california tax update - handout...jan 18, 2016 · 2015/2016 update • individual tax provisions /...

California Tax Update - HandoutKathleen K. Wright, CPA, J.D., L.L.M

Armanino LLP January 18, 2016

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California Update 2015/2016

Kathleen K. Wright CPA, MBA, JD, LLM

Welcome!

• Here is what we will talk about:– Conformity– Mobile Work Force– ABLE accounts– NOLs– Like Kind Exchanges– MyFTB– Administrative dissolutions– Community Property– Credit for Tax Paid to Other States– Nexus developments– Apportionment

• Decision in Gillette• Sales Factor and Throwback.

– Independent contractor and the “Concierge Economy”– Other new laws in California– New Nevada Commerce Tax.

Update

• Conformity

– AB 154 (Ch 15‐359) rolls forward date of conformity from 1/01/2009 to 1/01/2015.

• Effective for years beginning on after 1/01/2015.

– Also includes provisions related to corporate NOL carrybacks; and

– Modifications made to large corporate understatement penalty (LCUP).

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Copyright 2015. These materials are copyrighted and may not be reproduced or distributed in whole or in part without permission from author.

Update

• Conformity

– American Recovery and Reinvestment Act of 2009

• CA did not conform to changes made to IRC 382. (CA impact limited).

– Change provides exception to the limitation imposed under IRC 382 (related to utilization of NOL carryovers by a loss corporation) shall not apply in an ownership change that occurs pursuant to a restructuring plan which is required by a loan agreement for a line of credit entered into with Treasury under Emergency Economic Stabilization Act of 2008.

Update

• Conformity

– Worker, Homeowner, and Business Assistance Act of 2009.

• CA does not conform:– Increase in penalty for failure to file a partnership/S corporation return. (from $89 to $195 per partner or shareholder).

» CA penalty is $10 per partner. S Corp is not assessed a penalty because it has its own tax return filing requirement and is subject to failure to file/pay penalties.

Update

• Conformity– Worker, Homeowner, and Business Assistance Act of 2009.

• CA does not conform:– Generally must electronically file is prepare at least 250 tax returns during calendar year. This provision now states that Secretary may require electronic filing by certain tax return preparers – those who prepare 10 or more individual income tax returns in a calendar year.

– CA has its own provision. Must file electronically if prepare more than 100 individual tax returns and prepares one or more income tax returns using tax preparation software in the current year.

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Update

• Conformity

– Hiring Incentives to Restore Employment Act.

• CA now conforms to the disclosure of information with respect to Foreign Financial Assets.

– Federal law requires individual taxpayers with an interest in a foreign financial asset to attach a disclosure statement in any year where the aggregate value of all assets is greater than $50,000.

– CA had not conformed to this reporting requirement. AB 154 amends 19141.5 to require reporting of this information for tax years beginning on or after Jan. 1, 2016.

Update

• Conformity– FACTA

• Under IRC 6038D, IRS requires individuals to attach statement to ta return disclosing all foreign financial assets if aggregate total exceeds $50,000.

• This includes all depository or custodial accounts held in foreign financial institutions plus stocks/securities issued by foreign persons; financial instrument/contract that is issued by or has a counterparty who is a foreign person; and any interest in any foreign entity.

• Penalties are steep – but eligible for reasonable cause exception.

– Foreign law prohibitions against disclosure are not reasonable cause.

Update

• Conformity

– FACTA Reporting

• Attach Form 8938 Statement of Specified Foreign Financial Assets to California tax return.

– Applies to individuals with foreign financial assets where the aggregate value of all such assets is greater than $50,000.

– Requirement applies to all taxpayers who are required to file California tax returns (not just residents)

– Failure to file is a $10,000 penalty (Could be total of $20,000 is also fail to file for federal purposes.)

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Update

• Conformity– Other CA reporting of foreign financial transactions:

• Controlling ownership in foreign business entities (Form 5471 and Form 8865)

• Foreign owned US Corporations (Form 5472)

• Transfers to foreign persons (Form 8865)

• Foreign corporations involved in US business (Form 5472).

• Reporting requirement is copy of information provided to IRS.

Update

• Conformity– CA does not technically conform to the FBAR reporting (under the Bank Secrecy Act). Since reports not required under Title 26 (Internal Revenue Code) not considered part of tax return and distribution of information by IRS to other law enforcement agencies is not limited.

• Required to report any financial interest in a bank account, debit/credit card accounts, securities account or any other account where aggregate total is in excess of $10,000.

Update

• Conformity– Patient Protection and Affordable Care Act.

• Federal law increased the additional tax on distributions from Archer MSAs not used for medical expenses.

– CA will now increase the additional tax from 10% to 12.5%.

• Federal law increased the itemized deduction threshold from 7.5% of AGI to 10% of AGI unless one or both spouses was over age of 65 before end of year. This provision goes through 2016.

– CA has not conformed and retains the 7.5% threshold.

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Update

• Conformity

– Small Business Jobs Act of 2010

• Federal law removes cell phones from definition of listed property for years beginning after 12/31/2009.

– CA conforms to this provision for tax years beginning on or after 1/01/2015.

Update

• Conformity

– American Taxpayer Relief Act of 2012

• Under federal law, qualified research expense paid in year where there is a change of ownership, are research expenses of disposing taxpayer, not acquiring taxpayer.

– Research credit for members of a controlled group of corporations is determined on a proportionate basis to share of current year aggregate research expense.

• CA has its own provisions for the research credit, but does conform to the provision described above.

2015/2016 Update

• Federal Tax Return Filing Date Changes:• H.R. 3236, the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (the Act), changes the due dates for partnership and corporate tax returns, as well as FinCEN Form 114 (FBAR) filings. Changes effective for taxable years beginning after December 31, 2015:

• Partnership returns (Form 1065): Moved up one month from April 15 to March 15 (2½ months after the end of the taxable year). Partnerships will be allowed a six‐month extension meaning that the extended due date is September 15; (continued)

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2015/2016 Update

• Tax Return Filing Dates:– C corporation returns (Form 1120): Moved back one month from

March 15 to April 15 (3½ months after the end of the taxable year). However, C corporations with tax years ending on June 30 will continue to have a due date of September 15 until taxable years beginning after December 31, 2025 (2025 is not a typo). C corporations will get an automatic extension of six months except for calendar‐year corporations, which will get an automatic five‐month extension;

– FBAR (FinCEN Form 114): Changed from June 30 to April 15, and taxpayers will now be allowed a six‐month extension. The Act also provides specific penalty waiver relief for taxpayers required to file an FBAR for the first time if they file it late by mistake; and

– S corporations (Form 1120S): The due date continues to be March 15 (2½ months after the end of the taxable year).

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2015/2016 Update

• Tax Return Filing Date– California conformity.

• California conforms to federal law as of January 1, 2015. This still leaves California out of conformity with the revised tax return due dates which was federal legislation enacted after January 1, 2015.

• California has its own provisions that specify the tax return filing date. CA requires that the corporate return be filed by the 15th day of the third month of the tax year. This puts the state return filing date ahead of the federal return filing date. Cal. Rev & Tax Code sec. 18601(a).

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2015/2016 Update

• Protecting Americans from Tax Hikes Act (PATH)

– On 12/18 President signs PATH which makes permanent several temporary provisions and adds other new provisions.

– California does not conform to most of the changes made by PATH.

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2015/2016 Update

• Individual tax provisions / PATH– Enhanced Child Tax Credit made permanent.

• $1,000 tax credit for each qualifying child under age of 17 claimed as dependent. Phases out at higher income thresholds. Refundable credit equal to 15% of earned income in excess of threshold amount ($3,000 unindexed). IRC 24.

– PATH: Makes $3,000 (unindexed) permanent. » Includes certain program integrity checks, such as prohibiting claiming the credit for any year in which individual or child do not have tax identification number.

» Paid preparer penalty if do not exercise due diligence in determining eligibility for CTC.

» No child credit in CA.

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2015/2016 Update

• Individual tax provisions / PATH– Enhanced American Opportunity Tax Credit (AOTC) Made Permanent. IRC 25A

• AOTC allows $2,500 ((indexed) credit for four years of post‐secondary education with phase out starting at $80,000 (Single) and $160,000 (MFJ).

• PATH: Makes AOTC permanent.– Includes certain program integrity checks, such as prohibiting claiming the credit for any year in which individual or student do not have tax identification number.

– Paid preparer penalty if do not exercise due diligence in determining eligibility for AOTC.

– No AOTC in CA.

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2015/2016 Update

• Individual tax provisions / PATH– Enhanced Earned Income Tax Credit (EITC) Made Permanent. IRC 32.

• Credit for low income workers. Amount depends on earned income and number of qualifying children. Temporarily increased to 45% for those with three or more children and EITC marriage penalty reduced by increasing phase out range by $5,000

• PATH: Made permanent.– Cannot claim unless individual or child for whom credit claimed has a SSN.

– CA has its own credit provision (Rev & TC 17052)

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2015/2016 Update

• Individual tax provisions / PATH

– Above the line deduction for educator expenses.

• $250 above the line deduction for books, supplies, computers and so forth used in classroom. IRC 62.

• PATH: Made permanent. $250 indexed for inflation. Professional development expenses eligible for deduction .

• CA does not conform.

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2015/2016 Update


– Increase in excluded employer provided mass transit and parking benefits.

• Employee exclusion for parking is $250 per month. Same amount applies for employer provided transit passes and commuter transportation in commuter vehicle. Expired 12/31/2014. (IRC 132)

• PATH: Parity of exclusion for mass transit and van pool benefits made permanent in 2015 and thereafter.

• CA has its own provision on mass transit benefits which allows any amount provided to be excluded by employee.

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2015/2016 Update


– Nontaxable IRA transfers to eligible charities.

• Taxpayers age 70 ½ and older can make tax‐free distributions to charity from IRA of up to $100,000. Effect is gift not subject to charity deduction limits. (IRC 408)

• PATH: Makes permanent. – CA automatically conforms to changes made to Subchapter D.

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2015/2016 Update

• Individual tax provisions / PATH– Exclusion for discharged home mortgage debt.

• Discharge of debt on qualified principal resident up to $2 million excluded from gross income (IRC 108).

• PATH: Extended for two years or through Jan. 1, 2017.

• CA provision was not extended.

– Mortgage insurance premiums deductible as qualified residence interest.

• Premiums paid in connection with acquisition indebtedness on qualified principal residence deductible as qualified residence interest. Phase out at higher levels of AGI. (IRC 163)

• PATH: Extended through Jan. 1, 2017.


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2015/2016 Update


– Above the line deduction for higher education expenses.

• Deduction allowed for qualified tuition and related expenses of taxpayer, spouse and dependents. Deduction is $4,000 up to AGI levels of $65,000 ($130,000 MFJ) and $2,000 for AGI above these amounts up to AGI of $80,000 ($160,000 MFJ).

• PATH: Extends through 2016.


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2015/2016 Update

• Depreciation and related expenses / PATH. – Enhanced expensing. (IRC 179)

• Deduction allowed for purchase of tangible personal property up to $500,000. Cap of $2,000,000 where phase out kicks in.

• Up to $250,000 allowed for qualified real property, qualified leasehold improvement property, restaurant property and retail improvement property.

• Off the shelf computer software.

• PATH: Deduction allowed for purchase of tangible personal property up to $500,000. Cap of $2,000,000 made permanent. Amounts indexed for inflation. (continued…).

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2015/2016 Update

• Depreciation and related expenses / PATH. – Enhanced expensing. (IRC 179)

• Expense of off‐shelf computer software made permanent.

• Expense election may be revoked without IRS consent.

• Qualified real property expensing up to $250,000 extended through 2015. No portion of disallowed amount can be carried over.

– After 2015, expensing made permanent without carryover limit. $250,000 expense limit is eliminated.

– In 2016, air conditioning and heating units are eligible for expensing.

• CA has its own provision which allows $25,000 expensing with a cap of $200,000. (Rev & TC 17255 and 24356)

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2015/2016 Update

• Depreciation and related expenses / PATH. – 15‐year write off for qualified leasehold, retail improvements and restaurant property. (IRC 168)

• Property included in 15 year MACRS class for depreciation.

• PATH: Makes permanent.


– Bonus Depreciation.• Deduction for 50% of adjusted basis of qualified property. Allowed for regular tax and AMT. (IRC 168)(continued…)

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2015/2016 Update

• Depreciation and related expenses / PATH. – Bonus Depreciation

• PATH: Extends bonus depreciation placed in service during 2015 through 2019 as follows:

– 50% depreciation allowance for property placed in service in 2015 through 2017;

– 40% depreciation allowance for property placed in service in 2018, and

– 30% depreciation allowance for property placed in service in 2019.

– After 2015, bonus depreciation is allowed for qualified improvement property without regard to whether improvements are subject to a lease, and no requirement that improvement must be placed in service more than 3 years after date building placed in service.

– Special rule for plants and long term contracts.

– CA does not conform.

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2015/2016 Update

• Depreciation and related expenses / PATH. – Enhanced first year depreciation cap for autos and trucks.

• Applicable first year depreciation limit (IRC 280F limit) is increased by $8,000 for autos that are qualified property under bonus depreciation rules.

• PATH: Passenger auto or light truck limit is increased by $8,000 for 2016 and 2017.

– For 2018, cap increased by $6,400

– For 2019, cap increased by $4,800.


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2015/2016 Update

• Depreciation and related expenses / PATH.

– Choice to forego bonus depreciation and claim credits instead.

• Allows taxpayers to elect to accelerate the use of AMT credits in lieu of bonus depreciation under special rules.

• PATH: Modifies rules to allow taxpayer to used increased amount of unused AMT credits. (IRC 168)


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2015/2016 Update

• Depreciation and related expenses / PATH. – Expense election for film and TV productions.

• Allows expensing of production cost up to $15,000,000 if produced in US. (Up to $20,000,000 in certain low income areas). (IRC 181).

• PATH: Extends expensing through Jan. 1, 2017. Expands deduction to include qualified theatrical production.


– 7‐year write‐off for motorsport racing track facilities. • Short recovery period applies to land improvement and support facilities at motorsports entertainment complexes.

• PATH: Extends through Jan. 1, 2017. • CA does not conform.

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2015/2016 Update

• Business Tax Provisions / PATH– Research Credit.

• Currently 20% of the excess of qualified research expenses over base amount; University basis research credit (20% of basic research payments) and 20% of payments for qualified research undertaken by energy research consortium. Can use fixed‐base percentage of alternative simplified method. (IRC 41).

• PATH: Retroactively extended and made permanent. – Years after 12/31/2015, eligible small business ($50 million or less of gross receipts) may claim credit against AMT.

– Years after 2015, small startup businesses (less than $5M of gross receipts) may claim up to $250,000 per year of credit against employer FICA tax liability.

– CA has its own Research Credit provisions.

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2015/2016 Update

• Business Tax Provisions / PATH

– Treatment of RIC as qualified investment entity.

• Gain from disposition of U. S. real property interest by a foreign person is treated as income effectively connected with U.S. trade or business and is subject to tax and withholding under FIRPTA. Exception for “qualified investment entity.”

• PATH: Retroactively extended and made permanent.

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2015/2016 Update

• Business Tax Provisions / PATH– Reduction in S Corp. recognition period for BIG.

• Recognition period for BIG was reduced to 5 years (from 10 years). IRC 1374.

• PATH: Retroactively extends and makes permanent. • CA does not conform.

– Exclusion of 100% of gain on certain small business stock.

• Taxpayer can exclude all of the gain on disposition of qualified small business stock. Excluded gain not subject to AMT. IRC 1202.

• PATH: Retroactively extends and makes permanent. • CA does not conform.

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2015/2016 Update

• Business Tax Provisions / PATH– Business Tax Provisions / PATH

• Lower shareholder basis adjustment for charity contributions by S Corporations.

– Shareholder deducts his share of charitable contribution based on FMV of qualifying property. Reduces basis by his share of adjusted basis of same property. (IRC 1367).

– PATH: Extends and makes permanent. – CA does not conform.

• Enhanced deduction for Food inventory.– Charitable contribution deduction for C Corporations allowed for

donations equal to basis plus one half of appreciation or twice property’s basis. Other than C Corporation, deduction limited to 10% of taxable income.

– PATH: Extends and makes permanent. » Increases 10% of taxable income limit to 15%.


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2015/2016 Update

• REITS / PATH. (Many provisions in PATH affecting REITS. Major abuse repealed by PATH described here). – Entity not subject to tax on income distributed to investors.– Qualification:

• Income Test: – Must derive at least 95% of income from sources listed in Sec. 856( c)(2) and

at least 75% must be from sources listed in Sec. 856( c)(3) 9generally from real estate sources). This includes rents from real property.

• Assets Test:– 75% of assets must be real assets, govt. securities and cash. Sec. 856( c) (4).

» Cannot own more than 10% of securities of another issuer except for taxable REIT subsidiary

• Distribution Test– Required to distribute at least 90% of taxable income each year (and is

entitled to a deduction for dividends paid). Taxable as ordinary income to investors.

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2015/2016 Update

• REITS– Abuse: Corporations would spin off (Sec. 355) real estate to newly formed REIT and then lease property back from REIT. Spin off is tax free and “rent” payments to REIT are fully deductible. No capital gain on disposition of real estate and rent payments not taxable to REIT as long as distribution test met.

• PATH: Spin off involving a REIT will only qualify under IRC 355 if immediately after the distribution both the distributing and controlled corporation are REITS.

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Update

• Conformity

– CA does conform to qualified ABLE Programs.

• See discussion under Gross Income.

Update

• AB 99: Vetoed.– Extension of mortgage forgiveness debt relief was vetoed by Governor.

• For CA purposes, provision applies only through 12_31_2013. Federal law had extended a similar law through 12_31_2014. More to come.

• SB 500: Vetoed. – Nonresidents working in the state.

• Would have provided a 20 day pre tax year threshold before nonresident would be subject to CA tax. More to come.

Fringe Benefits

• Nonconforming Provisions.– The conformity bill does not change any of the longstanding nonconformity under the PIT or CTL.

• Health Savings Accounts– CA does not conform (Cal. Rev. & TC 17131.4). Therefore, the contributions to a HSAs are not deductible on the state return; interest/dividends on the funds are fully taxable; amounts rolled over from a MSA to a HSA are fully taxable.

– Most states do conform to HSAs but there are a few that don’t (like CA).

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Fringe Benefits

• “529” Plans or Qualified Tuition Programs– For federal purposes, provides a way to contribute money for education expense of beneficiary. No deduction for contribution, but earnings on account and distributions (used for education) are tax free.

– Many states allow a deduction (within limits) for contributions to that State’s plan.

• CA is one of the few states that does not allow a deduction.

Conformity

• A Qualified Small Business Stock (IRC 1202)

– 100% exclusion of gain on sale of small business stock is extended for stock acquired after 9/27/2010 and before 1/01/2015.

• There is no AMT preference for stock acquired during this time period.

• For tax years beginning after 12/31/2012 the AMT preference is limited to 7% of the excluded gain. The excluded gain could be 50% or 75% based on when the stock was acquired.

Conformity

• Gain on Sale of Small Business Stock (IRC 1202)

– CA had its own provisions Cal Rev &TC 17052.

• Exclude 50% of gain. Half of the exclusion (or 25% of total gain) is an AMT preference.

• Also must have 80% of payroll and 80% of assets in California for substantially all of the five year holding period.

• Provision struck down as unconstitutional by Court of Appeal in Cutler v. FTB. No. B233773, Aug. 28, 2012).

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IRC 1202 Stock

• AB 1412 (CH 13‐546)

– Reinstates the 50% exclusion/deferral for 2008 through 2012.

– Repeals the requirement that 80% of the business activity must occur in CA during the holding period.

– Requires that issuer must have 80% CA payroll at the time the shareholder acquired the stock to claim the 50% exclusion.

• If this is unconstitutional, statute prohibits assessment of interest and penalties.

2015/2016 Update

• Attorneys Fees

– Cutler v. Franchise Tax Board (229 Cal. App. 4th

419, 9_02_2014)

• Ct. of Appeal reverses the lower court and holds that the tests which must be met to award attorneys fees was met here. Test for attorneys fees under CCP sec. 1021.5)

– Action is one that affects the public interest.

– Significant benefit has been conferred on the public;

– Financial burden of private enforcement is such to make award appropriate.

Conformity

• Discharged Debt on Principal Residence (IRC 108 (a)(1)(E)).– Discharge of indebtedness on principal residence excluded from gross income of individuals extended through 1/01/2015.

– CA exclusion expires on 01/01/2014. (Cal Rev and TC 17144.5)

• This is not part of the EGTRRA Bush Tax Cuts. This provision was not extended by the CA legislature through 2014.

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Conformity

• Short Sales – Anti‐Deficiency Statutes– CA. Code of Civil Procedure (CCP) 580e.

• “No deficiency shall be owed or collected, and no deficiency judgment shall be requested or rendered for any deficiency upon a note secured solely by a deed of trust or mortgage for a dwelling of not more than four units, in any case in which the trustor or mortgagor sells the dwelling for a sale price less than the remaining amount of the indebtedness outstanding at the time of sale.”

– Applies to any type of loan including purchase money, refinance, home equity loan – as long as secured by dwelling. Effective January 1, 2011.

– IRS: Appears that underlying loan is often recourse – and lender accepts a short sale offer. But does this result change underlying character of loan?

Conformity

• Anti‐Deficiency Statute– Cannot pursue collection against borrower for deficiency in the following instances:

• CCP 580b: Purchase Money Mortgage– Prohibits lender from pursuing collection of deficiency above the amount collected from the property. Unclear if applies to a short sale – But see 2013 case ….

– As of 1/01/2013 includes refinances up to the amount of the original amount of the mortgage. Does not apply to new money.

• CCP 580d: Non‐judicial foreclosure.– Prohibits deficiency judgment in non‐judicial foreclosure.

Conformity

• Example:– Nancy buys house for $465,000. Mortgage (after re‐finances) is $475,000. Last refi she took $35,000 extra money to pay off credit cards.

– House value drops to $325,000 in 2011. She decides to sell and lender agrees in writing to a short sale.

– If recourse debt:• FMV of property $325,000

• Basis in property ($465,000)

• Loss on sale ($140,000)

• Loss is not deductible. Continued….

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Conformity

• Example:

– If recourse debt:

• Debt Balance $475,000

• FMV of property ($325,000)

• COD income $150,000

• Exclude under QPRI $115,000. Amount taken out to pay off credit cards ($35,000) does not qualify as QPRI.

• Continued…

Conformity

• Example:– If a nonrecourse debt:

• Amount realized: $475,000

• Basis of the property ($465,000)

• Gain on sale $10,000

• Gain can be excluded under IRC 121 as she has lived in house for over two out of the last five years and she uses property as a principal residence.

• Since transaction occurred under CCP 580e, the entire reduction in loan payment is barred by statute (from being assessed against the borrower by the lender) and is treated as a nonrecourse loan.

Conformity

• Other States with Anti‐Deficiency Statutes

– Alaska, Arizona, Iowa, Minnesota, Montana, North Carolina, North Dakota, Oregon, Washington and Wisconsin.

– They are each very different and have to be analyzed individually.

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Conformity

• IRS interpretation of CCP 580(e).

– Originally responded to Sen. Boxer that short sales would be nonrecourse loans in CA.

– Then withdrew that letter and stated that their analysis had been overly broad and conclude that loans would be nonrecourse if they were purchase money loans to acquire principal residence.

• Short sales of non purchase‐money loans appear to be recourse.

Conformity• Other CA nonconformity under PIT:

– CA phases out exemption credits and itemized deductions based on 6% of federal AGI. (R & TC 17054).

– CA generally does not follow federal treaties. (FTB Pub. 1001).

– State income tax refunds – not taxable in CA.

Conformity• Other CA nonconformity under PIT:

– Club Dues not allowed if paid to club that discriminates. (R & TC 17269).

• Cannot discriminate on basis of age, sex, race, religion, color, sexual orientation, national origin or disability.

– CA does not conform to IRC 199 deduction – Domestic Production Activities Deduction. (R & TC 17201.6)

– No special capital gain rate.

– Pre‐1987 IRA and SEP contributions were different (creating a different basis). (R & TC 17203).

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Conformity

• Other CA nonconformity under PIT.– Social Security is not taxable. (R & TC 17081)

– Unemployment compensation is not taxable. (R& TC 17083).

– CA lottery winnings are not taxable (Govt. Code 8880.68)

Conformity

California Nonconformity

– Passive Activity Losses

• CA does not conform to the special status of qualified real estate professional.

– This is an individual who spends at least 50% of their personal service time in the trade or business of real estate, spends over 750 hours per year on real estate and materially participates in the property in question. If meet test, then federal law allows the owner to treat the property as a trade or business.

• For CA purposes, the losses are passive losses.

2015/2016 Update

• Repair Regs (1.263(a)).

– California conforms to all aspects of these regs including partial dispositions.

– Materials and Supplies Safe Harbor.

• IRS asks for comments on increasing the de minimisamount for taxpayers who do not have an applicable financial statement to something greater than the $500 limit found in the current regulations. The AICPA has recommended $2,500.

• Update: Notice 2015‐82 (continued)

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2015/2016 Update

• Materials and Supplies Safe Harbor– Notice 2015‐82 increases materials and supplies safe harbor to $2,500 for taxpayer who do not have applicable financial statements.

– Change is effective for tax years beginning on or after January 1, 2016. IRS will not raise as issue use of $2,500 for tax years beginning before Jan. 1, 2016.

– If have applicable financial statement, safe harbor remains $5,000.

– FTB indicates that they will conform, but as of Jan. 1, 2016 – not prior years.

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Gross Income

• Identity Theft Protection Services

– Includes reporting /monitoring services, theft insurance and identity restoration services.

– IRS rules nontaxable (Ann. 2015‐22).

• Do not have to be reported on Form W‐2 or 1099.

• Does not apply to cash received in lieu of benefits or to benefits received as a result of something other than a data breach.

• FTB will conform.

Gross Income

• ABLE Accounts.– Created in CA by AB 449 and SB 324.

– Account established to fund expenses of qualified disabled person on a tax free basis.

– Designated Beneficiary:• Only one per account. Can be transferred to sibling, step brother/sister of the original beneficiary.

• Must have received a disability certification from Secretary (of Treasury) or have met requirements of SS Disability Insurance relating to disability or blindness.

– In general, must be blind/disabled before reaching age 26.

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Gross Income

• ABLE Accounts.

– ABLE account cannot receive more than the annual gift tax exclusion amount ($14,000 in 2015).

– Income on amounts in account accumulate tax free.

– Distributions are tax free if used for qualified disability expenses of beneficiary. If not used for this purpose, then subject to 10% tax, unless made after death of beneficiary.

– Can only have one ABLE account per beneficiary.

Gross Income

• ABLE Accounts– Donor treats as completed gift. Distribution not subject to gift tax (if qualifies).

– Qualifying expenses include:• Education, housing, transportation, employment training and support, assistive technology and personal support services, health, prevention and wellness, financial management and administrative services, legal fees, expenses for oversight and monitoring, funeral and burial expenses.

– CA conforms.• Contributions must be made in cash and are not deductible. • Any distribution includible in income subject to 2.5% tax. • Report submitted to Secretary also required to be submitted to FTB.

Gross Income

• Student Loan Forgiveness.– SB 150 (Ch. 15‐650) excludes from gross income student loan debt used to attend a for‐profit higher education institution that is discharged on or after Jan. 1, 2015 (and before Jan. 1, 2020) for the following reasons:

• Could not complete program of study because school closed;

• Successfully proves that school does not do something that they should have done;

• Debt discharged associated with attendance at Corinthian College on or before May 1, 2015; or

• Debt discharged under agreement between ECMC Group, Zenith Education Group and Consumer Financial Protection Bureau concerning purchase of certain assets of Corinthian Colleges.

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NOLs

• NOL Carrybacks and carryforwards.

– Federal (IRC 172) – Generally back two years and forward 20 years. Federal had extended carryback periods for certain 2008 and 2009 NOLs.

• States which conform to federal law (with exception of extended carryback periods).

– Alaska, Delaware, Georgia, Indiana, Maryland, Missouri, New York, Oklahoma, Virginia, West Virginia.

NOLs

– States with no carryback:• Alabama (+15)

• Arizona (+20)

• Arkansas (+5)

• Colorado (+20)

• Connecticut (+20)

• Florida (+20)

• Illinois (+12)

• Iowa (+20)

• Kentucky (+20)

• Continued..– Maine (+20)

– Massachusetts (+20)

– Michigan (+10)

– Minnesota (+15)

– Nebraska (+20)

– N. Hampshire (+10)

– N. Jersey (+20)

– New Mexico (+5)

– N. Carolina (+15)

– N. Dakota (+20)

NOLs

• States with no carryback:

– Oregon (+15)

– Pennsylvania (+20)

– Rhode Island (+5)

– S. Carolina (+20)

– Tennessee (+15)

– Vermont (+10)

– Wisconsin (+15)

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Conformity

• CA NOLs: Suspension.

– Legal Ruling 2011‐04 (9/23/2011).

• Suspension Years

– 2002/2003

– 2008/2011

– Every suspended year adds one year to the overall carryover period.

• Carryforward Period:

» 1987 to 2000 – Five years (Rev and TC 17276.20 and 24416.20).

» 1/01/2000 and before 1/01/2008 ‐ 10 years

» 1/01/2008 – 20 years (Rev and TC 17276.22 and 24416.22)

Conformity

• CA NOL Carryback– Legal Ruling 2011‐04 (9/23/2011).

• Carryback NOLs.– 50% of the NOL for 2013 eligible for carryback for two years, or to 2011 and 2012.

– 75% of the NOL for 2014 eligible for carryback for two years, or to 2012 and 2013.

– 100% of the NOL for 2015 eligible for carryback for two years, or to 2013.

– NOL after 2015 eligible for a two year carryback.

– Oldest NOL is used first.

– Must elect out of NOL carryback.

Conformity

• CA NOL Carryback

– NOL carryback not subject to NOL suspension period.

• Joey has ($20,000) NOL in 2013 of which ($10,000) can be carried back in 2011. In 2011, Joey had $550,000 of federal AGI and was not allowed to use his NOL carryovers. Although the NOL carryover might have been suspended, the NOL carryback is not suspended and can be applied against taxable income in 2011.

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Conformity

• CA NOL Carrybacks

– Statute of Limitations

• Carryback year will generally be closed when audit commences.

• CA does not have the special rule (IRC (h) and (k)) which allow the IRS to open up a carryback year. (continued…)

Conformity

• NOL Carryback– Example: Carryback a $10,000 NOL for the year 2013 to 2011. FTB has a 4 year statute of limitations to audit any year so probably will not commence audit of 2013 until early 2018. By that time, the 2011 year is closed. Therefore, will not be able to open up the carryback year.

• In in the carryback year it is determined that the taxpayer omitted income – resulting in an increase in tax liability of $5,000 – then for federal purposes, the refund related to the NOL carryback could be reduced by the tax on the omitted income. Not so for CA, as year is closed.

Conformity

• Modified conformity to federal NOL carryback provisions.– Federal law (IRC 6164) allows a corporation with an NOL in current year to file statement with Secretary to extend time for payment of tax in immediately preceding year which includes extension of time for payment of tax deficiency. Cannot be greater than expected overpayment amount (from NOL carryback).

• AB 154 conforms CA law to this extension of time for payment.

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Conformity

• Modified conformity to federal NOL carryback provisions.– File Form 1138. File after start of year where NOL expected, but before due date of prior year return (or March 15, 2016 for calendar year taxpayers.)

– Only allows extension of time for payment of tax for immediately preceding year (carryback is for two years).

• Extension runs until filing date (including extensions) for return of year with NOL.

Deductions

• Casualty losses.– SB 35 allows election of disaster loss treatment (claim loss on prior years return) for any loss declared by the Governor to create a state of emergency.

• Currently have to wait until Legislature enacts legislation recognizing disaster. This can significantly delay benefit of immediate refund claim.

• SB 35 also allows the prior year return to be filed before the return due date (including extension) for year where loss was incurred.

• Applies to tax years beginning on or after Jan. 1, 2014 through Jan. 1, 2024. See list (in materials) for disasters that qualify.

Sale or Exchange

• Like Kind Exchanges: Swap and Drops.– Appeal of Rago Development Corporation (2015‐SBE‐001, June 23, 2015).

• Exchanged three properties (one held by a partnership) for a shopping center. Due to financing arrangement, they then transferred the shopping center to a single purpose LLC.

– FTB argued that taxpayers received interest in the LLC in exchange for their properties, which was the same as swapping partnership interests (does not qualify under IRC 1031).

– SBE said that drop down was to meet an independent business purpose and that they did hold shopping center as TIC for seven months. SBE upheld the like kind exchange.

– Be careful – Very factual analysis.

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Procedure

• MyFTB accounts– Allows tax preparer to access client account information (copies of returns, notices and correspondence FTB has sent to client, file protests and communicate with FTB using secure chat.)

– All current accounts are disabled as of January 2, 2016. On or after Jan. 4, 2016 you must re‐register your account.

– FTB recommends using PTIN to register.– Have to register twice – once to access your information and a second time to access client information.

Procedure

• Tax Sharing Information– Current law authorizes FTB to share information with cities to exchange specified tax data. FTB can only provide name, address, SSN and business activity code to city. City provides business tax or license data to FTB.

– If they provide more information, must let taxpayer know.

– AB 279 expands sharing of specified data to include counties.

Procedure

• Large Corporate Understatement Penalty– Assessed against corporation that has an understatement of tax if understatement exceeds greater of:

• $1 million; or

• 20% of tax shown on original return

• Penalty is 20% of understatement of tax.

• Exceptions to penalty:– Change in law

– Reasonable reliance on written advice of FTB

– AB 154 adds:

» Properly made IRC 338 election reported on amended return

» Imposition of alternate apportionment; and

» Change to federal method of accounting.

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Procedure

• Electronic Funds Transfer

– AB 1245 requires employers to e‐file Unemployment Insurance and PIT withholding return for employers:

• With 10 or more employees beginning Jan. 1, 2017, and

• All employers beginning Jan. 1, 2018.

Procedure

• Ask a Legal Expert.

– Online resource to get answers to basic legal questions directly from Legal Division.

• Will not respond to matters under audit, on appeal, in settlement or in litigation.

• If relates to matter governed by federal law – may be advised to contact IRS.

• Must describe facts and provide your research.

• Retain discretion to not respond to question.

Procedure

• Tax Shaming and License Revocation– Publishing list of delinquent taxpayers on Internet.

• BPC 494.5 states that all governmental licensing entities shall refuse to issue, reactivate, reinstate or renew a license and shall suspend a license for anyone whose name appears on list.

• TP can challenge the suspension with respective agency. • In Berjikian v. FTB (and other Boards) (March 12, 2015) challenged suspension of pharmacist and drivers license because on FTB’s top 500 list.

– Argued that process denied them due process. At the time that they could have requested a hearing on tax assessments, they had not received assessments. By the time they received assessments, statute had closed.

– Court of Appeal holds in favor of taxpayer.

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Procedure

• Interest Computations

– FTB might have made an error:

• TP filed an amended return for additional tax OR received a deficiency assessment after original return was filed, AND

• On original return, TP elected overpayment be transferred to next year’s estimate, AND

• In subsequent year, the required first quarter estimate was less than overpayment transfer amount. Under federal case, FTB should pay interest on refund.

Procedure

• Interest Computations:– In 2013, TP requested that $400,000 overpayment for 2012 be transferred and applied to estimate for year 2013. In 2014, TP receives notice of additional tax of $75,000 for 2012.

• What FTB does: Apply entire $400,000 to first 2013 first quarter estimate. TP still owes interest of $1,910 on $75,000 underpayment for 2012.

• What they should do under May Dept. Stores v. U.S (case limits interest to one year of interest on additional tax or deficiency).

– Should only have owed interest of $383 in above example. Due to a refund of $1,527 ($1,910 ‐ $383).

Procedure

• Refund Fraud.– If discrepancies on refund tax return, then FTB may contact taxpayer using one of the following Forms (Letters):

• FTB 3904 Request to Confirm Tax Return Filing. Sent to last good address.

• FTB 4734D. Request for Tax Information and Documents. FTB unable to validate taxpayer withholding or other information from third party data sources;

• Form 4579. Demand to Furnish Information. Sent to employers when FTB unable to validate wages and withholding claimed on tax return.

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Procedure

• Administrative Dissolution for Nonprofits.– AB 557 (Ch. 15‐363) provides for administrative dissolution if corporate powers are suspended by FTB for not less than 48 months. Effective as of Jan. 1, 2016.

• Qualified nonprofits:– Tax‐exempt status revoked because it failed to confine activities to what was approved under exemption;

– Was tax‐exempt under federal law, but had exemption revoked because it failed to file annual returns or notice for 3 consecutive years;

– Never doing business in CA at any time after time of incorporation in CA.

Procedure

• Administrative Dissolution for Nonprofits.

– FTB can abate minimum tax, penalties and interest (not any tax due on income earned).

– Corporation must show that it has ceased all business at time of filing request.

– Corporation must dissolve within 12 months of date of filing request for abatement.

Procedure

• Process of Administrative Dissolution– FTB provides written notice of pending administrative dissolution;

– SOS also provides notice of pending dissolution by posting name of non profit on web site.

– Non profit can object and then must pay past due tax, penalties and interest and file Statement of Information with SOS within 90 days of objection.

– If no objection, then FTB automatically dissolves and abates taxes, interest and penalties.

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Procedure

• Process of Administrative Dissolution

– Does not abate:

• Other liabilities, such as unpaid liabilities to creditors.

• Liabilities of Directors

Procedure

• Taxpayer’s Advocate: Authority expanded effective Jan. 1, 2016.– SB 540 (CH 15‐541) extends and makes permanent the Advocate’s ability to abate penalties, interest and fees up to $10,000 ( up from $7,600) of taxpayer’s liability in tax year.

• Relief in excess of $500 must be approved by executive officer.

• Abatement allowed:– Erroneous action by FTB in processing documents or payments made by TP.

– Unreasonable delay by FTB;– Erroneous written advice not covered by Rev & TC 21012.

Procedure

• Taxpayer’s Advocate: Authority expanded effective Jan. 1, 2016.– Rev & TC 21012 abates interest, taxes, penalties and fees when :

• TP requests written advice to FTB and fully describes facts and circumstances involved;

• FTB provides a written response (in form of Chief Counsel Ruling)

• TP reasonably relies on advice;• No subsequent change in law or facts has occurred.

– Written advice not covered by sec. 21012: Notices, News Releases and Ask a Legal Expert. Forms Instructions?

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Residency

• Legal Ruling 2015‐02 Tribal Members.– FTB will apply “closest connection test” to determine if TP living on reservation. Same as general residency test. Appeal of Stephan Bragg.

• The location of all residential property that the Tribal Member either owns or has been granted the right to occupy, and the approximate sizes and values of each of the residences;

• The address used for correspondence with government agencies, financial institutions, and the like;

• Utility and service provider usage, if applicable;• Declarations as defined by section 116.130 of the California Code of Civil Procedure specifically, a written statement signed by an individual which includes the date and place of signing, and a statement under penalty of perjury under the laws of this state that its contents are true and correct.

Residency

• Legal Ruling 2015‐02– The location wherein the taxpayer’s spouse and children reside;

– The location wherein the taxpayer’s children attend school;

– The origination point of the taxpayer’s checking account and credit card transactions;

– The location wherein the taxpayer maintains memberships in social, religious, and professional organizations;

– The address at which the taxpayer registers his or her motor vehicles; and

– The address at which the taxpayer maintains a driver’s license.

Residency

• Legal Ruling 2015‐20

– Also applies residency test for temporary absences.

• If temporarily away from residence, then still a resident.

– Attendance at school is temporary absence.

– Move out due to construction on home on reservation –temporary absence.

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Residency

• Gilbert H. Hyatt back to U. S. Supreme Court:– Background: Moves to Nevada (sloppy move) and claims

Nevada residency when big royalty payments start coming in. Audited by FTB who extended CA residency period for several months (which resulted in significantly more income being reported to CA.)

• Challenged CA residency audit process as invasion of privacy. • Won right to bring lawsuit in Nevada Superior Court with a jury. • Jury awarded $360M to Hyatt, subsequently reduced to $1M by Nevada Supreme Court.

• FTB appeals decision to U. S. Supreme Court on following issues:– Can Nevada refuse to extend to another state the same immunities Nevada

enjoys in Nevada court? (Cannot assess punitive damages against Nevada employee doing their job, and civil damages capped at $75,000.)

– Should Nevada v. Hall (which allows a state to be sued in another state without its consent) be overruled?

Community Property

• States with community property:– Arizona– California– Idaho– Louisiana– Nevada– New Mexico– Texas– Washington– Wisconsin– Alaska – CP is elective.

Community Property

• Effect on Tax Return:

– Generally federal law looks to state property law to determine ownership.

– What is community property differs by state:

• In Texas, Louisiana, Wisconsin and Idaho the income from separate property belongs to the community.

• In remaining CP states, income from separate property is separate income reportable by owner‐spouse.

• In all CP states, earned income (salaries, wages, income from professional partnership) is CP.

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Community Property

• Example:– Fred and Wilma are married but file separate, Fred received $25,000 salary and $300 of taxable interest on savings account (funded from Fred’s salary). Wilma collected $2,000 taxable dividends on stock she inherited from her father. Wilma’s gross income is as follows:

California Texas Common Law State

Dividends $2,000 $1,000 $2,000Salary $12,500 $12,500 ZeroInterest $150 $150 Zero

Community Property

• Community Property (California)

– Only spouses can acquire community property. (Fam. Code 751)

• Community property liable for debts incurred by either party.

• Subject to equal division upon dissolution of marriage or legal separation.

• Surviving spouse entitled to at least ½ of community property if one spouse dies testate.

– Entitled to all community property if dies intestate.

Community Property

• Separate Property– Separate property of a married person includes:

• Property owned by the person before marriage

• All property acquired by the person after marriage by gift, bequest, devise or descent, and

• Rents, issues and profits of foregoing profit.

• Quasi Community Property– Property acquired by either spouse while domiciled elsewhere that would have been community property if the spouse who acquired the property had been domiciled in CA at the time of its acquisition.

• Treated as community property upon dissolution of the marriage.

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Community Property

• Termination of Community Property– Fam. Code 771.

• Property acquired after “date of separation” is separate property.

• Date of separation means living separate and apart evidenced by physical separation and a breakdown of the marital relationship.

– Parties have no present intent to resume the marital relationship. There is conduct evidencing a complete and final break in the marital relationship.

» Subjective intent to end the marriage and objective evidence of conduct furthering that intent.

Community Property

• Termination of Community Property

– In re Marriage of Manfer (2006)

• Wife decided marriage was over and H moved out. Agreed to hide separation from family and friends. Took occasional trips together, but did not commingle funds or support one another. Court decided marriage was over.

– In re Marriage of Norviel (2002)

• H informed W that marriage was over and they lived together as “roommates” for a period of time. Then H moved out. Marriage over (per opinion) when H moved out.

Community Property

• Termination of Community Property– In re Marriage of Davis (2015)

• CA Supreme Ct. has agreed to hear the case. See below. • Parties found to have separated five years before W moved out of house. Parties moved into separate bedrooms and then W announced that she wanted to strictly separate finances which they did. Lived this way for five years. Social relationship was limited and primarily for sake of children.

• Supreme Ct. holds that "living separate and apart" refers to a situation in which spouses are living in separate residences and at least one of them has the subjective intent to end the marital relationship ‐‐ an intent that is objectively evidenced by words or conduct reflecting that there is a complete and final break in the marriage relationship.

– Living in same house does not qualify to “terminate” CP.

36


Community Property

• Federal law has its own provision on termination of community property IRC section 66, which requires parties meet following conditions:– The spouses are married to each other at any time during the calendar

year. – The spouses live apart at all times during the calendar year. Note that

living apart requires that spouses maintain separate residences.– The spouses do not file a joint return.– One or both spouses have earned income that is community income

for the calendar year. – No portion of earned income is transferred (directly or indirectly)

between spouses before the close of the calendar year. Note that transferred income does not include a de minimis amount of earned income that is transferred between the spouses. Also, any amount of earned income transferred for the benefit of the spouses' child will not be treated as an indirect transfer to one spouse.

Community Property

• Example:– H and W are married, domiciled in California, and have lived

apart the entire year of 2015. H and W are estranged and intend to live apart indefinitely. H and W do not file a joint return for tax year 2015. H occasionally visits W and their two children, who live with W. When H visits, he often buys gifts for the children, takes the children out to dinner, and occasionally buys groceries or new clothes for school. H and W have recently been attending marriage‐counseling sessions in an attempt to reconcile differences. Both W and H have earned income in the year 2015 that is community income under the laws of California.

• CP under California law ‐ not much objective intent to terminate the marriage).

• For federal purposes, H and W may report their own income on separate returns under IRC section 66.

College Access Tax Credit

• SB 798 (CH 367, Sept. 16, 2014)– Rev & TC 17053.86 and 23686 create a new tax credit which is 60% of amount contributed in 2014;

• 55% for 2015• 50% for 2016.

– Monies placed in separate fund to be used to provide additional Cal Grants to eligible students.

– California Educational Facilities Authority can allocate up to $500 million of credit over 2014 through 2016.

– Taxpayer must get certification for credit. – Contribution also deductible on federal tax return as charity deduction.

37


College Access Tax Credit

• Extended by AB 108 and SB 81.

– Extended through January 1, 2018.

– Credit percentage is 50%.

– Maximum amount of credit that can be allocated is $500 million.

– Can reduce tax liability below the tentative minimum tax. This change is retroactive to tax years beginning on or after January 1, 2014.

CA EITC

• AB 107/SB 80 enacts a refundable state EITC.

– Available in 2015 and thereafter if funded in the Budget. (Rev & TC 17052)

– Based on the federal credit multiplied by the EITC adjustment factor. (in 2015 this is 85%.)

– Credit percentage is same as federal and is based on number of children (then multiplied by state EITC adjustment factor).

CA EITC

• Eligible Individual– Same as federal except must have a principal place of abode in CA for over half the year.

• Same for qualifying child.

– “Earned income” includes all amounts subject to CA withholding.

• Specifically excludes income from self‐employment.

– Like federal, credit is refundable.

– For California purposes report on Form FTB 3514. (Note paid preparers must file a checklist – Form FTB 3596).

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CA EITC

• Maximum credit:

– State credit starts phase out immediately once state earned income amount is reached.

• Earned income up to $3,290 (phased out at $6,580).

• Maximum EITC = $252

• Maximum CA EITC (multiplied by adjustment factor) = $214.

• Married taxpayers receive the same credit as single or HOH.

CA EITC

• CA EITC:

– Earned income and unearned income are limited. To qualify, TP must not have more than $3,400 investment income for 2015.

– State credit cannot exceed excess of:

• Credit percentage times earned income , over

• Phaseout percentage multiplied by the amount of TP AGI or, if greater, the TP earned income which exceeds the phase‐out amount.

CA EITC

• Phase out amounts for TP with one child:

– Credit percentage (and phase out percentage) is 34%.

– Earned income amount where phase out begins:

• $4,940

• Fully phased out at $9,880.

– Maximum EITC before EITC adjustment (85% for 2015).

• $1,680

39


CA EITC

• Example:

– Sammy has one child and earns $8,000 working at a hardware store. He has no other income or above the line deductions. His EITC credit is:

• Maximum credit $1,680

• Phaseout Amount (1,040)($8,000 ‐ $4,940) x 34

• Total $640

• Adjustment Factor x .85

• Total $544.

CA EITC

• Penalties

– Waiver of estimated penalty if underpayment is attributable to the adjustment factor for year being less than adjustment factor for preceding year.

– CA conforms to federal penalty of $500 for paid preparers who fail to comply with due diligence requirements to determine eligibility for EITC.

California

• New economic development program.– CA Competes Incentive (Rev & TC 18410.2 and 23689).

• Agreement will include details, like years covered, minimum compensation level, minimum job retention period and yearly allocation (based on milestones achieved).

• Amount of credit available to be allocated is $30 million for 2014, $150 million for 2015, and $200 million for 2016 to 2018, plus:

– Unallocated amount from prior years;

– Amount of previously allocated credits that were recaptured;

– Total amount granted limited by the other exemptions for the sales tax, hiring credit and GO‐BIZ credits. Overall limit is $750 million.

• No single taxpayer will get more than 20% of allocation for year. 25% of yearly allocation reserved for small business.

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California

• FTB Notice 2014‐02– FTB required to review books and records of taxpayers awarded a CCC to ensure compliance with the written agreement with Go_Biz.

• In general, will examine only compliance with CCC agreement. Based on size of award, will determine if field or desk review.

• May review small business who get award. (Gross receipts under $2 million).

• Will look at payroll records, invoices, analysis of expenditures, depreciation schedules, general ledger accounts/records.

• If a breach of agreement, then reported to Go‐Biz who may give time to resolve issues, or may recommend recapture.

118

California

• Recapture– If Go‐Biz orders recapture, then report on tax return for year that Committee notifies taxpayer of recapture decision.

• If not reported on return, then FTB sill bill for tax due and owing.

– Reasons for recapture:• Failure to provide information

• Material misstatements

• Failure to satisfy or maintain the milestones (set forth in agreement.

119

California Competes Credit

• California Competes Credit

– Results in 2015: Total credit awarded to date in 2015 is $150 million.

– Ranges from a high of $15 million of credit to a low of $20,000 of credit.

• The $15 million of credit was awarded to Tesla for a commitment of a $2.3 billion investment in Palo Alto with a net increase of 4,400 employees.

– Cal. Rev & TC 17059.2, 18410.2 and 23689.

120

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California Competes Credit

• Application dates for fiscal 2015/2016

– July 20, 2015 to Aug. 17, 2015 ($75 million)

– Jan. 4, 2016 to Jan. 25, 2016 ($75 million)

– March 7, 2016 to March 28, 2016 ($50.9 million plus any unallocated amount from prior application periods).

121

California

• Research Credit (Cal. Rev & TC 23609)– Based loosely on federal credit. Must claim federal credit to get state credit.

– Research must be conducted in California. – Basic Research Payments.

• Payments in cash to a qualified organization who will agree to perform the research in CA.

• Must relate to scientific or engineering knowledge. Does not include:

– Research in social science, arts or humanities.– Research related to style, taste, cosmetics or seasonal design.– Exploration for oil/gas or mineral deposits,

• For biotechnological research payments can be made to hospital or research center.

122

California

• Qualified Research Expenses.

– A taxpayer's "qualified research expenses" include 100% of expenditures for research conducted by the taxpayer and 65% of expenditures for research conducted on the taxpayer's behalf (75% in the case of research conducted on the taxpayer's behalf by qualified research consortia). (Rev & TC 23609).

– California does not allow the increase in the credit for amounts paid to an eligible small business, university, or federal laboratory from 65% to 100%.

123

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California

• Qualified Research Expenses

– Largely follows federal law:

• Wages directly associated with research (including direct supervision and support).

• Supplies– But not land, improvements to land, depreciable property, utilities, small tools and allocated shipping costs.

124

California

• Research Credit Amount– 24% of a defined portion of a taxpayer's basic research payments; plus

– 15% of the excess of the taxpayer's qualified research expenses for the taxable year over a fixed‐base percentage of the taxpayer's average annual gross receipts for the four preceding taxable years (the taxpayer's "base amount"). (Rev & TC 23609).

• California does not incorporate the federal alternative simplified credit, generally effective for federal purposes in tax years ending after 2006.– FTB sponsored bill in legislature that would conform CA law to federal

alternative simplified credit. Bill Failed. (AB 2330, Mullin)

125

California

• Research Credit Amount– Only that portion of a taxpayer's basic research payments equal

to the part that exceeds the taxpayer's base period amount is taken into account for purposes of calculating the basic research component of the research expenditures credit.

– The term "base period amount" means the sum of a taxpayer's minimum basic research amount and the taxpayer's maintenance of effort amount.

– A taxpayer's "minimum basic research amount" is equal to the greater of 1% of the average of the taxpayer's expenditures during the three preceding tax years for in‐house and contract research or the taxpayer's total contract research expenditures during the three preceding tax years.

126

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California

• Research Credit– A taxpayer's "maintenance of effort amount" is the excess of the

inflation‐indexed average of the taxpayer's nondesignated university contributions during the three preceding tax years over the taxpayer's nondesignated university contributions for the current tax year.

– Generally, the "fixed‐base percentage" used to calculate a taxpayer's base amount for purposes of calculating the qualified research expense component of the research expenditures credit is the ratio that the taxpayer's total qualified research expenses for 1984 through 1988 bears to the taxpayer's total gross receipts for those years, expressed as a percentage. However, in no event may a taxpayer's base amount be less than 50% of the taxpayer's total qualified research expenses for the year.

127

California

• Example:– A taxpayer had qualified research expenses for 1984 through 1986 of $10,000. The taxpayer had total gross receipts for that same period of $500,000. The taxpayer's fixed‐base percentage is 2% ($10,000 over $500,000).

– A taxpayer had qualified research expenses for the 2014 taxable year of $20,000. The taxpayer had average annual gross receipts for the 2010, 2011, 2012, and 2013 taxable years of $500,000. Continued…

128

California

• Example:– If the applicable fixed‐base percentage for the 2014 taxable year was 2%, the qualified research component of the taxpayer's research expenditures credit was $1,500.

• $500,000 in average gross receipts for the four preceding taxable years multiplied by the 2% fixed‐base percentage equals $10,000;

• the resulting $10,000 subtracted from current qualified research expenses of $20,000 equals $10,000 in excess qualified research expenses;

• $10,000 in excess qualified research expenses multiplied by the 15% credit amount allowed equals $1,500.

129

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California

• Start Up Companies– A start‐up company's fixed‐base percentage is 3% for each of the first five taxable years beginning after December 31, 1993, for which the company has qualified research expenses.

– For the sixth through the 10th taxable years, its fixed‐base percentage is a portion of the percentage that the company's aggregate qualified research expenses bear to its aggregate gross receipts for specified preceding years.

– Thereafter, the company's fixed‐base percentage is the percentage that its qualified research expenses bear to its gross receipts for any five years selected by the company from its fifth through its 10th taxable years.

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California

• Alternative Credit Computation– A taxpayer may elect an alternative incremental credit method of computing the research expenditures credit, wherein the credit is equal to the sum of the following:

• 1.49% of qualified research expenses for the tax year in excess of a base amount computed using a fixed‐base percentage of 1%, but not in excess of a base amount computed using a fixed‐base percentage of 1.5%;

• 1.98% of qualified research expenses for the tax year in excess of a base amount computed using a fixed‐base percentage of 1.5%, but not in excess of a base amount computed using a fixed‐base percentage of 2%; and

• 2.48% of qualified research expenses for the tax year in excess of a base amount computed using a fixed‐base percentage of 2%. (Rev & TC 23609).

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California

• Limits on use of the Research Credit:– the minimum franchise tax;

– the annual tax on partnerships and qualified subchapter S subsidiaries;

– the alternative minimum tax;

– the tax on built‐in gains of S corporations; or

– the tax on excess net passive income.

• The credit is nonrefundable and nontransferable.

• Can reduce a taxpayer's regular tax below the tentative minimum tax.

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California

• Reduced credit amount:– In lieu of reducing the deduction amounts or capitalized expenses, taxpayers may elect to take a reduced credit rather than make an adjustment to research and development expense deduction. ( Rev. & TC 24440).

• Corporations multiply their research credit by 91.16%

• individuals and estates or trusts multiply their research credit by 87.7%, and

• S corporations multiply their research credit by 98.5% to arrive at the reduced credit amount.

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California

• Example:– For the taxable year ending December 31, 2013, ABC, Inc., an S

corporation, generated $3,000 in research credit. ABC, Inc. elects the reduced regular research credit. ABC, Inc. figures its research credit as follows:

• Step 1: $3,000 x 1/3 = $1,000• Step 2: $1,000 x 98.5% (.985) = $985• This amount is the research credit available to ABC, Inc. for its 2013 taxable

year.

– John is the sole shareholder (100%) in ABC, Inc. John materially participates in the business of ABC, Inc. The election by ABC, Inc. to reduce the research credit also applies to John.

• Step 1: $3,000 x 100% (1.0) = $3,000• Step 2: $3,000 x 87.7% (.877) = $2,631

– This amount is the pass‐through research credit available to John for his 2013 taxable year.

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California

• Research Credit

– Unlimited carryforward.

– Permanent (does not expire).

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Research Credit

• Other States

– States with no research credit include:

• Alaska, District of Columbia, Kansas, Mississippi, Missouri, Oklahoma, South Dakota, Tennessee, Texas, Virginia and Vermont.

– States which offer a research credit that is independent of the federal credit and may be limited to specified taxpayers and\or economic development area include Alabama, Arkansas, Colorado, Kentucky and New Mexico.

136

Research Credit

• Other States– Generally no termination date on state research credit with exception of Maryland, North Carolina, and Pennsylvania.

– Research must be conducted in the state. Exceptions:

• Iowa, Louisiana, and Nebraska that base their credit on the taxpayer’s apportioned share of its total qualifying research expenses. However, Iowa does determine its alternative incremental credit (AIC) based solely on expenses for research conducted in Iowa.

137

Credit for Taxes Paid to Other states

• Comptroller of the Treasury v. Wynne (U.S. Supreme Court Dkt. 13485, May 18, 2015).

– A Maryland Court of Appeals had held that a state’s disallowance for county income tax for purposes of credits for taxes paid in other states violates the Commerce Clause.

– Decision upheld by U.S. Supreme Court.

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Credit for Taxes Paid to Other States

• Facts of Wynne:– MD residents (like NY residents) pay tax on their

worldwide income

– MD personal income tax has two components: (1)state and (2) county

– Nonresidents only pay tax on sourced income, but they pay BOTH the state and county tax (called “special nonresident tax”)

– Residents only allowed credit against state portion of tax


• Facts of Wynne:– MD residents who held stock in an S Corp that

operated and filed returns in 39 other states

– Reported flow-through income from the S Corp on MDincome tax returns

– Claimed resident tax credit (against both the stateand county components) for taxes paid to otherstates

– The MD State Comptroller disallowed credit against county component


• Facts of Wynne:– Wynnes pay tax to MD as residents (say 6%) and

rate includes a county component (say 1%)

– They also pay tax in CA at 13% rate

– MD will allow an offset for CA taxes paid, but onlyagainst the 5% state tax; 1% county tax can NEVERbe offset

– Constitutional dispute: Is that legitimate? Can astate tax its residents on all income and NOT provide full credit for taxes paid to other states?

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Credit for Taxes Paid to Other State

• History of Case:• Tax Court affirmed the Hearings and Appeals

Section’s ruling which held that the no credit was allowed against the county component of MD’s income tax

• Tax Court reversed by Circuit Court for Howard County, which held that MD’s tax scheme violatedthe Commerce Clause


• The test: whether interstate and intrastatecommerce would be taxed equally if every state were to adopt the precise tax scheme at issue.– State A imposes a 1.25% tax on all residents, regardless of where

earned State A also imposes a tax on nonresidents’ source income at 1.25%

– No resident credits– Jane and Joe live next door to each other in State A; Joe’s business

located in State B; Jane’s is all in State A– To apply the I/C test, we have to assume all states have the State A

scheme. If this was the case, then there would be a double tax. • State A imposes a 5% state tax and 1.25% county tax. Joe pays tax to

another state at rate of 6.25%. He gets credit against home state tax for 5%. Ends up paying 7.25% state tax (6.25% + 1.25%).

– If he got a credit for 6.25%, then he would be on equal footing with Jane.

• April Bob


Quotes from the case:“We see no reason why the distinctionbetween gross receipts and net income shouldmatter” and in any event “our cases rejectedthis formal distinction some time ago”Does this mean that gross receipts are now creditable?

49



• Quotes from the Case:– Just because a state has jurisdiction to tax (under

the 14th Amendment’s Due Process Clause) doesn’t preclude a finding that the tax violates the Commerce Clause

– The focus is on the total tax burden on interstate commerce; not whether MD gets more or less taxfrom a particular taxpayer — it’s a substance over form inquiry

Credit for Taxes Paid to Other State

• Conclusions from the Case:– Commerce Clause protections extend equally to

• Taxes based on gross and net income; and• Both corporations and individuals are covered under

commerce clause (prior cases generally dealt with corporations)

– Maryland counties to pay more than $200 million inrefunds. Are local taxes now creditable against state tax in home state?

Doing Business

• Ownership of General Partnership Interest

– Out of state general partners will be deemed to be doing business in the state in all states except New Hampshire.

• New Hampshire

– Taxes the entity under their Business Profits Tax and Business Enterprise Tax. If income is taxed at the entity level (like a corporation) it is not taxed again at the partner level.

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Doing Business

• Ownership of a Limited Partnership Interest– California

• Could be doing business in state if meet statutory threshold.

• Include TP pro rata share of income from CA entity to determine if doing business in state. (Rev and TC 23101(d)).

• Result is that out of state corporate limited partner could be doing business in state (if they had CA sourced income in excess of $500,000 from their investment in the partnership).

Nexus

• FTB Nexus Guidelines

– Example:

• Corporation E is a limited partner in a CA partnership. His share of the partnership CA sales is $70,000. Corporation E has no property or payroll in CA, but does have sales of $450,000 sourced to CA. Is Corporation E doing business in CA?

– Yes, because it has total sales (including its share of flow through sales from the partnership) in excess lf $500,000.

Nexus

• California: Limited Partners

– Position of FTB seems to conflict with (or overrule) prior case (Appeal of Anman & Schmid Finanz AG (96‐SBE‐008) which held that limited partner interest does not create nexus for out of state limited partner.

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Nexus

• Flow Through Entities: California– LLCs: FTB aggressively pursues out of state LLCs and out of state members.

• R&TC 19135 extends the $2,000 penalty assessed against corporations doing business in the state that are suspended to both foreign and domestic LLCs.

• Liability for this penalty can accrue in different scenarios:

– Managing member of LLC lives in CA.

– Out of state LLC (or corporation) owns an interest in an LLC doing business in California.

Nexus

• Flow Through Entities: California

– Legal Ruling 2014‐01

• “Doing business” if actively engaging in activity in the state for profit (Rev & TC 23101).

• If an LLC “doing business” in the state, then so are members. Members have the right to manage the LLC.

– Doing business whether they actually are or not.

– Can be non‐member managed and still would qualify as doing business.

– But see next slide…

Doing Business

• Limited Liability companies– California

• Swart Enterprises v. FTB (filed in Fresno Superior Court) – Doing business in Iowa. Has $50,000 investment in an LLC that is organized in CA to acquire, lease and dispose of capital equipment. Swart is a passive investor with a .02% interest. FTB claims that Swart is doing business in CA.

» Prior case (Appeal of Anman & Schmid Finanz AG (96‐SBE‐008) holds that limited partner interest does not create nexus for out of state limited partner.

» FTB maintains that LLC statute gives all members the right to mange LLC whether they do so or not.

» Ignores the fact that LLC statute also allows the members to be manager managed – not member managed. (continued…)

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Doing Business

• Swart Enterprises v. FTB (Nov. 20, 2014, No. 13CECG02171). – Superior Court finds in favor of taxpayer.

• LLC interest was an investment.

• Swart had no ability to manage the affairs of LLC.

• Ownership interest was not comparable to that of a general partnership.

– Court found that Appeal of Anman & Schmid Finanz AG (96‐SBE‐008) applied. The involvement of Swart was much more similar to that of a limited partner. No statutory authority to view Swart as a general partner.

• FTB has appealed.

Nexus

• Flow Through Entities: California

– Legal Ruling 2014‐01

• LLC only registered to do Business in CA. – LLC must file and pay at a minimum $800

– Nonresident corporate members do not have to file. LLC not engaged in transactions for profit.

• LLC only organized in CA– LLC must file and pay at a minimum $800.

– Nonresident corporate members do not have to file. LLC not engaged in transactions for profit.

Nexus

• Flow through entities – California

– Member doing business in CA.

• Sammy is the only member of a SMLLC that owns an apartment building in Montana. Sammy hires a manager in Montana but the operating agreement does state that Sammy is responsible for managing the LLC and the LLC used a CA address, had a CA CPA and a CA bank account used for most bill payment. Out of state LLC doing business and owes $800. (Appeal of Mockingbird Partners (SBE, May 17, 2006). Might also owe penalty.

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Nexus

• Flow through entities: California

– LLC “doing business” in CA.

• Legends LLC organized and doing business in CA, owns a hotel in the state. The LLC is owned by ABC Corporation (organized and doing business in Texas). ABC has never filed and paid tax in CA as Legends has always operated at a loss (and ABC thought that there was nothing to report). If ABC is a managing member of the LLC, then FTB will argue that ABC is doing business in the state and must file and pay the minimum tax of $800.

Nexus

• Example:

– An Illinois LLC (Number 1) owns an interest in a CA rental property. One of the members of LLC #1 is LLC #2 (SMLLC) which is owned by a resident of Illinois.

• LLC#2 is doing business in CA as the general partner of LLC#1. This means that owner of LLC#2 is doing business in CA as they are making decisions regarding the management of the CA property.

Nexus

• Example:

– LLC #1 holds a limited partnership interest in a limited partnership which owns property in CA. Is LLC#1 (which has nothing else in the state and does not file in the state) have a filing requirement in CA?

• No, as long as LLC #1’s distributive share of the income from CA does not exceed the statutory threshold of $500,000 of gross receipts sourced to the state.

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Nexus

• Penalties for Failure to File (for LLCs and Corporations)– 5% per month up to 25% of amount due for failure to file. If amount due is $800 then penalty is $200. (R&TC 19131)

– $2,000 penalty for doing business in the state without filing and registering as doing business in the state. Penalty is per taxable year and can be assessed within 60 days after notice and demand to taxpayer. (R&TC 19135)

– Interest.

– $18 per member penalty for failing to file Schedule K‐1. Penalty assessed monthly up to a maximum of 12 months. (Rev and TC 19172).

Nexus

• Statutory nexus:

– For 2015 tax years the statutory nexus standard are as follows:

• $536,446 (Sales )

• $53,644 (Property)

• $53,644 (Payroll)

Nexus

• California Legal Ruling 2011‐01 (1/11/2011)– Disregarded entity will be deemed to be activity of owners.

• Y owns B which is doing business in CA. Y is an out of state company that does not do business in CA – but owns B as a SMLLC. Y is deemed to be doing business in CA through activities of B which are part of Y (treated like a division).

– All assets, liabilities, income, deduction and credits of a QSSS are treated as activities of the S Corporation. (Rev and TC 23800.5).

• Example: Out of state S Corporation owns a qualified subchapter S subsidiary doing business in CA. Even if they are not unitary, out of state S Corporation now deemed to be doing business in CA.

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Gillette

• Gillette Co. v. State of California, California Court of Appeal, First District, No. A130803, October 1, 2012. – Six taxpayers file suit alleging that they are entitled to use an

equally weighted three factor apportionment formula as allowed by CA adoption of the MTC (Multistate Tax Compact) which provided for an equally weighted formula.

• CA argues R&TC 25128 has been amended to provide that the apportionment formula would be a double weighted sales factor.

• Ct of Appeal (in two decisions) upheld taxpayer’s right to use the equally weighted 3 factor formula.

• As a result, CA repeals legislation (and withdraws) from the MTC.

Issues raised by Gillette

• Can the States group together to form a “compact”?

– This was the question in U.S. Steel Corp. v. MTC 434 U.S. 452.

• Compact is valid as long as it does not increase the political power of the states and interfere with the operation of the U.S. government.

• US Supreme Court holds the Compact does not infringe upon the power or the US govt. Also no delegation of state sovereign power to MTC because states are not required to enact MTC proposals and can withdraw at any time.

Gillette

• Ct of Appeals decision– A Compact is an enforceable contract and a state statute. – The compact is part of the statute, and cannot be “nullified, revoked

or amended” by the legislature. – “Re‐enactment Rule” – A section of a statute cannot be amended

unless the section is re‐enacted as amended. (Art. IV, section 9 of the California Constitution.) CA legislature cannot repeal Rev & TC 38006 by amending R& TC 25128 with the “notwithstanding” language.

• CA Supreme Court – In unanimous decision, overruled Ct of Appeals and held that Compact

is state law and not a binding, reciprocal agreement amongst its members. Legislators had right to adopt mandatory double weighted sales factor in 1993. Decision in favor of FTB. Gillette indicates it will appeal to U.S. Supreme Court.

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Gillette

• CA Supreme Court reverses Ct of Appeal and upholds State. (Cal Sup. Ct. No. S206587, 12/31/2015). – Compact not a binding reciprocal agreement.

– Effectiveness does not depend on other members’ conduct.

– Unilateral member action not prohibited.

– Not a regulatory organization.

– Re‐enactment rules does not bar the Legislature’s amendment of Sec. 25128.

Gillette

• Results of Gillette in California.

– Potentially looking at large refund claims for all open years from most out of state corporations (who would pay less with the Compact formula).

– Enacts SB 1015 (CH 37‐2012) to reduce impact of decision.

• Withdraws CA from the MTC

• Makes statutory the “doctrine of elections” which the bill states is a restatement of existing law.

Gillette

• Impact for taxpayers– File protective claims for refund.

• SB 1015 might be struck down as a tax increase that should have been approved with a 2/3rds vote.

– FTB Notice 2012‐01 (Oct. 5, 2012)• Provides procedure for protective claims• Makes clear that since Ct of Appeal decision was not issued until Oct. 2, 2012 that it does not become final until 30 days after that date. Therefore, on extended due date of Oct. 15, 2012 the decision was not in effect and the statute required use of a double weighted sales factor.

• If TP applies equally weighted formula they will be subject to the large corporate understatement penalty (a strict liability penalty).

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Aftermath of Gillette

• International Business Machines Corp. v. Dept. of Treasury (Mich. Supreme Ct. No. 146440, July 14, 2014)– Michigan Supreme Court reached opposite conclusion from Court of Appeals.

• Held in favor of the taxpayer allowing evenly weighted three factor formula under Compact. Held that Compact (while in existence) provided for an election in Michigan.

– Michigan repealed Compact in 2011 (implying that it was otherwise in place).

– Michigan Business Tax Act (BTA) did not repeal the Compact evenly weighted three factor formula by implication. BTA requires use of a single sales factor.

Gillette

• Texas

– Graphic Packaging (GP) filed using single sales factor until 2010, when it filed using the evenly weighted three factor formula. Went back and filed amended returns (using same methodology) for open years.

• Refund claim was denied, and GP has filed a Suit for a refund in District Court. GP argues that Texas Margin Tax is an income tax and cites several examples. Also argues that SSF violates due process and commerce clause because distortive.

• Eleven other cases also filed in Texas.

Gillette

• Oregon– Case filed by Health Net, Inc. and asserts that it has the right to use the evenly weighted three factor formula because Oregon is a full member of the MTC. Tax Court upholds the Dept. of Revenue – MTC Compact formula not allowed.

– Dept. of Revenue has notified taxpayers that all corporate tax returns will be processed using SSF (and will not recognize the Compact apportionment formula).

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Gillette

• Minnesota– Kimberly Clark Corp. v. Comm. Of Revenue (Tax Court, 2015)

• Arguing that they should be allowed to apportion to the state under the MTC compact formula (evenly weighted three factor).

• Minnesota had repealed statutory provisions requiring use of three factor formula (in an attempt to direct apportionment formula as they wanted.)

• Kimberly Clark argues that they cannot change the binding commitment in the MTC Agreement.

• CT upholds Commissioner (State) on basis of “unmistakability doctrine”. Govt contracts must be strictly construed against the relinquishment of sovereign powers. If govt. has relinquished any rights, it must be crystal clear that this was the intent. Otherwise, the ambiguity must be resolved in favor of reserving state sovereignty power.

Apportionment

• Sales Factor

– CCR (July 30, 2015)

• Distortion– Reg. 25137( c) excludes gross receipts which are distortive (substantial and occasional).

» Facts involved sale of a line of business which (if taken out of denominator, results in a 33% decline). Meets substantial test.

» “Occasional” considers frequency and regularity of transaction. Disposing of a line of business was not a frequent or regular transaction.

» Leave receipts from sale of business out of sales factor.

174

Sales Factor• Sales of Tangible Property

– Throwback• If not taxable in the other state then throwback

• Taxable in the other state if:

– Subject to net income tax, franchise tax, or corporate stock tax; or

– State has jurisdiction to tax whether they do or do not assess a tax. (Continued…)

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Sales Factor

• Sale of tangible property

– “Taxable in the other state”

• Taxpayer must be able to provide evidence that they paid tax.

• Taxpayer must not “voluntarily” pay the tax.

• Minimum tax must bear relationship to the taxpayer’s level of business activity in the state.

• If tax is a substitute for an income tax, then must be a revenue raiser.

175

Sales Factor

• Throwout

– Maine is the only state with “throwout”.

• Sales of tangible personal property delivered or shipped by the taxpayer to a purchaser in a state in which the taxpayer is not taxable are excluded from both numerator and the denominator of the taxpayer's sales factor.

– Rule does not apply where any member of an affiliated group with which the taxpayer conducts a unitary business is taxable in the state to which the property is delivered or shipped. ( 36 M.R.S.A. Sec. 5211(14) ; Rule 801.06(A) (18‐125 CMR 801) )

Sales Factor

• Double Throwback– Sell to purchaser and merchandise delivered by third party in another state. If seller not taxed in state where purchaser located and also in state where third party located, then sales throws back to state where salesperson operates.

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Question

• Your client is commercially domiciled in Illinois and has a salesman in Kentucky who maintains a small stock of inventory in the state and helps customers with installation of the product. Your client does not file a tax return in Kentucky (although they should). Is your client required to throwback the sale to Illinois if they are subject to tax in Kentucky but do not actually pay the tax in Kentucky?

– Yes, because they must actually pay the tax to negate throwback.

– No, as long as they are subject to the tax in the other state, there is no throwback.

– Varies by state.

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Sales Factor

• Tax Trap in Question

– In 2009, client is required to comply with ASC 740 (or FIN 48). FIN 48 analysis puts sale in Kentucky –must accrue liability in that state. If throw back sale to home state may end up accruing tax expense twice.

• File in Kentucky for all open years

• File amended returns in Illinois, eliminate throwback and ask for refund.

179

180

Sales Factor

• Throwback in Unitary Group: California history.– 1966 ‐ Appeal of Joyce – Look at the entity (not the entire unitary group).

– 1988 ‐ Revert to Appeal of Finnigan. Look at the entire unitary group.

– 1999 – Switch back to Appeal of Joyce.

– 2011 – Switch back to Appeal of Finnigan.

– Generally, Finnigan results in less throwback to CA.

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181

Sales Factor

• Joyce v. Finnigan

– Appeal of Joyce (In bound example) • Gross receipts from sales of goods shipped to CA customers by seller who is part of a unitary business conducted in CA (but does not itself conduct business in CA because of PL 86‐272) will throw back.

– Appeal of Finnigan (Outbound example)• CA subsidiary makes sales of property into other states where it does not do business, but its corporate parent was taxable in those states. SBE decides should look at entire unitary group to determine throwback, and no throwback required in this case.

Sales Factor

• Throwback in Foreign Commerce– Generally U. S. treaties do not apply

– States take three different approaches:• Apply PL 86‐272 standard even though the statute might not apply. Statute applies only to interstate commerce.

• Apply a U. S. Constitutional standard (i.e., Due Process clause) California and Idaho.

• Do not throwback sale if taxpayer can prove they paid “tax” in foreign country.

– Problem: What foreign tax do you use – the VAT?

182

Sales Factor

• Appeal of Dresser (1983)– Taxpayer manufactured pumps in CA and shipped them to foreign subsidiaries for sale to customers overseas. Taxpayer actively solicited sales in these countries. Do these sales throwback?

• PL 86‐272 will not apply to foreign commerce.

• 14th Amendment (Due Process Clause) does apply. Test– Minimal connection or Nexus with taxing state.

– Rational Relationship between income attributed to the foreign country and the activity in the foreign country.

– Continuous local solicitation provided basis for foreign country to assess a tax. No throwback.

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Sales Factor

• Throwback (Chief Counsel Ruling 2012‐03)– R&TC 25135(a) states that property shipped from CA and made to US Government or to state where TP is not taxable will throw back to CA.

– “Taxable in another State” (Rev and TC 25122)• Subject to net income tax, franchise tax and so forth in other state, or

• State has jurisdiction to tax whether they do or not. • Jurisdiction to tax is not present if activity protected by PL 86‐272.

– Determination of whether state has jurisdiction to tax is made by looking at jurisdictional standard applied in California.

184

Sales Factor

• Chief Counsel Ruling 2012‐03– How to handle foreign sales?

• Under R&TC 23101(b)(2), TP is doing business in CA if they have sales that exceed the lesser of $500,000 or 25% of total sales. Same provision applies to entities in foreign jurisdictions. Also PL 86‐272 does not apply. If meet this test, then deemed to be “doing business” in foreign country and no throwback.

• If jurisdiction is present, then CA is not considered without jurisdiction by reason of a treaty between US and country.

– How to handle sales in a unitary group?• Look at entire group to determine throwback

185

Sales Factor

• CCR 2012‐03

– FTB also rules that seller should not throw back if affiliates make sales of other than tangible personal property to a state in excess of $500,000.

• Under Finnegan look at entire group.

• Sales of tangible property are not subject to throwback if another member of unitary group has more than $500,000 of sales of other than tangible property in the other state – considered “taxable in another state”.

186

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Sales Factor: Throwback

• Appeal of Craigslist (Dec. 16, 2015)– They lost because they tried to apply the new laws prior to the effective date (Jan. 1, 2011). Otherwise, what they did would work:

• Website used for posting want ads and classifieds. Generally free – except for job postings. Income from job postings in five states exceeded $500,000.

– Market based sourcing: Source to state where ad appears.

– Throwback: Only applies to tangible property. Sale would not throwback anyway under CCR 2012‐03 which applies CA doing business standard for purposes of throwback.

– Creates “nowhere” income if destination state does not require filing a tax return.

Update

• Legal Ruling 2015‐02 IC DISCs

– Created under federal law (IRC 991).

– Income typically attributed to DISC is sales of goods offshore, and owner pays a commission to DISC for acting as broker for foreign sales.

• Generally DISC has no employees or operations.

• Owners pay tax on earnings and profits of DISC whether or not distributed. Owner is often an S Corporation.

– First $10 million of export revenue not included in earnings and profits.

Update

• Legal Ruling 2015‐02 IC DISCs

– IC DISC not recognized for CA purposes.

• If owned by a C Corp. and unitary – then inter‐co transactions eliminate and no effect.

• If owned by an S Corp. then FTB will allocate income from IC DISC to owner (i.e., S Corp.). No economic substance.

• Example: Sammy (CA Resident) owns S Corp (doing business in CA) which owns an IC DISC which it uses to book overseas sales. Gross income of IC DISC will be attributed to S Corp. who will pay tax to CA on these sales.

– If IC DISC organized in CA, it would have to pay minimum tax.

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Unitary

• Must be actual control (not potential to control).

– Comcon Production Services v. FTB (No. BC489779 (Ca. Super. Ct. Mar. 6, 2014).

• Case involves Comcast (a cable network provider) and QVC (a home shopping network transmitted over cable).

– Comcast owns majority stake in QVC.

– Some common management (but Comcast employees perform only ministerial functions)

– QVC maintained own administrative functions

– QVC went forward with overseas expansion without Comcast approval

– Comcast had the potential to control but did not.

Nexus

• Special Purpose Entities– Harley‐Davidson v. FTB 237 Cal. App. 4th 193 (2015)

• If you want to buy a Harley, you might go to dealership and finance the purchase through Harley’s financing subsidiary who will make the loan. Then the financing sub bundles the loans and sells them to a special purpose entity (nothing in CA) to sell in the market as securitized loans.

• Finance company continues to service loan. • Harley left out SPE’s because they had no connection with state. Appellate Court agreed with lower court that SPE’s were operating within the state. SPE’s were not doing business for themselves – but for the related financing entities. Court found that financing subsidiary was agent of SPE’s (which had no employees of their own).

Update

• Combined Report

– Harley‐Davidson v. FTB 237 Cal. App. 4th 193 (2015)

• Ct of Appeal also struck down Cal Rev & TC 25101.15 which allows unitary taxpayers who are doing business entirely within CA, to file using either combined report or separate returns.

– Choice can give different results and multistate taxpayers do not have the same benefit. Multistate taxpayers who are unitary must use the combined report.

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Update

• Other Legislation– Medical Marijuana Licensing.

• Requires individuals/companies to get separate licenses for each aspect of growing/selling medical marijuana.

– Separate licenses for indoor/outdoor cultivation, transportation, product testing, distribution and dispensaries.

– Expected to start issuing licenses In 2018.

• Tax treatment:– Under PIT, CA conforms to IRC 280E. Limits deductions to CGS. Corporate taxpayers can deduct CGS and business expenses because CTL does not conform to 280E.

– All medical marijuana subject to sales tax.

Update

• Other Legislation

– Mandatory Sick Pay

• Mandatory paid sick leave benefit begins July 1, 2015.

• No exception for small employers

• All employees who work for same employer more than 30 days in year entitled to paid sick days.

– Part time also covered.

– Generally accrue 1 hour of sick leave for every 30 hours worked.

– Unused sick days must carry over to following year – but can limit carryover to 6 days.

Update


– Mandatory Sick Pay

• Can start using sick pay after 90th day of employment. Can use for own health or health of family member.

• Employer can limit sick leave to three days in a year.

• Does not require payment for unused sick leave upon termination.

• Must post a “poster” advising employees of benefit.

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Update


– Fair Pay Act

• Prohibits employer from paying employees of opposite sex lower wage rate for substantially similar work.

• If different, employer must establish that wage differential is due to: seniority, merit system, education, training, experience.

2015/2016 Update

• Independent contractor v. employee.

– Fair Labor Standards Act

• New guidance on worker classification (published by Labor Dept.)

– Result of employee classification under these rules relates to minimum wage, overtime compensation, unemployment insurance and workers’ compensation.

– Labor Dept. has information sharing arrangements with states and IRS.

– Uses a very broad “economic realities” test.

197

2015/2016 Update

– Fair Labor Standards Act• New guidance on worker classification (published by Labor Dept.)

– Fundamental test: Is worker economically dependent on employer, or is worker truly independent business person?

» Is the work an integral part of the employer’s business?

» Does the workers managerial skill affect the Worker’s opportunity for profit or loss?

» How does the worker’s relative investment compare to the Employer’s investment?

» Does the work performed require special skill and initiative?

» Is the relationship between the worker and employer permanent or indefinite?

» What is the nature and degree of the employer’s control?

198

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2015/2016 Update

• IRS worker classification standards.

– A hot issue ‐ if employee then employer must provide health insurance under ACA.

– Still uses 20 factor test in Rev Rul 87‐41.

• These factors focus on direction and control exerted by the employer, such as worker instructions, training, hours, location, realization of profit or loss, and investment in facilities.

199

2015/2016

• California Labor Code and Uber Drivers.

– California Labor Commission ruled that Uber drivers were employees (June 3, 2015) and Uber promptly appealed decision to San Francisco Superior Court.

• Case involved employee suit for reimbursement of business expenses.

200

2015/2016 Update

• Tests used by the CA Labor Commission:– Whether the person performing services is engaged in an occupation

or business distinct from that of the principal;– Whether or not the work is a part of the regular business of the

principal or alleged employer;– Whether the principal or the worker supplies the instrumentalities,

tools and the place for the person doing the work;– The alleged employee's investment in the equipment or materials

required by his or her task or his or her employment of helpers;– Whether the service rendered requires a special skill;– The kind of occupation, with reference to whether, in the locality, the

work is usually done under the direction of the principal or by a specialized without supervision; (continued…)

201

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2015/2016 Update

• Tests used by the CA Labor Commission:– The alleged employee's opportunity for profit or loss depending on his or her managerial skill;

– The length of time for which the services are to be performed;

– The degree of permanence of the working relationship;

– The ∙method of payment, whether by time or by the job; and

– Whether or not the parties believe they are creating an employer‐ employee relationship may have some bearing on the question, but is not determinative since this is a question of law based on objective tests.

202

2015/2016 Update

• Uber’s arguments:– Do not exert control over driver – no minimum number of trips.

• If driver inactive for 180 days then apps expire.

– Driver must get a permit from CA Public Utilities Comm. to carry passengers for a fee.

– Driver must carry liability insurance of $1M. – Driver does get Iphone from Uber.– Uber does conduct background checks. – Uber does get SSN, CA Drivers License, proof of insurance.– Uber does maintain quality control standards and checks passenger

ratings of driver. – Driver provides their own vehicle. – Passengers pay Uber who pays drivers a set fee for each trip. – Drivers held to be employees!

203

2015/2016 Update

• Crowdfunding– Practice of funding a project by raising contributions thru various web sites

• Players are project initiator, moderator and “backers”. • Example: Joey wrote a book that he wants to turn into a movie. He uses crowdfunding to raise money – He will reward backers based on amount of contribution:

– Thank you note.– Thank you note and list contributor as supporter.– Give backer signed copy of book– Invite backer to private screening of movie.– Invite backer to private screening and dinner with cast. – All of the above and give backer role in movie. – All of the above and fly backer to LA for grand opening of film.

204

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2015/2016 Update

• Crowdfunding– Tax Consequences

• Nontaxable gift.– Not if a reward is given for contribution.

• Nonshareholder contribution to capital.– Applies to corporations (Sec. 118) so largely inapplicable to most crowdfunding scenarios.

– Requirements for Sec. 118 treatment:» Contribution becomes a permanent part of working capital.» Not be compensation» Provide a foreseeable benefit to the corporation in amount equal to its value

» Be used to generate additional income.

• Taxable Income.

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2015/2016 Update

• Crowdfunding

– Sales Tax.

• Washington (Dept. of Revenue, Dec. 17, 2014) advises that creator must collect sales tax on donations for which it provides a reward.

– Sales tax rate is rate in effect where backer receives reward.

– Income Tax

• Crowdfunding host is providing internet link for contributors to make contributions. If results in sales for creator which exceed statutory threshold, then creator might be doing business in state where host is located.

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2015/2016 Update

• Airbnb

– Hosts website which posts property available for short term rent. Subject to local occupancy (or hotel) tax?

• Does collect the 14% San Francisco hotel occupancy tax of 14%. City enacted ordinance which legalizes short‐term rentals in the city (which eliminated the ban on rentals of 30 days or less in multi unit buildings.) Now can rent unit for maximum of 90 days per year.

• Airbnb in dispute with several other cities.

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Update

• FUTA

– FUTA taxes on employer go up on January 1, 2016.

• Amount of increase is related to failure by state to repay federal loan to UI fund.

– State has outstanding loan balance on January 1 for two consecutive years and loan is not repaid by Nov. 10 of second year, the state FUTA credit is reduced until loan is repaid. Reduction is 0.3% until loan is repaid.

– This amounts to an increase of about $105 per employee for employers.

Corporate Income Tax

• Nevada– July 1, 2015 Nevada imposes a “commerce” tax based on gross revenue sourced to state.

• Applies to Nevada businesses with gross revenue that exceeds $4 million.

• Applies to 12 month period that runs from 7/01/2015 to 6/30/2016. (Taxpayers will have to consider how to conform their reporting to this time period.)

• Rates are from .051% to .331 % based on Nevada gross revenue minus $4 million.

– Retail 0.1111%– Food services and drinking places ‐ .194%– Professional services ‐ .181%


• Nevada– Applies to all business entities (exception for REITS) and individuals who file a federal Schedule C, E or F.

– Gross Revenue: No deduction for CGS or other expenses. Can exclude:

• Royalties from trademarks, tradenames, patents, copyrights.

• Amounts realized from certain federal nonrecognition transactions (1031, 331, 332 and so forth).

• Amounts not considered revenue under gaap.

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• Nevada

– Gross Revenue: Can deduct:

• Interest and dividends

• Allocated share of receipts from pass through entity (pass through entity pays the tax).


• Nevada– Sourcing:

• Rents/royalties from real property – where property is located.

• Sale of tangible property sourced to NV if property is delivered or shipped to buyer in Nevada.

• Revenue from sale of transportation services if both point of origin and destination is in the state;

• Revenue from services sourced where the purchaser receives benefit

• Catch all category – If cannot determine source from above rules, then NV receipts if business conducted in NV.


• Nevada

– Nevada imposes an excise tax on certain businesses equal to 1.17% of total wages paid by business each calendar quarter that exceed $85,000 (went up as of July 1, 2015 to 1.475% on wages that exceed $50,000)

• Allowed a credit against the business excise tax equal to 50% of commerce tax liability.

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Mobile Workforce

• The Problem:– Problem #1: Employee works in five states over

the course of year. Employer will have to withhold income tax for the five different states – but each state uses different withholding thresholds.

• Employee may have to file a tax return – but each state uses different filing thresholds. If employee pays income tax to the nonresident state, they should get a credit back against the tax imposed on the same income by their resident state.

– Problem #2: Employer allows employee to work from home in a different state. Employer might have nexus with that state.

Mobile Workforce

• Employer Withholding– Employee works in a state/ employer located in a different

state.• Is out-of-state employer doing business in the employee’s

state?• Probably if in-state employee activities further out-of-state

company’s business activities. – Employee will probably create nexus. – Might make employer subject to not only withholding requirements, but

also income tax reporting and sales tax collection. – Telebright Corp, Inc. v. Director, Division of Taxation (25 N. J. Tax 333).

» Delaware corporation subject to N. J. tax because employee telecommuted from her residence in N. J.

– N. C. provides by statute that compliance with withholding requirements by a nonresident employer does not constitute evidence that the person is doing business in N. C. Sec. 105-163.4.

Mobile Workforce

• Employer Withholding.– P.L. 86-272

• Protects an out-of-state corporation from a state’s income tax if the business’ only in-state activity consists of the solicitation of orders for sales of tangible personal property if orders are sent out of state for acceptance and filled by shipment from out of state.

• Only protects from income tax, not from state withholding requirements.

– Oklahoma may be an exception – withholding statute exempts activity defined under PL 86-272.

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Mobile Workforce

• Nonresident PIT Withholding– Many states do not have thresholds – or if they

do they are different from the NR filing requirements.

– Withholding threshold based on number of days:• Arizona – 60 days• Connecticut – 14 days• Hawaii – 60 days• Maine- 12 days (and earns more than $3,000 sourced

to Maine) • New Mexico – 15 days• North Dakota – 20 days• Utah – Employer doing business in Utah for over 60

days.

Audience Question

• Jamie frequently works part of a day in Connecticut where he lives and part of the day in New York. Both states will count part of a day as one day. Will Connecticut give a credit against the Connecticut tax for the tax paid for NY for a day where Jamie works in both states?– A. Yes, to prevent a double tax.– B. No, because both states count the day as

one day.

Mobile Workforce• Withholding threshold based on wages earned in

state. Examples:– Georgia – Earns more than $5,000 or 5% of total income

in GA, or works more than 23 days in calendar quarter. – Idaho – Compensation exceeds $1,000.– New Jersey – Compensation exceeds the personal

exemption.– New York – Compensation exceeds the personal

exemption. – Oklahoma – Wages exceed $300 in calendar quarter.– South Carolina – Earn more than $800. – Wisconsin – Wages exceed $1,500 in calendar quarter.

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Mobile Workforce

Sourcing Wages

◦ 36 states use physical presence.◦ 5 states use convenience of employer test.

Delaware, Nebraska, New Jersey, New York, Pennsylvania.

New York Rules: Nonresident employees are taxed in state where there employer is located and they work. If they work in a different state, then it must be for the convenience of the employer and not for their own convenience.

If assigned to a primary work location outside New York, and do not go into NY for more than 14 days, then not taxed by NY.

Mobile Workforce

• New York: Convenience of Employer– In 2006 issued TSB‐M‐06(5)I which explained and clarified “convenience of employer” test.

• For office to be considered bona fide home office (and employee not subject to NY income tax):

– Home office near employer specialized facilities (such as a test track and the employee tests employer’s cars); or

– Three of the following six factors:» Home office is condition of employment» Employer has business reason for requiring employee to have home

office» Employee performs core duties at home» Employee meets with clients, patients at home» Employer does not provide office space in NY» Employer reimburses expenses of home office (must pay at least

80%).

Mobile Workforce• Reciprocal Withholding Agreements.

– Generally restricts state tax to state where employee resides. • Jamie lives in Illinois but works in Iowa. They have a reciprocity agreement, so

Illinois taxes Jamie’s salary.

• Examples:– Illinois – Has agreements with Iowa, Kentucky, Michigan and

Wisconsin..– Indiana – Has agreements with Kentucky, Michigan, Ohio, Pennsylvania

and Wisconsin,– Iowa – Has agreements with Illinois.– Kentucky – Has agreements with Illinois, Indiana, Michigan, Ohio, West

Virginia and Wisconsin.– Maryland – District of Columbia, Pennsylvania, Virginia and West

Virginia.– Michigan – Illinois, Indiana, Kentucky, Minnesota, Ohio and Wisconsin.– See materials for balance of list of states with reciprocity agreements.

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Mobile Workforce

• Penalties– Employer can be liable for payment of employee’s

tax. Often imposed on “responsible person”(meaning corporate officer).

– Sarbanes-Oxley• Management required to certify that processes and

procedures are in place to comply with applicable law (including state withholding).

Mobile Workforce

• Mobile Workforce State Income Tax Simplification Act of 2015 (federal proposed legislation S. 386)– Establishes a 30-day threshold for employer

withholding and employee income tax return filing.– Employer can rely on employee records of time spent

in state.– Definition of “service within the state” is defined as

preponderance of employment duties performed in state.

• Tiebreaker rule: If performs service both in resident and nonresident state – then day goes to nonresident state.

– Legislation did not pass and is again on the agenda for Congress in 2015.

Mobile Workforce

• MTC Mobile Workforce Statute – 20-day threshold for employer withholding and

employee income tax filing. Exclusion from income sourced to state if all of the following requirements are met:

• Nonresident has no other income from sources within the state.

• Nonresident is present in the state to perform employment duties for not more than 20 days during the tax year.

– Presence for any part of a day counts as a day – unless purely for purposes of transit through the state.

• Nonresident’s state of residence provides substantially similar exclusion or does not impose an income tax.

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Mobile Workforce

• CA withholding requirements.– Withholding required by any employer who:

• Does business in state• Derives income from sources within CA• Subject in any manner to the laws of the state.

– The withholding requirement is broader than the nexus requirement – but in most cases if subject to withholding statute, will be doing business in the state.

– PL 86-272 provides no protection to wage withholding requirements.

Mobile Workforce

• Nonresident withholding requirements– Wages paid a nonresident are subject to CA

withholding if wages are earned in CA. CA uses a physical presence test to source wages.

– Generally computed using a working days formula.

Mobile Workforce

• Example: Joey works for Gems Galore, Inc. a California corporation. Joey works from his home in Nevada as a regional sales rep. He phones and faxes in his orders. He does not perform services in CA. – Gems Galore will not have to withhold CA

income tax on Joey’s wage. No physical presence in CA.

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Mobile Workforce• Example: Joey works as a food critic for

Revue, Inc. (a California based business). Joey covers NYC, Miami and Chicago, but does come to Los Angeles for about two months each year which is the main office of his employer. The wage earned in LA will be subject to PIT withholding. – Wage will also be subject to UI, ETT and SDI

because Joey’s base of operations is in CA and he does work in LA.

Mobile Workforce

• Sourcing wage for purposes of state payroll tax – In CA, state payroll taxes include unemployment (employer pays), state disability (employee pays) and Employer Training Tax (employer pays).

– Sourcing Rules (same as Unemployment Insurance Code)

• Employee services performed in state

• Services in and out of state, but out of state is incidental

• Some services in CA, but base of operations is in CA

• Some services in CA, but base of operations not in any location where services performed, but employee lives in CA.

Mobile Workforce

• Example:– Joey is a food critic who works for a company based in Los Angeles, but he lives in Nevada. His job requires him to travel and he works three/four months per year in New York, Chicago and Miami. He spends about one month a year in the LA office.

• Joey is subject to CA payroll taxes (unemployment (employer), SDI and ETT (employer). This is because he performs some service in CA and his base of operations is in CA.

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