arguments were. But the court’s summation needs to be put on a bulletin board at the BOE’s headquarters:

The Board’s conduct in this litigation falls squarely within the heartland of section 7156, and the core purposes of the Taxpayer’s Bill of Rights of which it is the key part—namely, to “deter[] state[] agents from asserting unreasonable and unfair claims and defenses against private citizens” and thus to “preserve[] the balance between legitimate revenue collection and ‘government oppression.’” The position the Board took in this case had been rejected by the Legislature that enacted the technology transfer agreement statutes, rejected by several courts interpreting those statutes, and specifically rejected by Nortel. Yet the Board continued to oppose AT&T/Lucent’s refund action, countersued for more than $18 million (and ultimately agreed to accept less than $2 million), propounded thousands of discovery requests, and generated a 20,000 page record on appeal. The net result is that AT&T/Lucent incurred more than $2.5 million in litigation costs to receive a tax refund to which it was indisputably entitled under controlling law. It is certainly up to the Board to decide whether to take positions at odds with binding, on-point authority, but section 7156 makes clear that the Board is not free to require taxpayers to bear the cost of a litigation strategy aimed at taking a third, fourth, or fifth bite at the apple. [citation omitted]

Oh yes, Lucent and AT&T were awarded costs for litigating the appeal. Dan Walters asks in his article how a small business would handle “the same imperious demands” of the BOE. They can’t; they almost always have to give in because to win is almost always a Pyrrhic victory. This is just another reason why the business climate in California is so dreadful.

I’ve reported on California’s Board of Equalization headquarters building in Sacramento on two occasions. It seems some employees of the BOE aren’t happy at all, and have filed a lawsuit against the BOE alleging that the agency has known for years that the building is a health hazard.

While the BOE has publicly stated that the building is safe, there have been a few “minor” problems. Like glass windows randomly falling to the ground. Given the building is 24 stories tall, you may want to walk on the other side of the street if you’re ever near it. There’s also a few pipes that have corroded; back in 2012 that was only in the waste lines. The elevator doors have this tendency to stay closed when you want to exit the elevators. There was also that infestation of bats.

But the big issue for the lawsuit is toxic mold. Those windows that randomly pop out have done so supposedly because of bad seals. That leads also to water entering the building. Sacramento’s summers are very warm, so that water leads to mold. The lawsuit alleges that the BOE knew back in 1995 (two years after the building opened) that mold was an issue leading to all sorts of illnesses.

It will likely be years before the lawsuit makes its way to trial.

When I last wrote about the home of California’s Board of Equalization–one of two tax collecting agencies in California–I called it a fixer-upper. That might have been kind.

It does have a good location (right in downtown Sacramento). It is 24-stories tall. Of course, there are a few problems. Like the windows that pop out randomly and take the wings of gravity down to the ground. There’s the mold that’s been found in many areas of the building…toxic mold. If you ever have to go above the ground floor you might want to use the stairs: The elevator doors periodically don’t open.

The most recent issues relate to water pipe issues. It seems that the waste lines tend to leak. Now it’s been determined that the entire drain system wasn’t built to code. Oops….

The California state auditor is now going to conduct a five-month long study about what to do with the BOE headquarters. Hopefully the auditor will be able to find some solutions before any more problems pop up.

If you want to rent a building in Sacramento (California’s state capital), I have one that’s perfect…for your enemies, that is. It does have some advantages: It’s a 24-story building right in the heart of downtown Sacramento. It’s owned by the State of California. It’s not for sale, but I’m certain that California’s Department of General Services would be happy to sell it to you. It’s fully leased to the Board of Equalization.

It does have issues. Be careful if you walk on the sidewalk next to the building; you may be hit by falling glass. It seems that the window seals on the building don’t work correctly and the windows have a tendency to pop out.

There’s also the pipes in the building. There are corroded pipes on several floors. A General Services spokesperson helpfully noted that, back in 2012, “At this point it’s isolated to waste lines.”

You may want to take the stairs if you have to go to this building. The elevator doors have a tendency to not open.

I also need to talk about the mold. That’s not the good kind of mold, but the toxic kind that you don’t want in any building. Well, given that water seeped in through the exterior glass, and there are reports of roof leaks, add in Sacramento’s summer warmth and you have a perfect environment for all sorts of gunk to grow.

On the bright side, California paid only $81 million for the building and the repair costs haven’t hit that much…yet. Add to the mix that the BOE is outgrowing the building and now the legislature has to figure out what to do with a building that no one in their right mind wants to work in. Of course, since the BOE pays General Services for leasing the building, and it’s unlikely anyone else would pay anything until all the problems are fully resolved, it’s not likely there will be any volunteers to move into a building that’s a construction zone. While nearby communities such as Elk Grove would pay the state to have the BOE relocate there, the problem is that you’d have to also pay to have someone relocate into a fixer-upper.

Last night I wrote about California’s messed up implementation of new Use Tax reporting requirements. I forgot the best (or worst) part of the fiasco.

Let’s assume that instead of purchasing a book you bought a computer monitor and did not pay sales tax. You register for Use Tax, duly pay the Use Tax, but the Board of Equalization asks you, “Have you registered to pay the eWaste fees?”

A couple of years ago California added a fee (er, tax) on sales of lcd and cathode ray tube devices (generally, computer monitors and laptop computers). This program, administered by the Board of Equalization, is separate from sales and use tax.

So what would your response be to the BOE? Perhaps you’d say, “OK, how can I pay the fee (er, tax) on my Use Tax return?” Well, you can’t. The program is separate and has separate registration and reporting. So if you are impacted by this, you must register separately, and make your payment separately from the Use Tax payments.

Adding to the joy is this thought: Once you register for the eWaste program, you must file a form every year even if you never again have to pay an eWaste fee (er, tax). For tax professionals, it’s yet another registration number to keep track of, and more paperwork to handle. The reporting and fee, by the way, is due quarterly (on the last day of the month of the quarter following collection of the fee/purchase of the item); however, the BOE will likely change the reporting requirement to annual for most impacted businesses.

I’m sure this all makes sense somewhere in the world of bureaucracy….