California Explains Sales Factor Throwback Rule

California updates taxpayers on a variety of corporation franchise and income and personal income tax issues, including:

  • sales factor “throwback” rule;
  • head of household audits;
  • nonprofit corporations that are suspended or dissolved;
  • reassignment of protest officers; and
  • new power of attorney and tax information authorization forms.

Throwback Rule

In guidance, the California Franchise Tax Board (FTB) provided an example of how the sales factor “throwback” rule applies to a California-based taxpayer that sells tangible personal property in several states, including:

  • Texas (franchise tax);
  • Ohio (commercial activity tax);
  • Washington (business and occupation tax);
  • Tennessee (franchise tax); and
  • Georgia (corporate net worth tax).

The example addresses two issues:

  1. can the taxpayer claim that it is subject to tax for the privilege of doing business in the states where it sells property, and
  2. does the California sales factor throwback rule apply to sales shipped to Texas, Ohio, Washington, Tennessee, or Georgia.

Under the California throwback rule, a taxpayer sources sales of property to California if:

  • the property is shipped from a location in California; and
  • the purchaser is the U.S. government or the taxpayer is not taxable in the purchaser’s state.

A taxpayer is taxable in another state if it is subject to:

  • a net income tax,
  • a franchise tax measured by net income;
  • a franchise tax for the privilege of doing business; or
  • corporate stock tax.

According to the FTB, California law provides two tests for determining whether a taxpayer is taxable in a destination state: the “subject-to-tax” test and the “jurisdiction-to-tax” test. To meet the subject-to-tax test, the taxpayer must be subject to one of the four taxes listed above and must meet certain other criteria. The FTB noted that each of the taxes for Texas, Ohio, Washington, Tennessee, or Georgia constitute one of the four listed taxes. As a result, the taxpayer in the example may claim that it is subject to tax in the destination states under the subject-to-tax test, provided it meets the other criteria.

Head of Household (HOH) Audits

The FTB will reject a 2017 personal income tax return if the taxpayer files electronically, but does not complete Form 3532, Head of Household Filing Status Schedule. However, if a taxpayer files his or her 2017 return through the mail, and does not complete Form 3532, the FTB will contact the taxpayer using:

  • an HOH Demand Letter;
  • a Notice of Proposed Assessments; or
  • an HOH Education Letter.

If a taxpayer receives an HOH Demand Letter, he or she must respond by the due date on the letter to avoid incurring a penalty for failure to furnish information. If a taxpayer does not qualify for the HOH filing status, he or she should mark the “I do not qualify for head of household” box on the top of the HOH Demand Letter. Taxpayers who fail to respond to an FTB letter, or whose responses indicate they do not qualify for HOH filing status, can expect a Notice of Proposed Assessment disallowing their HOH filing status.

Suspended or Dissolved Nonprofit Corporations

The FTB has noted that a nonprofit corporation’s exempt status is automatically revoked upon suspension. Accordingly, they are subject to the $800 annual minimum tax. However, the FTB encourages nonprofit corporations that have continued to operate for a valid exempt purpose to apply (using Form 3500) to have their tax exempt status reinstated. This reinstatement often retroactively covers the period the corporation was suspended, resulting in no minimum taxes due (although filing fees and penalties may still apply). Inactive nonprofit corporations are not entitled to exemption, and would be required to pay the $800 minimum tax in order to revive.

Furthermore, the FTB noted that administrative dissolution is currently available only for entities organized as nonprofit public benefit, nonprofit mutual benefit, and nonprofit religious corporations. The majority of these corporations subject to administrative dissolution had previously obtained tax-exempt status but were suspended and revoked for noncompliance in filings with the FTB or the Secretary of State and have since become inactive. According to the FTB, the taxes that have accrued since revocation for these corporations would have been exempt if the taxpayer had been in compliance, and therefore are abatable. Nonprofit corporations that never obtain tax-exempt status are in a similar situation and would be treated the same as if they were tax-exempt and revoked.

Reassignment of Protest Officer

According to the FTB, a protest case is reassigned based on staff changing positions, being no longer employed by the FTB, or on leave of absence. When this occurs, the manager will review the status of the case and reassign it to a new hearing officer. When possible, the outgoing hearing officer will notify the taxpayer or representative that the case will need to be reassigned. Otherwise, the manager or the newly-assigned hearing officer will inform the taxpayer or representative that the case will or has been reassigned.

The newly-assigned hearing officer will review the file and make contact within 30 days of reassignment to pick up where the prior hearing officer left off. The FTB noted that it will work with the taxpayer and/or representative to ensure this process is seamless and to minimize any delays due to the reassignment of the case.

In addition, for circumstances where there is an unreasonable error or delay due to a ministerial or managerial act by the hearing officer or staff involved with the case, interest attributable to the period of unreasonable delay may be subject to review for relief and, where appropriate, will be abated.

New Power of Attorney and Tax Information Authorization Forms

Beginning January 2, 2018, the FTB will start using new power of attorney (POA) forms:

  • Form 3520 PIT, Individual or Fiduciary Power of Attorney Declaration;
  • Form 3520 BE, Business Entity or Group Nonresident Power of Attorney Declaration; and
  • Form 3520 RVK, Power of Attorney Declaration Revocation.

The forms will be released on December 13, 2017.

The FTB will no longer process non-FTB POA declaration forms or prior versions of FTB 3520 after January 1, 2018, except for:

  • military durable declarations submitted without a completed Form 3520 PIT or Form 3520 BE (although the FTB recommends that one of the new forms be attached for faster processing); and
  • general/durable declarations when submitted with a complete Form 3520 PIT or Form 3520 BE attached.

All POA forms received prior to January 2, 2018, will be processed. In addition, all active declarations will retain the same privileges and will remain in effect until revoked or expired. All POA declarations filed after January 1, 2018, will expire six years from the signature date.

The Tax Information Authorization (TIA) is a new relationship recognized by the FTB starting January 2, 2018. It gives representatives authority to receive information only for all tax years. Form 3534, Tax Information Authorization, and Form 3535, Tax Information Authorization Revocation, will be used. TIAs will expire 13 months from the signature date or the date the TIA client was added in MyFTB.

Tax News, California Franchise Tax Board, December 2017, ¶406-750

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CCHTaxGroup

All stories by: CCHTaxGroup