C ˜˚˛˝˙ˆˇ˛˜ T ˜˘˚ ˆ® - Spidell

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Your California Solution Since 1975

California Taxletter®

No 2017 deduction for prepayment of 2018 state income taxes .... Page 1

California conformity to tax reform provisions ............................... Page 2

Proving identity theft .............. Page 4

Voluntary Disclosure Program expanded ................................ Page 5

FTB Taxpayers’ Bill of Rights issues ...................................... Page 6

Another ruling in tax case that dates back to 1978 .......................... Page 8

Missing head of household info will delay refund ........................... Page 9

When only one partner wants to make a like-kind exchange ...Page 10

NFL wide receiver Keyshawn Johnson scores touchdown against FTB ........................................ Page 11

Claiming previously unclaimed depreciation on a California return .................................... Page 13

Deficiency offsets available even if refunds are barred by SOL ....Page 15

Thumb Tax ............................ Page 17

2018 January Self-Study ........................Supplement

No 2017 deduction for prepayment of 2018 state income taxesCongress puts the kibosh on the deduction.

By Lynn Freer, EAPublisher

H.R. 1, the Tax Cuts and Jobs Act (TCJA), put an end to the discussion of prepaying the 2018 state income tax in 2017 and taking a current deduction. Apparently, the conference committee was worried that taxpayers would prepay the 2018 tax in 2017 so as to have a 2017 deduction, and they put a stop to it.

The law provides that, in the case of an amount paid in a taxable year beginning before January 1, 2018, with respect to a state or local income tax imposed for a taxable year beginning after December 31, 2017, the payment will be treated as paid on the last day of the taxable year for which the tax is due.1 So, a payment made in 2017 for the 2018 year would NOT be deductible in 2017, but rather in 2018.

Payments may not be recouped once processedIf your client already paid their 2018 California tax and it has been

processed by the FTB, there is no way to recoup the money. According to the FTB Web Pay FAQs, you may cancel your request up to two business days before your scheduled payment date. But once the payment has been made, you may not get a refund of the payment.

J a n u a r y 2 0 1 8 VOLUME 40.1

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2017/18 Federal and California Tax Update SeminarTake one day and be ready for tax season and tax reform

● Review the Tax Reform Bill ● Get an overview of tax reform legislation

○Most provisions don’t take effect until next year ○ Uncover California conformity to the bill ○ Prepare for new FTB POAs and 540X

● Get critical identity theft updates ● Review other federal cases and rulings

http://www.caltax.com/spidellweb/public/editorial/CAT/2018/print/CAT_0118p-bwvk.pdf

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This publication is sold with the understanding that the publisher is not engaged in rendering legal, accounting or other professional advice and assumes no liability whatsoever in connection with its use. Since tax laws are constantly changing and are subject to differing interpretations, we urge you to do additional research before acting on the information contained in this publication.

SPIDELL’S CALIFORNIA TAXLETTER® (ISSN No. 0194-8237) is published on the first day of each month by Spidell Publishing, Inc.®, 1134 North Gilbert Street, Anaheim, California 92801-1401. Telephone: (714) 776-7850. Fax: (714) 776-9906. Web site: www.caltax.com. E-mail: [email protected]. The subscription price is $129 for 12 months. Periodicals Postage Paid at Anaheim, CA.© 2017, Spidell Publishing, Inc®. POSTMASTER: Please send address changes to Spidell’s California Taxletter, P. O. Box 61044, Anaheim, California 92803-6144. Federal law prohibits unauthorized reproduction of Spidell’s California Taxletter®. All reproduction must be approved in writing by Spidell Publishing, Inc.® Publisher Emeritus: Robert Spidell. Publisher: Lynn Freer. Editor: Renée Rodda. California Editor: Sandy Weiner, J.D. Senior Editor: Tim Hilger. Contributing Editor: Kathryn Zdan. Contributing Editor: Diane Fuller. Managing Editor: Austin Lewis. Layout: Jeremy Suppes.

California Taxletter®JANUARY 2018

Overpayment from 2017But the question remains: What about a 2017 estimated tax paid in December and a

subsequent overpayment applied to 2018? This is permissible, but only if the 2017 tax estimated is a reasonable amount made in good faith. Under IRS Revenue Ruling 82-208, a taxpayer was denied a deduction when the taxpayer’s entire prepayment was refunded in the following year and was considered not reasonable. But, other cases where a portion of the estimated tax paid was refunded were allowed as reasonable, for example in Revenue Ruling 71-190.

So, you can make a reasonable estimate of the 2017 balance due and pay it before the end of the year. But if the payment is refunded, that refund will be included in the 2018 tax return (subject to the tax benefit rule).

Property and income taxThe law allows up to a combined maximum of $10,000 in property tax and state income

tax for years beginning on or after January 1, 2018.

1 H.R. 1 §11042(a), amending IRC §164(b)

California conformity to tax reform provisionsCalifornia will not conform to most of the provisions in the Tax Cuts and Jobs Act.

By Lynn Freer, EA and Renée Rodda, J.D.California Taxletter Staff

On December 22, 2017, the President signed into law H.R. 1 — An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018 — also known as the Tax Cuts and Jobs Act (TCJA). This means some major changes to federal law, but California will not conform to most of those changes without specific legislation.

Here is a brief discussion of California conformity to federal law, and a list of the new items California will not conform to.

The specified dateBecause the IRC is constantly changing, the Legislature created the concept of a

“specified date” to identify which version of the IRC is to be applied to each year for California purposes. The “specified date” freezes state law to that which is already known, and avoids unintended conformity to subsequent federal changes. Generally, changes in federal law do not automatically change state law. The Legislature first reviews the federal changes and modifies the specified date before any federal changes become effective, or enacts a “spot” conformity bill that conforms to a specific provision.

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In simple terms, if a federal law is retroactively enacted after the specified date, the change is generally not incorporated for California purposes. There are some limited exceptions. For example, California automatically conforms to certain areas of federal law such as most retirement benefit provisions, S corporation formation and termination provisions, and filing status provisions.

California currently conforms to the federal law as it read on January 1, 2015.1 As a result, most of the changes enacted as part of the TCJA will not apply for California purposes, unless California specifically enacts legislation to conform.

Conformity to TCJABecause the TCJA makes significant changes to itemized deductions and standard

deduction amounts (among other things), we are likely to have significant Schedule CA adjustments for 2018 California returns. It is possible that the FTB could develop a Schedule A to be used for California purposes.

California will, however, automatically conform to these provisions: ● Employees whose retirement plans terminate or who separate from employment while they have outstanding plan loans could contribute the loan balance to an IRA by the due date for filing their tax return, including extensions, for that year in order to avoid the loan being taxed as a distribution;2 and

● Repeal of the rule allowing taxpayers to recharacterize Roth IRA contributions as traditional IRA contributions to unwind a Roth conversion.3

In addition to itemized deductions, new areas where there are potential nonconformity include:

● Business interest: California will not conform to the limitation on the net interest expense deduction for businesses that do not qualify as small businesses;

● Accounting methods: California will not conform to the increased gross receipts limit allowing additional C corporations or partnerships with corporate partners to use the cash method of accounting. This means some taxpayers who will now be permitted to use the cash method of accounting for federal purposes must continue to use the accrual method for California purposes;

● Technical terminations: California will still require filing two short-year returns, and basis could be different;

● §1031 only for real property: A taxpayer who trades in a business-use vehicle will have a §1031 exchange for California purposes but not for federal purposes;

● NOLs: California will still allow NOL carrybacks, carryovers will not be limited to 80% of taxable income, and carryovers would be limited to 20 years;

● Listed property: Computers and peripheral equipment will continue to be listed property for California purposes;

● Entertainment expenses: California will not conform to the changes applicable to entertainment expenses. Items such as tickets to sporting events or the theater will continue to be deductible for California purposes, and meals provided for the convenience of the employer will not be subject to the 50% limitation;

● Transportation fringe benefits: Qualified transportation fringe benefits will continue to be deductible for California purposes;

● Research and experimental expenditures: California will not conform to the requirement to capitalize research or experimental expenditures. This will complicate the analysis for taxpayers analyzing the benefits of the Research Credit;

● Alimony: For divorce or separation agreements entered into after December 31, 2018, alimony will no longer be deductible by the payor spouse, nor included in the recipient spouse’s gross income for federal purposes. California will still allow a deduction and exclusion from income;

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● Student loans: California will not conform to the COD exclusion for debt discharged due to death or disability of a student;

● Kiddie tax: A child’s income will still be taxed at the parent’s rate on the California return, while it will be taxed at trust rates on the federal return;

● §529 plans: California will not conform to the provision allowing distributions from §529 plans for K-12 education; and

● Sexual harassment settlements: California will not conform to the limitation disallowing deductions for settlements subject to nondisclosure agreements.

1 R&TC §§17024.5, 23051.5

2 H.R. 1 §13613, amending IRC §402(c); R&TC §17501(b)

3 H.R. 1 §13611, amending IRC §408A(d); R&TC §l7501(b)

Proving identity theftDocumentation is key, and victims need to take action immediately.

By Kathryn Zdan, EAContributing Editor

If a client is a victim of identity theft, it’s important that they take appropriate action to document and resolve the matter, especially if the thief earned wages under the client’s Social Security number. That may cause future problems if the FTB performs income matching and determines that the taxpayer has unreported income.

In a recent hearing before the Board of Equalization, a taxpayer claimed that he had no filing requirement and had not worked for two years. His argument was that someone had stolen his identity, and he hadn’t actually earned the wages that had been reported to the IRS under his Social Security number.1 Because he didn’t have any proof to support this argument, he lost his case.

If a taxpayer needs to prove to the FTB that there is income fraudulently reported on their account, the Board has cited the following documents that would prove the claim:2

● A police report indicating the taxpayer filed a claim for identity theft; ● A revised IRS report showing that the IRS modified the assessment to account for the wages being incorrectly reported under the taxpayer’s Social Security number; and

● Various materials relating to proof of the taxpayer’s California employment.Regarding proof of employment, it would seem that time cards, work schedules, paystubs,

and statements from employers would provide evidence that the taxpayer was not working in the other location.

Report theft to the FTBIf a taxpayer knows, or even just suspects, that he or she is a victim of identity theft, it’s

important to immediately file Form FTB 3552, Identity Theft Affidavit, and be prepared to send copies of the following documents to the FTB:

● Passport; ● Driver’s license or Department of Motor Vehicles identification card; ● Social Security card; ● Police report; and/or ● IRS letter of determination, if applicable.

Form 3552 can also be filed as a precautionary measure when a taxpayer believes his or her identity has been compromised but has not yet experienced any direct tax ramifications.

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Theft and taxesThere are two specific types of identity theft that affect taxpayers:3

● Refund fraud: The thief steals an identity to get a refund. In this situation, the taxpayer normally finds out he or she is a victim when trying to e-file their return and it is rejected because the IRS or the FTB has already received a return under the Social Security number; and

● Employment-related fraud: The thief uses the taxpayer’s identity to gain employment under false pretenses. In this situation, the employer reports the income to the FTB or IRS. When the FTB performs income matching, they will send a notice to the victim regarding the unreported income. Usually, the FTB notice is the first indication to the taxpayer that he or she is a victim of identity theft.

ResourcesThe California Attorney General’s Office provides resources for those who have had their

identity compromised, including checklists and an affidavit for filing a police report:

1 Appeal of Morales (August 29, 2017; released December 13, 2017) Cal. St. Bd. of Equal., Case No. 950895

2 Appeal of Mendoza (July 17, 2013) Cal St. Bd. of Equal., Case No. 575960

3 Transcript from FTB webinar “Tax Fraud and Identity Theft — Protecting Your Clients and Yourself” (February 4, 2014)

Voluntary Disclosure Program expandedWhat is voluntary disclosure?


The Voluntary Disclosure Program was designed to encourage qualified taxpayers who had previously not filed a California return or paid California tax to come forward, file returns, and pay outstanding taxes and interest in exchange for having specified penalties waived for the prior six tax years. The FTB will also waive taxes, additions to taxes, fees, and penalties for the taxable years ending prior to the six income years covered by the voluntary disclosure agreement.1

With the recent enactment of the economic factor nexus thresholds and market-based sourcing for services and intangibles, many out-of-state entities have unknowingly become subject to California filing and payment requirements. With at least an $800 minimum or annual tax and significant penalties accruing, these out-of-state taxpayers can quickly find themselves subject to a sizeable tax liability.

What changed?SB 813 (Ch. 17-288) expands the types of taxpayers eligible to participate in the

Voluntary Disclosure Program as well as the penalty relief available. In addition to the current qualified entities (corporations, LLCs taxed as partnerships, and trusts) and qualified

https://oag.ca.gov/idtheft

https://oag.ca.gov/idtheft/facts/victim-checklist

http://oag.ca.gov/sites/all/files/agweb/pdfs/privacy/id_theft_affidavit.pdf




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shareholders and beneficiaries eligible to participate in the program, the following entities may now participate:

● Out-of-state partnerships with nonresident partners (this applies to general partnerships, limited partnerships, and limited liability partnerships. LLCs classified as partnerships were previously eligible to participate); and

● Out-of-state administered trusts with California beneficiaries. Note: The FTB’s waiver of taxes, fees, or penalties for a trust for a taxable year ending

prior to six years from entering into a VDP agreement does not preclude the FTB from assessing the beneficiary on California-source income.2

Additional penalty reliefThe bill also expands the FTB’s authority to include the waiver of per-partner/member

and per-shareholder penalties under R&TC §§19172 and 19172.5 as part of the VDP agreement. This is especially important for S corporations, LLCs, and limited partnerships with large numbers of shareholders or partners/members.

SB 813 is applicable to voluntary disclosure agreements entered into on or after January 1, 2018.To be eligible, the business entity must not:

● Be qualified, registered, or organized in California, so don’t register first or you won’t be able to use the program;

● Have previously filed a return. In other words, you must request voluntary disclosure before filing or you won’t qualify; or

● Have previously received a notice from the FTB requesting a tax return.

Application processTaxpayers can apply to enter into a voluntary disclosure agreement by submitting Form

FTB 4925, Application for Voluntary Disclosure. The form, as well as detailed information about the program, can be found at:

1 R&TC §§19191, 19192

2 R&TC §19191(d)(1)

FTB Taxpayers’ Bill of Rights issuesSpidell makes recommendations to the FTB to make things easier for tax professionals and taxpayers.


Here are the issues Spidell presented at the FTB’s Taxpayers’ Bill of Rights meeting on December 7, 2017. These are issues that we hear about from our subscribers and seminar attendees, and wanted to bring to the attention of the FTB to work toward solutions.

www.ftb.ca.gov/Bills_and_Notices/voluntary/voluntary.shtml

CautionStart the voluntary disclosure process first. Do this before filing returns, or

qualifying or registering with the Secretary of State. If you file returns, or qualify or register first, you are not eligible for penalty relief.

http://www.ftb.ca.gov/Bills_and_Notices/voluntary/voluntary.shtml

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Power of attorney: copies of certain noticesWhen the FTB sends certain collection notices to the taxpayer, the POA is not getting

a copy of the notice in their MyFTB folder and, as such, is not getting an e-mail that correspondence has been added to their account.

The problem seems to be that when a Notice of Intent to Levy or final notice before levy goes out to the taxpayer, the POA representative does not get a copy of the notice. This can create a serious problem. One example is when a taxpayer is out of the country for an extended period of time and has authorized, by valid POA, a representative to handle all tax issues. The POA representative does not get the notice, the account is levied, and the POA representative does not have the ability to fix the problem.

Form 1099-GFor the second year in a row, tax return processing has caused tax refunds on returns filed

on or just before the extended due date to be held up and issued in the following year. FTB staff has found a workaround for those refunds that are applied to estimated tax. However many refunds claimed on extended returns were not mailed until after January 1 of the following year.

Most tax software programs pro forma the refund and apply it to the year it should have been mailed. We are concerned that taxpayers will receive CP 2000 notices assessing tax on a refund that should have been sent in a previous year but was not, due to a delay in processing.

We requested that the FTB work with the IRS to see if the IRS will allow the refund to be reported in the year the timely filed extended return was filed rather than the subsequent year.

EITC refundsTo reduce fraudulent EITC claims, the IRS holds refunds until February 15 for returns with

EITC refunds. We suggested the FTB implement the same policy.

AuditsWhile we realize statistics show that audit time has dropped significantly, we continue

to get calls from taxpayers, particularly business entities, where the audit takes an unacceptable amount of time to complete. This generally arises due to one of two issues:

1. The auditor sends a document request. After the request has been fulfilled, the auditor sends a subsequent request, and sometimes a third request is sent. There is also often a time lag between the time the representative has sent requested documents and when the subsequent request is made. It appears that auditors are either untrained on complex issues or are not prioritizing audits based on age; or

2. The auditor is not at work for an extended period of time or leaves, and a new auditor takes over the case and starts over.

We requested a process be established for moving a case forward quickly when an auditor is either not available or a new auditor is assigned. Additionally, we’d like to see a new procedure established for more complex issues so that most required documentation can be identified at the beginning of the audit process to prevent taxpayers from being bombarded with additional document requests.

Office of Tax AppealsWhat changes will happen for the FTB with the Office of Tax Appeals handling income

and franchise tax appeals beginning January 1, 2018? We suggested the FTB revise Publication 985, Audit/Protest/Appeals (The Process).

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Partnership audit changesThe Bipartisan Budget Act of 2015 replaced the partnership audit rules enacted in

TEFRA, generally assessing tax on an audited partnership return against the partnership rather than each partner. We inquired about the FTB’s plans regarding sponsoring conforming legislation or handling partnership audits for years beginning on or after January 1, 2018.

SwartNow that the Swart case is settled, we requested that the FTB issue a new Legal Ruling

regarding nonresident businesses with an interest in a California LLC. The current statement in FTB Legal Ruling 2014-01 is not sufficient guidance to assist taxpayers in relying on the Swart decision.

Another ruling in tax case that dates back to 1978

The Second District Court of Appeal in November affirmed a Los Angeles County Superior Court judge’s attorney fee award in a tax case that has been in the courts since 1978.

In its unpublished opinion, the Court of Appeal said Charles Patrick Woosley v. State of California — possibly the longest-running tax-related litigation in the country — “is beginning to rival Jarndyce v. Jarndyce,” the fictional case from the Charles Dickens novel “Bleak House” in which an inheritance dispute remains in court for so many generations that the entire estate eventually is eaten up by legal costs.

The case began in 1978 as a constitutional challenge focused on California’s disparate treatment of cars purchased outside the state when levying vehicle license fees and user taxes. Mr. Woosley, an attorney from Glendale, purchased a classic car in North Carolina in 1976, and brought it to California. The Department of Motor Vehicles said he owed $1,927 in taxes for the vehicle. Had he purchased the 1936 Auburn Speedster in California, the car would have been subject to just $8 in taxes.

Mr. Woosley filed a class-action suit, claiming that the DMV’s tax and fee calculations based on a car’s place of purchase violated both the state and federal constitutions. The trial court agreed in 1983, and the California Supreme Court upheld the decision in 1992.

While the 1992 decision resolved the disagreement over the tax, both parties remain in dispute over millions of dollars’ worth of attorney fees. The case bounced back and forth between the state Supreme Court and trial court several times, each time rendering a different award amount — ranging from $2 million to $800 million.

In the latest action, the Court of Appeal upheld the award of attorney fees to several firms at varying rates, and rejected the state’s argument that the awards should be reduced for lack of success, inappropriate billings and other causes. The court also rejected Mr. Woosley’s argument that the trial court abused its discretion when it determined the rate and hours for his fee award at levels he disputes.

This article is reprinted with permission from the California Taxpayers Association’s December 1, 2017, issue of CalTaxLetter.

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Missing head of household info will delay refundCalifornia does not conform to a new federal due diligence requirement.

By Kathryn Zdan, EAContributing Editor

Effective for tax years beginning on or after January 1, 2018, federal law includes new due diligence requirements when a client uses head of household filing status. This requirement is similar to the current due diligence requirements for the Earned Income Tax Credit, the American Opportunity Tax Credit, and the Child Tax Credit. Like the requirement for those credits, there is a $500 penalty (adjusted for inflation) for failure to perform due diligence.1 California does not conform to this provision.

Filing requirementThe FTB will reject a 2017 return that is e-filed claiming the head of household filing

status if the return does not include Form FTB 3532, Head of Household Filing Status Schedule.2 If the return is paper filed, the FTB will contact the taxpayer regarding a missing Form FTB 3532. This is the third year the requirement has been in place.

Taxpayers may return the HOH information request or any requested substantiation to the FTB by:

● Logging in to MyFTB and uploading the Form FTB 3532 and any required substantiation. The taxpayer will need their account number from the top of the HOH letter or their Social Security number; or

● Mailing the HOH Form FTB 3532 and substantiation to:

If the FTB confirms the taxpayer qualifies for the HOH filing status, they will mail an acceptance letter to the taxpayer. The acceptance letters are tax-year specific and only apply to the specific tax year examined; they do not qualify the taxpayer to use HOH status for other tax years.

Notices taxpayers may receiveTaxpayers may receive one of the following contacts from the FTB regarding HOH

status: ● HOH demand letters: Request the taxpayers to complete and return Form FTB 3532. Taxpayers are usually given 30 days to respond to this notice;

● Notices of Proposed Assessment: Inform the taxpayer that they did not qualify for the HOH filing status. They may protest the notice within 60 days of the date on the notice if they do not agree; and

● HOH education letters: Remind taxpayers of their requirement to attach Form FTB 3532 when filing their 2017 return if they are claiming the HOH filing status.

1 Tax Cuts and Jobs Act, Act §11001(b)

2 FTB Tax News (December 2017)

Franchise Tax BoardP.O. Box 942840

Sacramento, CA 94240-5340

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When only one partner wants to make a like-kind exchangeTaxpayer failed to make successful “drop” before the “swap.”

By Sandy Weiner, J.D.California Editor

An IRC §1031 exchange claimed by a former LLC manager in his individual capacity was disallowed because the sale of the original property was in reality made by the LLC and not the member-taxpayer.1 The taxpayer’s error resulted in a $484,236 assessment and a $96,847.20 accuracy-related penalty.

The co-owner of the LLC wanted to sell the LLC’s property and was willing to pay the tax on the sale. However, this taxpayer claimed he never would have sold unless he could have entered into a tax-free exchange.

Failure to dropAfter the deal had been negotiated, a purchase and sale agreement was signed and

escrow was opened, but before the property was transferred to the buyer, the LLC transferred the property to revocable trusts held by each of the LLC owners. This meant that it was the taxpayer and the other co-owner who actually signed the final sale documents as well as the assignment of rental agreements to the new owner. The taxpayer claimed that as the seller of the property owned by his trust and the other co-owner’s trust as tenants in common (TICs), he was entitled to enter into a §1031 exchange for his share of the gain.

But the evidence showed that the taxpayer signed most of the original documents pertaining to the sale in his capacity as the LLC owner-manager, and not in his individual capacity, demonstrating that it was the LLC and not the taxpayer who sold the property. These documents included:

● The brokerage agreement; ● The two offer letters; ● A letter noticing the opening of escrow for the sale of the property; ● The buyer’s title and due diligence notice; and ● The loan payoff statement.

Even more damaging was the fact that the LLC reported the gain on its return for the tax year and all the rental income from the property prior to the sale. Additionally, the co-owner reported all the flowthrough income on his tax return (although, these were later amended to report the sale consistent with the taxpayer’s contention that they sold the property in their individual capacity).

LLC was the sellerThe Board ruled that under both the substance over form doctrine and the assignment of

income doctrine, it was the LLC that sold the property and not the taxpayer-owner. Therefore, the taxpayer in his individual capacity was not qualified to enter into a tax-deferred exchange because he was not the owner of the original property.

The Board also ruled that the taxpayer was liable for the accuracy-related penalty because he failed to show that he provided sufficient information and documentation to his accountant so that his accountant could provide informed and accurate advice.

Practice PointerThis case is an important reminder that if partners or members want to enter into a

drop-and-swap type transaction (where the property is transferred to the owners and then disposed of by each individual owner), the property must truly be transferred to the owners well before entering into any sale-related activities for the property.

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Drop and swap In a typical drop-and-swap scenario, the entity converts the partnership interests to TIC

interests, therefore “dropping” the title to the property to the TICs. The investors can then make a tax-free distribution of the investment property’s title to the individual investors. With title placed in the name of the individual investors, rather than the partnership, each investor is free to either “cash out” or make a like-kind exchange of his or her own using the equity obtained from the original property as payment.

While drop-and-swap transactions are commonly used, the IRS and the FTB will attack the strategy on two fronts:

● Step transaction: The IRS may determine that the arrangement was designed solely to avoid taxation and disallow the exchange; and

● Investment: They will assess whether the property is held long enough to be treated as an investment.

Swap and dropA partnership may do the reverse, make the exchange, and after waiting “long enough,”

elect out of the partnership treatment. To avoid the step transaction treatment, the partnership should drop title to the individual partners, or refinance the new property to acquire cash to redeem the partner wanting to leave.

The IRS indicated that a post-exchange distribution may occur relatively soon after the exchange without destroying the tax shield.2

1 Appeal of Giurbino (November 29, 2016; released October 18, 2017) Cal. St. Bd. of Equal., Case No. 861813

2 PLR 2005-21002

NFL wide receiver Keyshawn Johnson scores touchdown against FTBThe Board finds Johnson was not a resident in five out of six tax years.


At its final hearing of FTB appeals, the Board ruled unanimously in favor of taxpayer Keyshawn Johnson, ending a residency audit that had lasted for over 15 years.1 At stake was over $2.1 million in proposed assessments and an additional $80,000 in penalties for the 1996 and 2000–2004 tax years. He’d filed California resident returns for 1997 and 1998; 1999 was not at issue during this appeal.

The Board ruled that while he had a California domicile during 1996, he was no longer a California resident or domiciliary in the remaining tax years at issue.

The ruling was a big upset for the FTB who argued that Johnson was always a California domiciliary, and all his excursions to the states in which he played, including New York, Florida, and Texas were only for temporary and transitory purposes during his annual “five to six month gig” during football season. (The FTB’s references to “seasonal employment” were a big point of contention for both Johnson’s attorney and Board Member Runner, whose nephew is a Major League Baseball player.)

Practice PointerThese transactions are extremely complex. We recommend the use of a tax

attorney specializing in real estate to construct these types of transactions.

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FTB’s argumentWhile the FTB conceded that Johnson was outside California during the five-month football

season, they claimed he always returned to California, as evidenced by numerous passages of his autobiography attesting to his pleasure and comfort in always coming home to California (at least in 1996). Based on prior Board rulings, the FTB contended the issue was not where he was living during the football season, but where his closest ties were during the “off-season.”

The FTB argued that Johnson maintained his closest connections to California during the tax years at issue, as evidenced by:

● Purchasing and/or leasing multiple luxury homes and apartments in California; ● Investing in both a restaurant and a store in Los Angeles; ● Registering eight vehicles in California; ● The presence of his wife and children in California during significant periods; ● The enrollment of his children in a Los Angeles school; ● The fact that he filed California resident returns for 1997 and 1998; ● The fact that he listed California as his state of residence in his prenuptial agreement signed in 1998 and his divorce settlement signed in 2003;

● His retention of numerous California attorneys, financial advisors, doctors, and other professional contacts; and

● The fact that a majority of credit card and financial transactions were initiated from California during this period.

Johnson runs it in for the winJohnson and his attorney countered that from the time he signed on with the New York

Jets in August of 1996, he abandoned his California domicile and took up new domiciles in New York, then Florida, and finally in Texas.

Johnson’s attorney contended that the FTB’s audit was shoddy and sloppy, citing numerous examples where the FTB claimed that Johnson was present in California based on financial transaction records, even though these days included days in which he was playing games in New York or Florida or traveling to such games.

Johnson also gave the FTB a lesson on what a professional athlete’s year-long schedule looks like, including attending mini camps, training camps, and in Johnson’s case, postseason playoffs, Super Bowl games, and Pro Bowl games. He essentially argued that anyone who thinks a professional athlete is a “seasonal employee” has no real understanding of what it takes to play in the big leagues.

Refuting the FTB’s arguments concerning his closest connections, Johnson’s legal team countered:

● Johnson’s home purchases consisted of purchasing a home for his mother (a dream fulfilled), his estranged wife, as well as numerous investments (Johnson claimed that he felt comfortable investing in California as that was where he was from, and he understood the real estate market there);

● The Los Angeles restaurant and shop were only investments and were run by on-site managers;

● He retained his professional advisors here because he had a long history with them, and California attorneys and financial advisors are the most familiar with issues concerning athletes and celebrities;

● Many of the vehicles registered in California were vehicles purchased for his family members;

● The school his children were enrolled in was essentially a day camp (his children were five and under during this period), and they also attended school in Florida;

● His mother and his California financial advisors all had credit cards in his name and handled most of his financial transactions;

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● He purchased luxurious homes in New York, Florida, and Texas when he was playing for their respective teams, and that was where he was domiciled;

● He registered to vote and voted in Florida during the 2000 election; ● He paid the Florida intangibles tax while a resident in Florida; and ● He didn’t read all the fine print in his prenuptial and divorce agreements because that’s what he paid his attorneys to do.

Hearing transcriptBecause the written decision has not been issued, we cannot state the Board’s final

reasoning behind this decision.To view the recording of the December 11, 2017, Board meeting in which this case was

heard and decided, go to:

The case is Agenda Item B2 and can be heard about 1 hour and 41 minutes in.

1 Appeal of Johnson (December 11, 2017) Cal. St. Bd. of Equal., Case No. 786255

Claiming previously unclaimed depreciation on a California returnFTB clarifies its current practices by withdrawing an obsolete notice.


Under federal law, taxpayers who have underclaimed the amount of depreciation they were required to claim have two options:

● They can file amended returns for open tax years if the error is due to a mathematical or posting error, or if the taxpayer has not adopted a method of accounting (by using the same method for two consecutive years) for property placed in service after 2003; or

● They can change their method of accounting to claim the correct amount of depreciation by either filing a complete Form 3115 and receiving prior IRS approval, or via the IRS’s automatic consent procedures available for specified method changes by submitting an abbreviated Form 3115 and making an IRC §481(a) adjustment to claim a “catch-up” depreciation deduction.1

The changes that qualify for the automatic consent process are listed in revenue procedures that have been periodically updated since 1997. The latest update is contained in Revenue Procedure 2016-29.

Throughout the years, questions have arisen about whether California follows these procedures for claiming previously unclaimed depreciation. The FTB has issued Notice 2017-3 to put to rest some of the lack of clarity in this area.

California’s conformityCalifornia generally follows federal law in this area as long as:

● California follows the underlying federal law (e.g., MACRS for personal income taxpayers and S corporations); and

● The taxpayer made the same election for California purposes as it did for federal purposes.2

www.youtube.com/watch?v=Wl4HEceJdb0

http://www.youtube.com/watch?v=Wl4HEceJdb0

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However, back in 1996 the FTB issued Notice 96-3, stating that it was not going to follow Revenue Procedure 96-31, which allowed taxpayers to receive automatic consent for a change in cost recovery method or to otherwise claim previously unclaimed depreciation. This allowed taxpayers to file a Form 3115, Application for Change in Accounting Method, and make an IRC §481(a) adjustment that allowed them to “catch-up” the amount of previously unclaimed depreciation in the current year.

The same policy stated in Revenue Procedure 96-31 has been periodically updated by the IRS in subsequent revenue procedures that the FTB has not disavowed, so for many practitioners it has been unclear whether the FTB was still following Notice 96-3.

FTB Notice 2017-3 formally withdraws FTB Notice 96-3, which finally lays this issue to rest. The FTB has clarified that it is following Revenue Procedure 2016-29 and its earlier iterations but will only follow the federal accounting method change if:

● The taxpayer has made a deemed California election (e.g., California conforms to or follows a proper federal election, and the taxpayer is not making a separate California election); or

● The taxpayer gets prior consent from the FTB. Note: According to the FTB, this reaffirms the FTB’s current practices.California does not have an independent automatic consent procedure in place, so if

a taxpayer wants to make a change in accounting method different than the method used on the federal return, the taxpayer must request a change from the FTB. This is especially true for C corporation taxpayers, as California does not follow MACRS for C corporations although it does for all other taxpayers, including S corporations.3 C corporations wanting to use a shorter useful life or a different depreciation method must file a separate request with the FTB prior to making the change.

Same treatment does not mean same deductionsTo the extent California follows a federal provision for which approval of a change

of accounting was granted by the IRS, the federal approval will apply for California purposes. The federal approval applies for California purposes even though the amounts claimed on the California return may differ, including any resulting IRC §481 adjustments.

This is fairly common in instances involving the tangible property repair regulations. Even though California may allow the same accounting method changes, due to basis differences or different depreciation methods (especially for corporate taxpayers), the §481(a) adjustment amounts will differ.

In cases where there is a federal–California difference, taxpayers should attach to their California tax return a copy of their federal Form 3115. In addition, to assist the FTB in reviewing their California tax returns, taxpayers should attach a ”California copy” of Form 3115 with adjusted California figures.

CommentAllowing the automatic consent procedure for previously unclaimed depreciation

opened the door to cost segregation studies. Taxpayers were able to examine all their property to see if they were properly classified, and if not, make an automatic method change.

For example, if a business had a factory and had previously treated all of its equipment as real property, it could reexamine all the property to see if any of it would qualify as seven-year property and thereby accelerate its depreciation deductions.

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Filing for an accounting change with the FTBPursuant to FTB Notice 2000-8, taxpayers that choose to make an accounting

method change on their California return must complete and submit a Form 3115 using the California computations to the FTB by the due date for their California returns.

A cover letter must be attached to the front of the Form 3115, clearly indicating that a “Change in Accounting Method” is being requested. The name of the taxpayer requesting the change and the taxpayer’s California corporate number must be included in the cover letter as well.

The form and cover letter should be sent to:

1 IRC §446; Treas. Regs. §1.446(e); IRS Publication 946, How to Depreciate Property

2 FTB Notice 2000-8, as corrected by FTB Notice 2001-2 (February 1, 2001)

3 R&TC §§17201, 24349; Form 100S Instructions

Deficiency offsets available even if refunds are barred by SOLDon’t forget this important relief when dealing with S corporation shareholder basis adjustment audits.


A basis adjustment audit for S corporation shareholders can be extremely complex, especially when there are shareholder loans involved. This was the case in a recently released Board decision involving an S corporation owned equally by two brothers.1

Franchise Tax Board Change in Accounting Periods and

Methods Coordinator P.O. Box 1998

Sacramento, CA 95812

EXAMPLE 1-1: An S corporation discovers that it has been mistakenly treating computer equipment as seven-year property rather than five-year property. The property was purchased in 2014 for a price of $100,000. The taxpayer claimed a 50% bonus depreciation deduction on its 2014 federal return but not on its California return.

On its 2017 return, the taxpayer makes an automatic consent accounting method change switching from a seven-year recovery period to a five-year recovery period. In doing so, it accelerates its federal depreciation deduction for the 2014–2016 tax years by $7,466, which it may claim as a §481(a) adjustment on its 2017 return when it completes its Form 3115.

Because the corporation could not claim bonus depreciation on its California return, the California basis is different, and it is able to accelerate its California depreciation by $14,931 for the 2014–2016 tax years. The corporation will attach its federal Form 3115 to its return and will also attach a “California Copy” Form 3115, showing the different §481(a) adjustment for California.

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At the crux of the case was how to treat the brothers’ debt basis in the S corporation from personal loans taken out by the brothers on behalf of the S corporation.

The FTB and the brothers argued back and forth about the actual amount of tax, penalties, and interest due for each tax year, but the key takeaway from the case was that overpayments arising from various adjustments made in a closed tax year could be used to offset the deficiency adjustments for the tax years at issue.

The loansThe details of the audit are complex, but the bottom line was that an original loan

of $750,000 was taken out by the brothers and contributed to the S corporation in 2002. The unpaid balance was refinanced and assumed by the S corporation in 2003.

The FTB began an audit in 2007 and issued a Notice of Proposed Assessment in 2009, assessing additional tax for 2003 and 2005, finding that various losses could not be claimed because the brothers did not have sufficient basis during those years.

Basis adjustmentsA shareholder’s losses from an S corporation are limited to the amount of the

shareholder’s stock basis and debt basis.2 The main issue in the appeal revolved around the brothers’ debt basis.

In this case, the brothers’ basis was increased by the amount of the original loan taken out, but decreased by the amount of the payments made by the S corporation and the S corporation’s ultimate assumption of the loan.

Unfortunately, part of the assessment was attributable to the CPA’s error in reducing the brothers’ stock basis in 2004 rather than in 2003 when the loan was assumed. The brothers argued that they were being subject to a double basis reduction where the FTB reduced the basis in 2003, but the CPA already made a basis reduction in 2004.

By the time the brothers raised this issue on appeal, the statute of limitations for claiming a refund for the 2004 tax year had already expired.

OffsetsFortunately for the brothers, R&TC §19134 allows the FTB to offset a taxpayer’s deficiency

from one year from an overpayment in another year if the overpayment results from the transfer of income or deductions from another year. This is allowed even if the statute of limitations has expired for the year of overpayment.

The FTB determined that the reduction in the brothers’ stock basis in 2003 resulted in an increase in the NOL carryover in 2004 and 2005. This meant that the brothers overpaid their tax in 2004, which was used to offset the entire deficiency for 2005 as well as reduce the amount of the deficiency for 2003.

But that wasn’t all. The brothers had previously paid estimated tax underpayment penalties in 2004 and 2005. The Board determined that as a result of the adjustments made to the 2004 and 2005 tax years, the penalties were improper and allowed these previously “overpaid” penalties to offset the 2003 deficiency as well.

1 Appeal of Fletcher (July 14, 2016; released September 18, 2017) Cal. St. Bd. of Equal., Case No. 603936

2 IRC §1366; R&TC §23801 et seq.

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Tax relief available to Southern California wildfire victims — The Governor has declared a state of emergency in Los Angeles County due to the Creek and Rye fires, in Ventura County due to the Thomas Fire, and San Diego County due to the Lilac Fire.

Taxpayers impacted by the fires may be able to claim a disaster loss throwback election on an amended California 2016 return even though the counties have not been declared a disaster area by the President.

CDTFA reliefThe CDTFA has announced relief for taxpayers in the impacted counties.1 Tax and fee

payers may request relief from penalties and/or interest and ask for an extension of time to file their tax or fee returns either online or by calling CDTFA’s Customer Service Center, Monday through Friday from 8 a.m. to 5 p.m. toll-free at:

EDD reliefThe EDD has announced that employers in Los Angeles, San Diego, Santa Barbara, and

Ventura counties directly affected by the Creek, Rye, Lilac, and Thomas fires which began on December 4, 5, and 7, 2017, may request up to a 60-day extension of time from the EDD to file their state payroll reports and/or deposit state payroll taxes without penalty or interest. A written request for an extension must be received within 60 days from the original delinquent date of the payment or return.

For more information, go to:

1 CDTFA News Release NR 29-17, December 8, 2017

2018 SDI rate announced — The EDD has released the 2018 State Disability Insurance (SDI) withholding rate. The rate for 2018 is 1.0% and the taxable wage limit is $114,967 for each employee per calendar year. The maximum to withhold for each employee is $1,149.67.

In 2017, the rate was 0.9% and the taxable wage limit was $110,902, with a maximum to withhold of $998.12.

New POA forms are now available — The new FTB Power of Attorney forms are now available on the FTB’s website, although they are not valid until January 1, 2018. These forms will be the required POA forms starting January 1. After that date, the FTB will not process IRS POAs, or 2017 FTB POA forms.

Money launderer taxed on full load of money in his accounts — A California court of appeal upheld the $1.25 million restitution award to the FTB to be paid by a nonfiler convicted of money laundering and identity theft.2

The taxpayer unsuccessfully argued that in the accounts his taxable income was limited to the 1.5% check cashing fee he charged his clients for his check cashing business.

However, the FTB presented evidence that in contrast to how he handled the bank account for his check cashing business, the six accounts involved with the money laundering scheme gave the taxpayer unfettered access to the money deposited, as evidenced by the taxpayer using funds from the accounts for his personal expenses and fees.

(800) 400-7115

www.edd.ca.gov/Payroll_Taxes/Emergency_and_Disaster_Assistance_for_Employers.htm

Thumb Tax

http://www.edd.ca.gov/Payroll_Taxes/Emergency_and_Disaster_Assistance_for_Employers.htm

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Contributing Editor Kathryn Zdan, EA

Contributing Editor Diane Fuller

Managing Editor Austin Lewis

Layout Ana Cervantes

Editor Renée Rodda, J.D.

Editorial Staff

Publisher Lynn Freer, EA

California Editor Sandy Weiner, J.D.

For resources on identity theft, go to:

https://oag.ca.gov/idtheft • https://oag.ca.gov/idtheft/facts/victim-checklist • http://oag.ca.gov/sites/all/files/agweb/pdfs/privacy/id_theft_affidavit.pdf

Form FTB 4925, Application for Voluntary Disclosure, and program information can be found at:

www.ftb.ca.gov/Bills_and_Notices/voluntary/voluntary.shtml

Taxpayers may return the HOH information request or any requested substantiation to the FTB to:

Franchise Tax Board • P.O. Box 942840 • Sacramento, CA 94240-5340

To view the recording of the Appeal of Johnson Board meeting in which this case was heard and decided, go to:

www.youtube.com/watch?v=Wl4HEceJdb0

To request a change in accounting method, send Form 3115 with a cover letter to:

Franchise Tax Board • Change in Accounting Periods and Methods Coordinator • P.O. Box 1998 • Sacramento, CA 95812

Wildfire victims can request relief from penalties and/or interest, or extension of time to file their tax or fee returns, by calling the CDTFA at:

(800) 400-7115

For more information on tax relief available to Southern California wildfire victims, go to:

www.edd.ca.gov/Payroll_Taxes/Emergency_and_Disaster_Assistance_for_Employers.htm

You may access the Disaster Losses special report at:

www.caltax.com/spidellweb/public/editorial/cat/0118DisasterLossesSR.pdf

California Contacts

Disaster losses special reportFollowing the numerous natural disasters that affected taxpayers in 2017, we have

updated our special report on disaster losses. It covers federal and California treatment of disaster losses, how to handle insurance and other reimbursements, how to calculate losses for business property, involuntary conversions, provisions specific to the California wildfires, and more.

Subscribers may access the report free of charge at:

For more information and to earn up to two hours of CPE, attend Spidell’s Disaster Losses webinar on February 9, 2018. Get more information at www.caltax.com.

www.caltax.com/spidellweb/public/editorial/cat/0118DisasterLossesSR.pdf

Therefore, the FTB’s “bank deposit method” used to determine the amount of the taxpayer’s taxable income was a reasonable method of determining the taxpayers taxable income.

2 People v. Jamal (November 16, 2017) Cal.App.2d, Case No. B269707 (not for publication)








http://www.youtube.com/watch?v=Wl4HEceJdb0



http://www.caltax.com/spidellweb/public/editorial/cat/0118DisasterLossesSR.pdf



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