TWIST–QA Quarterly Roundup of This Week in State Tax
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House Bill 62, signed into law on June 9, 2008, amends Alabama’s expense disallowance statute to codify (1) the regulatory limitations on the "subject to tax" exception and (2) the conduit exception contained in the regulations. The provisions in House Bill 62 are effective for all tax years beginning on or after December 31, 2006. The revised statute clarifies that the "subject to tax" exception does not apply to any portion of income that is not attributed to a taxing jurisdiction, as determined by the jurisdiction’s allocation and apportionment provisions. The conduit exception provides that addback is not required for "that portion of interest expenses and costs and intangible expenses and costs that the corporation can establish was paid, accrued or incurred, directly or indirectly, by the related member during the same taxable year to a person that is not a related member." The bill also adopts a definition of "captive REIT" and requires a captive REIT to add back any dividend paid to a related member that the REIT deducted for federal purposes. A corporation is allowed a deduction for dividends received from a captive REIT to the same extent the dividends would have been deductible under I.R.C. § 243 if they were received from a non-REIT.
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The Arizona Department of Revenue upheld an assessment of corporate income tax against an out-of-state franchisor that granted in-state franchisees the right to use certain service marks in exchange for a percentage of the franchisees’ sales. Corporate Tax Decision No. 200700083-C (Mar. 27, 2008). Citing the South Carolina Supreme Court’s Geoffrey decision, the Hearing Officer determined that the physical presence requirement in Quill applied only to sales and use tax. The Hearing Officer further observed that when the tax at issue is a corporate income tax, the relevance of physical presence and activities is less significant than the taxpayer’s receipt of income from the use of its property in the state. Interestingly, the Hearing Officer did not address the fact that it was stipulated that the taxpayer had an employee physically present in Arizona at least four times per year.
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House Bill 08-1380, signed May 20, 2008, adopts mandatory single–sales factor apportionment—combined with a throwback rule—for tax years commencing on or after January 1, 2009. Also effective for tax years beginning on or after January 1, 2009, the bill adopts special apportionment provisions for "mutual fund service corporations," provides that taxpayers can make an election to treat all income as business income, and provides that under the new single-sales factor apportionment regime, taxpayers can carryforward net operating losses (NOLs) to any tax years. Under current law, a corporation is not allowed to carry forward an NOL to any income tax year if the corporation used a different method of allocation and apportionment in that tax year than it used in the tax year when the NOL was generated.
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Senate Substitute for House Bill 2434, signed into law on May 22, 2008, amends the statutory definition of "business income" for tax years beginning after December 31, 2007, to clarify that the definition contains both a "transactional" and "functional" test and includes any income that may be apportioned to the state under the provisions of the U.S. Constitution. The bill also amends the definition of "sales factor" to provide that for taxable years commencing after December 31, 2007, only net gains from sales of business assets, other than sales of tangible personal property sold in the ordinary course of the taxpayer’s trade or business, are included in the sales factor. Additionally, for tax year 2008, the state's top corporate income tax rate, which applies to taxable incomes above $50,000, is reduced from 7.35 percent to 7.10 percent. The top corporate income tax rate is further reduced to 7.05 percent for tax years 2009 and 2010, and reduced again to 7.00 percent for tax year 2011 and all following tax years.
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House Bill 258, signed April 9, 2008, amends Kentucky’s apportionment rules. Effective for taxable periods beginning after December 31, 2007, the Kentucky sales factor must include the overall net gain from each treasury function transaction in the tax period.
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The Maryland Tax Court has held that an intangible holding company subsidiary lacked economic substance and was therefore subject to Maryland corporate income tax because its parent’s Maryland activities were attributed to the subsidiary. The Classic Chicago, Inc. / The Talbots, Inc. v. Comptroller of the Treasury (Apr. 11, 2008). The Department did not have to demonstrate that the parent-subsidiary scheme was a sham transaction, only that the subsidiary lacked economic substance. Furthermore, the parent’s deductions for royalty payments made to the subsidiary in exchange for the use of trademarks, tradenames, and related intangible property were denied.
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The Massachusetts Department of Revenue has announced a more stringent look-back policy for nonfiling intangible holding companies and financial institutions. Technical Information Release 08-4 (Mar. 24, 2008). Previously, the Department announced a general seven-year look-back period in which it would assess tax against nonfilers, including a discretionary three-year look-back period and penalty waiver for taxpayers that voluntarily disclosed their failure to file and did not conduct extensive activity in Massachusetts. Recently issued TIR 08-4 notes that the Department will apply a five-year look-back period for certain intangible holding company and financial institution taxpayers if the taxpayer comes forward by September 30, 2008, and meets certain requirements—otherwise, the Department will not be bound by the general seven-year look-back.
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House File 3149, signed into law May 29, 2008, amends the definition of foreign operating corporation (FOC) and adopts new addback provisions for corporations that have unitary group members that are FOCs. Under Minnesota law, an FOC that is a member of a Minnesota unitary group is excluded from the unitary report. Effective for tax years beginning on or after December 31, 2007, to qualify as an FOC a domestic corporation must have, among other things, either (i) a valid I.R.C. § 936 election or (ii) at least 80 percent of a corporation’s gross income from all sources in the tax year must be active foreign business income. "Active foreign business income" means gross income that is both derived from sources without the United States and is attributable to the active conduct of a trade or business in a foreign country. In addition, the bill adopts addback provisions for the following: (1) certain interest and intangible expenses paid by a member of the unitary group to or for the benefit of an FOC that is a member of the unitary group; (2) certain interest income and income derived from intangibles that is received or accrued by an FOC member of the taxpayer’s unitary group; (3) dividends attributable to the income of an FOC member of the taxpayer’s unitary group in an amount equal to the dividends-paid deduction of a REIT for amounts paid or accrued by the REIT to the FOC; and (4) income of an FOC member of the taxpayer’s unitary group from gains derived from the sale of real or personal property located in the United States. Effective for tax years beginning after December 31, 2007, H.F. 3149 also clarifies that a corporation’s subtraction from federal taxable income for 80 percent of royalties or other like income accrued or received from an FOC is not applicable if the income resulting from such payments or accruals is income from sources within the United States under the Internal Revenue Code.
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The New Jersey Tax Court has held that New Jersey’s so-called "Throwout Rule" is facially constitutional. Pfizer, Inc. v. Dir., Div. of Taxation (May 29, 2008). The Throwout Rule provides that receipts attributable to a state or foreign country where the taxpayer is not subject to a tax measured by profits, income, business presence or business activity are excluded from the sales factor. The Tax Court held that because the Rule operated constitutionally under certain circumstances, it is not facially unconstitutional. The opinion leaves open the possibility that a taxpayer can demonstrate that the Throwout Rule is unconstitutional as applied to the specific taxpayer.
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Senate 6807, signed April 23, 2008, makes numerous changes to New York State's general corporation, bank, and insurance franchise tax laws. Effective for tax years beginning on or after January 1, 2008, S. 6807 (1) adopts economic nexus standards for certain credit card banks, (2) enacts "loophole closing" provisions related to captive REITs and RICs, (3) decouples from the I.R.C. § 199 domestic production activities deduction, (4) revises the LLP and LLC filing requirements, and (5) increases the capital base tax cap. Additionally, for sales and use tax purposes, S. 6807 institutes a vendor re-registration program effective November 1, 2008, and, effective as of the date the bill was signed, redefines the term "vendor" for sales tax collection purposes.
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Effective January 1, 2008, Senate Bill 2034, signed into law June 3, 2008, adopts addback provisions for rental expenses and interest paid to captive REITs, as defined in the statute. The bill does not adopt any exceptions to the addback requirements. In addition to the captive REIT addback provisions, Senate Bill 2034 also authorizes the Oklahoma Tax Commission to establish a Voluntary Compliance Initiative (VCI) beginning on September 15, 2008, and ending on November 14, 2008.
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Legislation (S.B. 4173) signed into law in Tennessee on June 5, 2008, adopts certain disclosure provisions for financial institutions that receive dividends directly or indirectly from captive REITs. "Captive REITs" are defined as entities with elections in place under I.R.C. § 856(c)(1) in which the taxpayer, directly or indirectly, has at least a 90 percent ownership interest by value determined by GAAP, and the shares of which are not traded on a national stock exchange. Effective for all tax periods after July 1, 2008, financial institutions that receive dividends, directly or indirectly, from one or more captive REITs must disclose the dividends on a form prescribed by the Commissioner. If the disclosure is not made, the dividends-received deduction shall be disallowed and the financial institution’s net earnings will be adjusted accordingly. In addition, the taxpayer will be subject to a 50 percent penalty on the amount of any underpayment arising from the adjustment.
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Senate Bill 136, signed March 14, 2008, eliminated Utah’s cost of performance rule for sourcing receipts of other than tangible personal property for tax years beginning on or after January 1, 2009. Generally, under the revised sourcing rules, receipts from services will be sourced to Utah if the purchaser of a service receives a greater benefit of the service in Utah than in any other state and receipts from intangible property will be sourced to Utah if the intangible property is used in the state. Additionally, effective for tax years beginning on or after January 1, 2008, Senate Bill 136 provides guidance on how net operating losses deducted by an acquired corporation should be calculated.
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Senate Bill 680, signed March 31, 2008, and applicable for all tax years beginning on or after January 1, 2009, (1) provides for a 0.25 percent corporate net income tax rate reduction, with further rate reductions in tax years after 2009 contingent on the balance in certain reserve funds, (2) changes the default methodology for determining business income or loss of a combined group from worldwide combined reporting to water’s edge, (3) provides that unused net operating losses earned during a tax year when the taxpayer filed a consolidated return may be applied against the taxable income of any member of the taxpayer’s controlled group, (4) provides an incremental rate reduction and phase out of the business franchise tax, and (5) provides certain credits for financial organizations. In addition, House Bill 4420, signed March 28, 2008, disallows the dividends-paid deduction for certain REITs and RICs effective January 1, 2009.
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Effective for tax years beginning on January 1, 2008, the Wisconsin Budget Bill, signed into law May 28, 2008, requires certain corporations, as well as individual taxpayers, to add to gross income the amount deducted or excluded under the Internal Revenue Code for interest expenses and rental expenses that are "directly or indirectly paid, accrued, or incurred to, or in connection directly or indirectly with one or more direct or indirect transactions with, one or more related entities." Included in the definition of "related entities" are captive REITs, as defined in the statute. The bill also adopts certain exceptions to the addback requirements, including a subject to tax exception, a conduit exception, and an exception for when there is a non-tax business purpose for the transaction giving rise to the payments. In addition, it is important to note that the statute specifies that under no circumstances will any interest or rental expense deductions be allowed if the aggregate amount paid, accrued or incurred to the related entities is not disclosed on a form prescribed by the Department.
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The United States Supreme Court issued a sharply divided opinion holding that a Kentucky tax exemption for interest income derived from bonds issued by Kentucky and its political subdivisions was constitutional, despite the fact that the state taxed interest from bonds issued by other states and their political subdivisions. Dep't of Revenue of Ky. v. Davis (May 19, 2008). Citing United Haulers, the Court declined to apply the standard Commerce Clause scrutiny because the statute at issue favored a governmental entity performing a traditional government function and treated all private entities—both in-state and out-of-state—essentially the same. Accordingly, the exemption did not violate the dormant Commerce Clause.
On April 15, 2008, the U.S. Supreme Court issued an opinion in MeadWestvaco Corp. v. Ill. Dep't of Revenue. The issue in MeadWestvaco was whether it was proper for Illinois to include gain from the sale of MeadWestvaco’s (Mead’s) division, Lexis, in Mead’s apportionable tax base or whether the gain was allocable outside Illinois. The court stated that the use of the operational function test—after determining that Mead and Lexis were not engaged in a unitary business—was improper. The court remanded the case for further proceedings.
Historically, states have maintained the position that if a pass-through entity has business activity within the state, the pass-through entity’s nonresident owners—by virtue of their ownership interest in the pass-through entity—have nexus with the state. Over time, the evolution in the legal relationship between many pass-through entities and their owners potentially has eroded this position.1 In the past few years, several nonresident owners of pass-through entities have been successful in arguing that the state in which the pass-through entity was doing business did not have jurisdiction over the nonresident owner.2 In such an instance, the state has a potentially challenging task in collecting from nonresidents any income tax related to income from sources within the state. The primary way that states have sought to address this situation is by requiring the pass-through entity to withhold tax on source income distributable to nonresidents.3 This article briefly examines a few important issues in pass-through entity nonresident withholding.
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One of the initial issues that a pass-through entity must address is: "Which nonresident owners potentially are subject to withholding?" This analysis is comprised of two sub-issues. First, one must determine whether the state in question requires the pass-through entity to withhold. Generally, partnerships, limited liability companies (LLCs) treated as partnerships, and S corporations must withhold on behalf of nonresident owners.4 Significant variation exists among the states. For example, certain states, such as Delaware, Hawaii and Utah, only require S corporations to withhold on behalf of their nonresident shareholders, but do not require partnerships or LLCs treated as partnerships to withhold on behalf of their nonresident owners.5 Additionally, certain states may not require a pass-through entity to withhold on behalf of a nonresident owner because (1) the state does not impose a broad-based income tax,6 (2) the state imposes an entity-level tax on some or all pass-through entities,7 (3) the state has opted against nonresident withholding legislation for policy reasons, or (4) the enacted legislation simply does not address the issue.8
Second, in a state that requires nonresident withholding by the entity in question, one must determine the types of nonresident owners for which withholding is required. Generally, states require withholding, at a minimum, for nonresident individual owners.9 Greater variation exists as to whether such a state will require withholding for a nonresident owner that is a corporation, estate or trust, or another pass-through entity.10 When a nonresident owner is, itself, another pass-through entity, difficult questions often arise regarding withholding responsibilities. This situation is discussed in further detail below.
Many states do not require a pass-through entity to withhold on behalf of a nonresident owner if the owner provides the pass-through entity with a completed nonresident owner agreement.11 A nonresident owner agreement typically provides that the nonresident owner agrees to submit to the state’s personal jurisdiction for purposes of the collection of income tax, including interest and penalties, and to timely file and pay any tax due on the nonresident owner’s distributive share of income sourced to the state. By filing a nonresident owner agreement, a nonresident owner essentially agrees to file an income tax return with the state and pay income tax in exchange for the state waiving the pass-through entity’s withholding requirement. Completing a nonresident owner agreement may be attractive to nonresidents that otherwise may be required to file an income tax return with the state (e.g., the nonresident may have income from other sources within the state). Generally, a separate agreement is required for each nonresident owner and typically is completed only once and remains in effect until revoked.12 However, the method of submission (i.e., provided only to the pass-through entity for retention versus submitted to the state with the pass-through entity’s income tax return) varies among the states.13
Under the Internal Revenue Code, certain tax-exempt organizations are taxable on their "unrelated business taxable income" (i.e., income derived from a trade or business unrelated to the organization’s tax-exempt purpose).14 Many states similarly impose income tax on the unrelated business taxable income of tax-exempt entities.15 Several common issues arise in the context of withholding for nonresident owners that are tax-exempt entities.
Even if a state generally imposes income tax on a tax-exempt entity’s unrelated business taxable income, nonresident withholding by a pass-through entity still may not be required. This may occur for several reasons. First, a tax-exempt organization may not be subject to withholding by virtue of it being an entity type, such as a corporation or a pass-through entity, for which the state specifically does not require withholding.
Second, a state requiring nonresident withholding by entity types such as that of the tax-exempt entity in question may provide a general exemption from withholding for some or all tax-exempt entities.16 For a pass-through entity creating unrelated business taxable income for a nonresident owner that is a tax–exempt entity, this situation can result in potential confusion in states that explicitly impose income tax on the tax exempt entity’s unrelated business taxable income. Did the state really intend for an exemption from withholding for tax-exempt entities with unrelated business taxable income from sources within the state? Or, should the pass-through entity withhold tax on the unrelated business taxable income from sources within the state? Some states, such as Georgia,17 specifically address this situation, but many others do not.
Another important issue for pass-through entities involves applying the proper withholding methodology in a "tiered" pass-through entity context. That is, when a state facially requires a pass-through entity (the "lower-tier pass-through entity") to withhold when it has an owner that is a nonresident pass-through entity (the "upper-tier pass-through entity"), how should the withholding be administered? Because the upper-tier pass-through entity generally is not a taxpayer per se, the potentially more logical location for the withholding to be administered is at the tier where the pass-through entity has nonresident owners that are taxpayers (i.e., corporations, individuals, etc.). However, the treatment of tiered pass-through entities varies from state to state.
The predominant treatment is that the lower-tier pass-through entity still has the withholding responsibility.18 However, if the upper-tier pass-through entity has resident owners, withholding based only on the upper-tier pass-through entity’s nonresident status may lead to the ultimate nonresident taxpayer being over-withheld.19 As a result, certain states allow a lower-tier pass-through entity to "look-through" to an upper-tier pass-through entity’s nonresident owners in determining the proper withholding for the lower-tier pass-through entity.20
Many states require withholding at both tiers, although several states specifically provide that withholding only is required by the pass-through entity doing business in the state.21 In the latter instance, the upper-tier pass-through entity (assuming it is the entity lacking business activity in the state) may not be required to withhold, but still may be required to report the withheld tax to its owners.22 When withholding is required at both tiers, a state generally will provide the upper-tier pass-through entity with credit for any amounts withheld by the lower-tier pass-through entity.23 Only a minority of states that facially require withholding for a non-resident owner that is another pass-through entity provide that only the upper-tier pass-through entity is required to withhold. Often this guidance is provided administratively.24
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As the above topics illustrate, there is a great deal of variation among the states with regards to pass-through entity nonresident withholding. The topics addressed above represent only a few of the important withholding issues encountered by pass-through entities. Thus, it is vital to understand each state’s rules and the nuances that exist among them.
This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.
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In the communications industry, "bundling" generally refers to the concept of combining separate products or services into a single package or "bundle" that is sold for a flat price or as a basket of services. Bundling is designed to make the seller a "one-stop shop" for communications services and is intended to help keep customers from switching service providers. You may have heard of the "double-play," the "triple-play," and now the "quadruple-play." Telephone or cable companies are now selling a bundle of services that can include cable television service, Internet access service, local and toll telephone services, wireless voice and data services—all for one price or potentially at a discount for each service, if purchased together. These "plays" can create issues from a transaction tax perspective as to how these bundled transactions should be taxed. Although bundled transaction issues are not new, with the rise in popularity of these bundled services and the lack of legislative guidance, telecommunications companies should be proactive in developing a supportable basis for the tax treatment of their bundled transactions. This can better position these companies to address possible challenges from taxing authorities.
The recent rise in the popularity of bundles is due largely to the concept of convergence, which in the communications industry simply means that formerly discrete businesses are now coming together and are seeking to, and are technically capable of, selling the various communications services that are available to the public. However, bundling can also happen unintentionally, such as when a company provides services that cross jurisdictional boundaries (e.g., allowing a customer to make local, intrastate, and interstate calls as part of a single package).
Bundling creates various state and local transaction tax issues, including (1) what tax rate applies to the bundle when some of the underlying elements are taxed at different rates or are not taxed at all, (2) what situsing rule applies when different rules apply to the separate items, and (3) perhaps most importantly, how can the separate items of the bundle be "unbundled" or disaggregated, and thus valued for tax purposes.
The tax issues created by bundles are largely governed by federal and state tax and regulatory statutes. For example, at the federal level, the Internet Tax Freedom Act as amended (ITFA)1 and the Mobile Telecommunications Sourcing Act (MTSA)2 both provide guidance for the taxation of bundles. Specifically, the Acts both provide that where separate elements of a bundle are taxed differently, the entire sales price can be taxed at the highest applicable rate unless the service provider can reasonably identify the portion of the sales price attributable to products and services taxed at lower rates or not taxed at all based on its books and records kept in the regular course of business.3 At the state level, the tax treatment of bundles also varies. Some state legislation:
Despite existing legislative guidance, significant questions remain about how companies can provide a rational basis for unbundling their services for transaction tax purposes. For example, what may constitute a reasonable standard for doing so in a company’s books and records is unclear. Should this determination be based on cost allocation, the cost of performance, or simply a voluntary segregation of the price by the service provider? Will the publication by communications providers of price allocations amongst the various services be respected as a valid standard by taxing jurisdictions? Federal preemption and regulatory issues also remain. For instance, if the Federal Communications Commission determines that a bundled service, such as voice over Internet protocol, is entirely interstate in nature, are states preempted from regulating it at all and/or taxing it under their applicable taxing statutes?
Without further guidance by the various taxing jurisdictions, communications providers may need to address these issues on their own. Current practices may include using fixed prices for separate items, using traffic studies to determine calling patterns for services, modifying billing systems to address the issue, as well as other practices. In addition, some may be simply applying a uniform discount rate to the regularly stated separate charges for the service to reach the bundled price. Based on our experience, taxing jurisdictions are challenging many of these methods.
The question of situsing for tax purposes can also be complicated by bundling. Local and wireless communications services may be taxed at the primary customer service location, toll services may be taxed based on a "Goldberg" concept8 or at the origination point of a telephone call, and private line services may be taxed at multiple locations. Including these different services in a bundle of services may cause some of the services to be taxed in unintended tax jurisdictions.
The various tax issues involved in bundling will not go away anytime soon. Indeed, more and more companies are providing bundled services, so tax departments will need to work with their marketing, legal, and accounting departments (and professional services firms) to address these issues going forward.
This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.
 Selvi Stanislaus |
 Ben Miller |
In a recent conversation with KPMG, Selvi Stanislaus, executive officer of the California Franchise Tax Board (FTB), and Ben Miller, of the FTB’s Multistate Tax Bureau, discussed the FTB’s response to the Multistate Tax Commission’s (MTC’s) recent uniformity projects, its position on UDITPA (Uniform Division of Income for Tax Purposes Act) revision efforts, and California’s new filing compliance program for out-of-state businesses.
The FTB is currently considering conforming to the MTC’s recently amended model apportionment regulation. This revised regulation considers services performed by independent contractors or others on behalf of a taxpayer in determining income producing activities for the purposes of sourcing sales of other than tangible personal property. When asked whether the FTB intends to adopt any other of the MTC’s recent uniformity projects—specifically, whether California plans to conform to the model combined reporting statute that requires the inclusion of tax haven entities in the water’s-edge group—Miller noted that "in general, the FTB has conformed to 90 percent of MTC rules" already. Because California has had combined reporting for decades and the California treatment is largely based on administrative and judicial authorities rather than specific statutes, the state does not need to conform to the MTC’s model combined reporting statute, according to Stanislaus and Miller.
Regarding the MTC’s tax haven rule, California has no plans to make separate provisions in its existing worldwide combined reporting system for entities operating in tax haven jurisdictions, according to Stanislaus and Miller. The state’s water’s-edge elective filing method requires the partial inclusion of subpart F entities in the water’s-edge group, so there is no need to address tax haven entities separately, they said. However, an effort is under way at the FTB to simplify the inclusion of subpart F entities.
California also has no plans to adopt the MTC’s 51-state spreadsheet, Miller said. According to Miller, California had a similar reporting requirement in the late 1980s, when it adopted worldwide combined reporting, but the rule was repealed over concern about compliance costs.
When asked whether the FTB is influenced by policies its sister states have adopted, Stanislaus responded that other states have a "huge" influence on its policymaking. She noted that the FTB’s legislative analyses of proposed California tax law changes often include a discussion of relevant laws in other states and that the FTB considered other states’ regulatory approaches when adopting mutual fund service provider regs in 2005.
The National Conference of Commissioners on Uniform State Laws (NCCUSL) has convened a drafting committee to revise UDITPA, generating concern from the business community. At the NCCUSL’s first drafting committee meeting in Chicago in May, Miller spoke on behalf of the FTB in favor of continuing with the revision process.
"It is entirely appropriate for UDITPA to be revisited" 50 years after its enactment, and, as the body that originally drafted the act, "NCCUSL is the proper, appropriate body" to review it, Miller told KPMG. Miller added that he couldn’t see "why the corporate community wouldn’t want to be involved in creating the best, most efficient system" possible.
However, the process of revising UDITPA will be a slow one, Miller warned, and also stated that it is unlikely that every state will adopt the revised uniform law in its entirety. He suggested that the MTC, as a "guardian for UDITPA," could have a positive influence on the NCCUSL’s work.
Compliance with the state’s income tax filing requirements continues to be a concern. As part of its filing enforcement program, Stanislaus noted that the FTB generally issues notices to over 30,000 businesses each year that fail to file California returns. To encourage greater compliance, the FTB has launched a new program as an alternative to the typical enforcement action. Early indications are the program is achieving its goal by allowing certain categories of taxpayers to quickly satisfy their filing obligations, come into compliance, and avoid the potential penalties and fees associated with filing enforcement actions.
This program allows out-of-state businesses, who have not previously been contacted by FTB, to voluntarily come forward and file returns self-assessing their unpaid tax. In exchange, the FTB will not impose certain penalties subject to the reasonable cause exception. The program can benefit taxpayers that do not qualify for California’s voluntary disclosure program. Stanislaus explained that eligible taxpayers typically provide evidence that they relied on their tax professionals who advised that they were not required to file in California. Such a showing may constitute reasonable cause.
Taxpayers entering into filing compliance agreements agree to pay tax and interest due. Under the agreements, the FTB will not impose late filing and late payment penalties where reasonable cause has been demonstrated. The FTB will broadly construe the reasonable cause exception because the goal of the agreements, said Stanislaus, is to bring businesses into compliance rather than to penalize them.
When asked about statutory authority for the compliance agreements, Stanislaus pointed to the fact that whether reasonable cause exists is based on decisional authority and the cases contemplate that these determinations will be made on a case-by-case basis. Neither the cases nor the code require payment as a precondition to the finding of reasonable cause. In addition, granting prepayment relief can further FTB’s principles of fair and efficient tax administration by not requiring the taxpayer to pay the penalty and file a claim for refund when the taxpayer is able to demonstrate from the outset that reasonable cause existed. This can be important for both the taxpayer and FTB in that resources need not be spent unnecessarily on the claim process. More information relating to eligibility to participate in the program and the conditions that must be satisfied can be found at FTB’s Web site.
Effective communication between taxpayers and the FTB is a key component in resolving disputes, according to Stanislaus. In the 16 years of its administrative settlement program, the FTB has settled thousands of cases involving billions of dollars; the cases are settled at the protest or appeal stage, after an audit has been completed. Claims for refund can also be settled.
The FTB strives to undertake "a complete and thorough analysis of the case, both the facts and the law"—including not just California law, but analogous federal and state law when applicable, according to Stanislaus. A desire and ability to discuss adjustments with taxpayers "is huge in settling a case," she said, and both sides are encouraged to use "a reasonable approach to a case and seek a reasonable compromise."
Stanislaus and Miller offered a list of the top 10 business entity errors that can delay return processing:
KPMG wants to thank both Selvi and Ben for taking the time to talk with us. In future issues of TWIST-Q, we hope to bring you additional interviews with professionals from state taxing authorities. We welcome suggestions from our readers on states they are interested in and potential topics they would like to see discussed.
This article represents the views of Selvi Stanislaus and Ben Miller only, and does not necessarily represent the views or professional advice of KPMG LLP.
TWIST-Q is a quarterly publication produced by KPMG's State and Local Tax practice. Each issue will focus on the last quarter to provide our readers with select state legislative and regulatory updates which can help you stay current in the fast-changing world of state and local tax. Each issue may also include articles on industry trends in the marketplace, interviews with high-level state tax officials and frequently asked questions.
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
The information contained herein is general in nature and based on authorities that are subject to change. Applicability to specific situations is to be determined through consultation with your tax adviser.
Significant Issues in Pass-Through Entity Nonresident Withholding
Bundling in the Communications Industry
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