CA Tax Regulation Updates | Garelick & Luengas Inc.

California

PERSONAL INCOME TAX—Mariposa County—disaster relief.

The Employment Development Department (EDD) has announced that employers in the county of Mariposa directly affected by the severe winter storms of December 2010 may request up to a 60-day extension of time from EDD to file their state payroll reports and/or deposit state payroll taxes, including personal income taxes withheld, without penalty or interest. Written request for extension must be received within 60 days from the original delinquent date of the payment or return to file/pay. Those with any questions should contact the EDD Taxpayer Assistance Center at (888) 745-3886. (EDD Tax Branch News #123, 01/26/2011.)

PERSONAL INCOME TAX—Health Care Act—state guidance.

The Franchise Tax Board (FTB) and the Employment Development Department (EDD) have announced that California has not conformed to the 2010 Federal Patient Protection and Affordable Care Act’s amendment of federal income tax laws excluding the value of an eligible adult child’s medical coverage from an employee’s California gross income. For California income tax purposes the following rules apply: (1) any amount paid on behalf of an employee for such added coverage is excluded from federal, but not from California taxable wages; (2) the additional income is reportable and taxable to the employee, not to the adult child; (3) the amount of income included in taxable ages is equal to the amount by which fair market value of the taxable benefit received by an employee exceeds the amount the employee pays for the benefit; and (4) amounts paid by self-employed individuals for health insurance for any child under age 27 who is not a dependent are not deductible for California purposes. The Health Care Act, signed by the President in March of 2010, requires employee benefit plans that provide coverage for family members to cover the employee’s adult children under the age 27 whether or not they qualify as dependents for tax purposes, effective for plan renewals beginning on or after September 23, 2010. (FTB Tax News Alert, 01/24/2011; EDD Announcement, 01/24/2011.)

PERSONAL INCOME TAX—Nonresident withholding publication.

The Franchise Tax Board has reissued its publication, Withholding on Nonresidents with California Source Income, that provides guidance to California nonresidents receiving payments for services and other non-wage income from sources in-state. Nonresident recipients of California nonwage income must file California nonresident returns to get credit for the 7% that their payers withheld from their payments. They must attach to their returns the withholding tax statement (Form 592-B) sent to them by payers as proof of the credit. (California FTB Informational Publication 1076, 01/01/2011.)

PERSONAL INCOME TAX—Carrybacks disallowed.

The taxpayers were denied a state refund for 2007 based on a carryback loss from the 2008 tax year. The taxpayers argued that they relied on Turbo Tax which told them they could elect to carry back three years the net IRC §1256 future contracts loss from 2008, and received a federal refund. The Franchise Tax Board (FTB) held that although federal law allows the carryback deduction and California generally conforms to federal law, California does not allow carrybacks under IRC §1256. The State Board of Equalization found that Cal. Rev. & Tax. Cd. §18155 disallows capital loss carry backs provided by IRC §1212. IRC §1256(a)(3) provides that any gain or loss with respect to a IRC §1256 contract shall be treated as either a short-term or long term capital gain or loss. A capital loss, for federal purposes, can be carried back under IRC §1212. Therefore, the SBE held IRC §1256 contracts losses cannot be carried back for California purposes. (Appeal of Yu, SBE, Case No. 522039 10/19/2010 (not to be cited as precedent).)

PERSONAL INCOME TAX—Cost basis of property.

The taxpayers were liable for tax, as well as a post-amnesty penalty, because they overreported their cost basis in properties sold by their partnership. The cost basis ultimately arrived at by the Franchise Tax Board (FTB) through its review of the taxpayers’ books and records substantially matched the depreciation schedule filed by the taxpayers and was found to be reasonable and rational. The taxpayers did not present any relevant evidence showing the FTB’s factual findings to be incorrect, and consequently, the FTB’s determination was affirmed. (Appeal of Levite, SBE, Case Nos. 449394; 492466; 449345, 10/19/2010 (not to be cited as precedent).)

PERSONAL INCOME TAX—Late payment penalty.

The late payment penalty was properly imposed on the taxpayer, a trust that generated a large long-term capital gain when it sold a portion of a partnership interest during the 2006 tax year. Due to a coding error, the taxpayer’s tax return preparer was not informed that the payment for the partnership interest was sale proceeds, and when the error was detected, the tax and interest was promptly paid. However, reasonable cause for abatement did not exist because, had ordinary business care and prudence been exercised, the coding error would not have been made, and the taxes would have been timely paid. Furthermore, the collection fee was properly imposed because it was a mandatory fee with no reasonable cause abatement provision. (Appeal of Donahue Marital Trust, SBE, Case No. 477472, 10/19/2010 (not to be cited as precedent).)

PERSONAL INCOME TAX—Accountant’s schedule insufficient proof of losses.

The State Board of Equalization found that taxpayers, husband and wife had failed to prove that they had unused passive activity losses from their 1989 and 1990 tax years that could be carried forward to absorb the capital gains they recognized during their 2001 tax year. The taxpayers had submitted into evidence a document drafted by their accountant which they alleged accurately depicted their passive losses for the tax years 1989 and 1990. The accountant’s schedule was conclusory, i.e., it merely listed passive activity losses that the taxpayers allegedly incurred in 1989 and 1990 without providing independent third-party evidence, such as the actual schedule K-1s or third-party tax returns from the various projects, to substantiate that the taxpayers had actually incurred the losses and the amounts thereof. The accountant also failed to provide an affidavit or declaration listing the assumptions he made when preparing the schedule and/or stating under penalty of perjury that the amounts set forth in the schedule were correct. (Appeal of Lenny, SBE, Case No. 506426, 11/17/2010 (not to be cited as precedent).

PERSONAL INCOME TAX—Bad debt loss deduction.

The State Board of Equalization (SBE) found that the taxpayers, husband and wife, had failed to show that they were entitled to a bad debt loss deduction for a $300,000 advance/loan to a company that was not repaid. The taxpayers claim that the company’s president was not going to repay the advance and asked the taxpayers to write off the balance. However, the SBE denied the bad debt deduction because there was no identifiable event to establish the worthlessness of the advance; the company president’s declaration was insufficient to establish worthlessness. The test for worthlessness is to demonstrate that the advance, as a matter of commercial fact, became worthless as of the close of 2001. No evidence was provided by the taxpayers to demonstrate that the company ceased operations during or after 2001 or that the company filed for bankruptcy on or after the 2001 tax year. (Appeal of Kazmi, SBE, Case No. 483699, 11/17/2010 (not to be cited as precedent).)

PERSONAL INCOME TAX—Distribution from tribal gaming activities.

A member of an Indian tribe who lived outside the Indian reservation was subject to tax on his per capita distribution from gaming activities conducted on the Tribe’s reservation. The reservation-derived income of a member of a federally recognized Indian tribe is exempt from state taxation only when the individual lives on the tribe’s reservation. When a tribal member lives in California but not on the reservation, the individual is a California resident who is taxable on his or her entire income, regardless of source. The tribe is similar to a corporation, so the per capital distributions from the tribe constituted income from an intangible sourced to the residence of the tribal member, which in this case was California. (Appeal of Jonathan B. Ryder, SBE, Case No. 486581, 10/19/2010 (not to be cited as precedent).)

PERSONAL INCOME TAX—Per capita income from Indian tribe.

The appellant’s wife, who was a member of an Indian tribe, was subject to tax on her per capita income received from the tribe, because she lived outside her tribe’s reservation. The evidence showed that the appellant and his wife owned a home in San Jacinto and used that address when dealing with mortgage lenders, banking institutions, government agencies, educational entities, and when claiming a homeowner’s exemption in California. Their home on the reservation did not have a physical mailing address, so they used a P.O. Box address as their reservation mailing address. The evidence indicated that they only use the reservation mailing address when dealing with the Indian tribe. The evidence supports the State Board of Equalization’s finding that the appellant and his wife treated their home in San Jacinto as their primary address and that the appellant’s wife lived off the reservation. Thus, the wife was a California resident subject to tax on her entire income. (Appeal of Timothy J. Ryan, SBE, Case No. 440948, 10/19/2010 (not to be cited as precedent).)

PERSONAL INCOME TAX—Refund based on investment fraud.

A taxpayer who filed claims for refund of taxes paid on sums previously reported as interest income was not entitled to refund because he failed to show that the income was improperly categorized as interest income rather than a return of principal, or to demonstrate that the amounts claimed were theft losses resulting from a fraudulent investment scheme. The taxpayer gave money to an individual who agreed to invest the money in loans to third parties secured by deeds of trust on real property and received periodic payments until discovering in 2008 that the individual had embezzled the invested funds. The taxpayer then filed amended returns excluding amounts previously reported as interest income from the investments and claiming refund of taxes paid on those amounts. The taxpayer presented no written documentation of the investments made, and no legal authority to support his argument that the interest payments received were a nontaxable return of principal. There was also no claim for refund based on theft loss because such a deduction can only be sustained where it is reasonably certain that reimbursement will not be received. The taxpayer still had a lawsuit pending against the individual who invested the money, which infers a claim for reimbursement that provides a reasonable prospect of recovery. A default judgment against the individual’s alter egos was not sufficient to show that there was no reasonable prospect of recovery where the suit against the individual was still pending. (Appeal of Lorti, SBE, Case No. 521843, 11/17/2010 (not to be cited as precedent).)

PERSONAL INCOME TAX—Claim for research and development credits denied.

The State Board of Equalization (SBE) upheld the denial of the taxpayers’ claim for research and development credits since they failed to satisfy the four part test for eligibility under IRC §41. Although the taxpayers produced a study to substantiate their claim that their winery committed significant time and resources in designing new wine products and manufacturing processes and improvements to existing wine products and manufacturing processes, the SBE determined that the taxpayers failed to set forth the steps involving the methods of scientific experimentation used to develop the bottle closure and therefore, the taxpayers did not met their burden of proving the bottle closure project constituted “qualified research” under IRC §41. While the taxpayers also submitted additional documentation detailing steps used in the winemaking process, the SBE found that these records did not establish that the winery engaged in a process of experimentation rather than the standard practices and methods in the production of wine. Specifically, the records failed to describe a process by which the taxpayers identified uncertainty concerning the development or improvement of wine, identified one of more alternatives intended to eliminate that uncertainty and identified and conducted a process of evaluating the alternatives. Moreover, the reports provided the results of analysis of the wine samples submitted by the winery but those analyses by themselves did not demonstrate that the winemaking process met the experimentation requirement necessary to constitute “qualified research.” (Appeal of Leonardini, SBE, Case No. 449478, 11/17/2010 (not to be cited as precedent).)

PERSONAL INCOME TAX—New Home Credit—update.

The Franchise Tax Board (FTB) has issued an update on estimated application and reservation requests received for the New Home Credit. As of January 18, 2011, the FTB has received 17,350 (up from 17,160 as of January 11) reservation requests and 25,810 (up from 25,570) applications. The FTB will stop accepting applications when it has received sufficient applications to allocate the full $100 million. It will take the FTB several months to process all the applications. The FTB is asking claimants to be patient and not to send their application a second time as it will slow down processing. Most applications are processed within three to six months after receipt. However, if claimants send more than one fax, it may take longer.

SALES AND USE TAX—New regulation—audit procedures.

The State Board of Equalization (SBE) has provided guidance on new Regulation 1698.5 (Cal Code Regs. §1698.5, Tit. 18), Audit Procedures, that formalizes audit expectations and documents the sales and use tax audit process for taxpayers and SBE staff. The new regulation explains the purpose of an audit, the expected timeframe for completing an audit, and the duties and responsibilities of the SBE staff as well as taxpayers during an audit. (California SBE Special Tax Notice L-270, 01/01/2011.)

PROPERTY—Property tax information directory.

The State Board of Equalization (SBE) has sent to county assessors a directory of SBE staff that should be of assistance to those in the property tax arena. (California State Board of Equalization Letter to Assessors 2011/008, 01/27/2011.)

PROPERTY—Listings of letters to assessors.

The State Board of Equalization (SBE) has issued two listings of Letters To Assessors, to help county assessors locate information sent out by the SBE. The first list, containing letters issued during 2010, is arranged numerically and indicates the date and subject of the letter. The second list is an accumulative index of letters sent from 1978 through 2010; it is arranged by topic and indicates the letter number. (California State Board of Equalization Letter to Assessors 2011/001, 01/21/2011.)

PROPERTY—SBE Property Taxes Staff move.

The State Board of Equalization’s Property Taxes Staff have moved from the headquarters building to 160 Promenade Circle in the Natomas area of Sacramento County—approximately six miles North of downtown Sacramento, near the interchange of Interstate 80 and Interstate 5. The Staff’s mailing address remains the same. However, their telephones numbers have changed: County-Assessed Properties Division (916) 274–3350; State-Assessed Properties Division (916) 274–3270; Tax Area Services Division, (916) 274–3250; Timber Tax Section, (916) 274–3230. (California State Board of Equalization Letter to Assessors 2011/006, 01/21/2011.)

GENERAL ADMINISTRATIVE PROVISIONS—New SBE Chairman.

The State Board of Equalization (SBE) members have unanimously voted to name Jerome E. Horton as the new SBE Chairman and Michelle Steel as Vice Chair. (California SBE News Release 13-11-G, 01/26/2011.)

CIGARETTE, ALCOHOL & MISCELLANEOUS TAXES—Cigarette distributors—guidance issued.

The State Board of Equalization has issued a pamphlet for California cigarette distributors on how to purchase California cigarette tax stamps. It also includes some general information on cigarette and tobacco product taxes and how to become a licensed cigarette distributor. (California SBE Information Publication 63, 01/01/2011.)

CORPORATE INCOME TAX—Mariposa County—disaster relief.

CORPORATE INCOME TAX—Health Care Act—state guidance.

CORPORATE INCOME TAX—Nonresident withholding publication.

CORPORATE INCOME TAX—Business income; unconstitutional statute.

The State Board of Equalization (SBE) denied a New York corporation’s claim that, for 1999-2001 tax years, dividends that it received from California Steel Industries, Inc. (CSI) a 50%-owned subsidiary that produced flat rolled steel from steel slab in a plant located in-state, was nonbusiness income because the dividends were business income apportionable to California under Cal. Rev. & Tax. Cd. §25120. The taxpayer was also denied the R&TC section 24402 dividends received deduction because the statute is unconstitutional. Taxpayer was engaged in business of distributing wood pulp and iron ore primarily in the United States and was considered to be engaged in business in California based upon its ownership interest in a California limited partnership that operated a dock and off-loading facility for iron ore in-state. Through its holding of CSI stock, the taxpayer helped maintain a market for the iron ore produced by its parent company in Brazil (Companhia Vale do Rio Doce (CVRD)), as CSI was a purchaser of steel slab from companies that purchased iron ore from CVRD. Because the taxpayer, through CSI, was CVRD’s entry into the U.S. steel market and, as such, operated as a vital part of CVRD’s worldwide business enterprise, the CSI stockholding materially contributed to the taxpayer’s and CVRD’s production of business income—so that the dividends met the parameters of the functional test of Cal. Rev. & Tax. Cd. §25120 and, as a result, was characterized as business income. As to the availability of the R&TC section 24402 dividends received deduction, the taxpayer asserted substantially all of the arguments which were rejected by the Court of Appeal in the Abbott Laboratories case. The Court of Appeal in the River Garden case has likewise determined that R&TC section 24402 is unconstitutional. As the SBE is bound by Court of Appeal decisions, it held that there was no legal basis for granting the relief sought by taxpayer, such that taxpayer was not entitled to claim a dividends received deduction for the dividends received from CSI. (Appeal of Rio Doce Ltd., SBE, Case No. 402204, 11/17/2010 (not to be cited as precedent).)

CORPORATE INCOME TAX—Accounting method—conversion.

A corporate taxpayer failed to meet its burden of showing error in the Franchise Tax Board’s (FTB’s) gross receipts upward adjustment of $213,882 for its 2005 return. The taxpayer had always used the cash method of accounting and on its 2005 corporate tax return, it reported net income of $313,297 and gross receipts of $28,116,498. Because of its high sales, however, the taxpayer was forced to convert to the accrual method of accounting. On appeal, the taxpayer did not dispute that, during the audit, it created a trial balance (cash basis) which listed 2005 sales of $28,330,380, and it also failed to show that its self-reported sales amount of $28,330,380 was incorrect. The State Board of Equalization held that the FTB was correct in its contention that the adjustment amount was the difference between the gross receipts reported on the taxpayer’s 2005 return and the “sales” of $28,330,380 listed on the taxpayer’s trial balance (cash basis). The taxpayer’s contention that the gross sales adjustment constituted a double counting of gross receipts during the accounting method conversion was no more than an incomplete and unsupported statement. (Appeal of B&B Plastics Recyclers, Inc., SBE, Case No. 519228, 11/17/2010 (not to be cited as precedent).)

PERSONAL INCOME TAX—Mariposa County—disaster relief.