Timothy A. Gustafson and Nicole L. Johnson, Co-Editors Winter 2012 … · 2016. 6. 13. · ABA Section of Taxation, 2012 Midyear Meeting San Diego, California Debra S. Herman February

Morrison & Foerster News Timothy A. Gustafson and Nicole L. Johnson, Co-Editors Winter 2012

(Continued on page 2)

Should Filmmakers Be Content to Have Taxing Authorities Judge Their Content?By Hollis L. Hyans and Open Weaver BanksThe vast majority of states have enacted tax incentive programs for qualifying motion picture and television productions. These tax incentives are available in many forms, including income tax credits (typically transferable), sales tax exemptions, hotel tax exemptions and cash rebates of qualified expenditures. Although the features of each state’s program vary, the common purpose of these programs is to spur local economic growth by incentivizing the motion picture and television industries to locate their productions in the state offering an incentive program.

So what happens when a production company meets all the eligibility requirements for a tax credit, but cannot get past the state’s censors? As we learned recently in New Jersey, the shooting location of the reality television series Jersey Shore, tax credits might be revoked if the state decides that the television program makes the state look bad.1 On September 26, 2011, Governor Christie informed the New Jersey Economic Development Authority that he vetoed its award of $420,000 in tax

InsightsState + Local Tax

3 Upcoming 2012 Speaking Engagements7 Individual Liability for Company Taxes ByMitchellA.NewmarkandRichardC.Call11 Potential Unity and Business Income in California ByEricJ.CoffillandTimothyA.Gustafson16 Managing Withholding for a Mobile Workforce:

Special Treatment of Deferred Compensation and Stock Options ByPaulH.FrankelandDebraS.Herman20 California's Property Tax Exclusion for Solar Energy Power Plants:

Waiting to Sell Until New Year's Day Might Produce a Huge Hangover ByPeterB.Kanter

Inside This Month

New York

Craig B. Fields [email protected]

Paul H. Frankel [email protected]

Hollis L. Hyans [email protected]

Mitchell A. Newmark [email protected]

R. Gregory Roberts [email protected]

Irwin M. Slomka [email protected]

Open Weaver Banks [email protected]

Debra S. Herman [email protected]

Roberta Moseley Nero [email protected]

Amy F. Nogid [email protected]

Michael A. Pearl [email protected]

Richard C. Call [email protected]

Nicole L. Johnson [email protected]

Bee-Seon Keum [email protected]

Rebecca M. Ulich [email protected]

Kara M. Kraman [email protected]

San Francisco

Thomas H. Steele [email protected]

Andres Vallejo [email protected]

Peter B. Kanter [email protected]

James P. Kratochvill [email protected]

Scott M. Reiber [email protected]

Kirsten Wolff [email protected]

Sacramento

Eric J. Coffill [email protected]

Carley A. Roberts [email protected]

Timothy A. Gustafson [email protected]

Jenny Choi [email protected]

Washington, D.C.

Linda A. Arnsbarger [email protected]

Philip M. Tatarowicz [email protected]

Denver

Thomas H. Steele [email protected]

Los Angeles

Gary W. Maeder [email protected]

State + Local Tax Group

http://www.mofo.com/hollis-hyans/http://www.mofo.com/open-weaver-banks/http://www.mofo.com/mitchell-newmark/http://www.mofo.com/richard-c-call/http://www.mofo.com/eric-coffill/http://www.mofo.com/timothy-gustafson/http://www.mofo.com/paul-frankel/http://www.mofo.com/debra-s-herman/http://www.mofo.com/peter-kanter/mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]://mailto:[email protected]:[email protected]:[email protected]:[email protected]

2

State + Local Tax Insights Winter 2012

creditstotheproducersofJersey Shore.2GovernorChristieexplained:“Ihavenointerestinpolicingthecontentofsuchprojects;however,asChiefExecutiveIamdutyboundtoensurethattaxpayersarenotfootinga$420,000billforaprojectwhichdoesnothingmorethanperpetuatemisconceptionsabouttheStateanditscitizens.”3

State Review of Motion Picture and Television Production Content

WhileGovernorChristie’svetooftheJersey Shoretaxcreditsmadenationalnews,NewJerseyisnottheonlystatethatreviewsthecontentofproductionsbeforegrantingtaxincentives.In2010,theNew York TimesreportedthestatementsofMichigan’sFilmCommissionerinconnectionwiththedenialoftaxincentivesforthemotionpicture,The Woman.Notingthefilm’ssubjectmatter,“namelyrealisticcannibalism;thegruesomeandgraphicallyviolentdepictionsdescribedinthescreenplay;andtheexplicitnatureofthescript,”theMichiganFilmCommissionerstated,“[t]hisfilmisunlikelytopromotetourisminMichiganortopresentorreflectMichiganinapositivelight.”4Similarly,theTexasFilmCommissionrefusedtopay$1.75millionintaxincentivestotheproducersofthemotionpictureMachete,citingastatelawthatallowsthestatetorefusetopayincentivesforcontentthatportraysTexasorTexansinanegativefashion.5

TheproducersofJersey ShorecouldnothaveanticipatedthattheirtaxcreditswouldberevokedbecauseNewJersey’sincentiveprogram,liketheprogramsin

moststates,doesnotdisqualifyproductionsthatmakethestatelookbad.However,ahandfulofstates,likeTexas,haveenactedsuchcriteriaintotheirlawsorcreatedsimilarstandardsintheirapplicationreviewguidelines.6Utah’sMotionPictureIncentiveFundapplicationinstructionsprovidethatthestateisnotrequiredtograntincentivestoprojectsthatinclude“inappropriatecontent”or“contentthatportraysUtahorResidentsofUtahinanegativeway.”7

InWisconsin,aproductionwillnotqualifyifitwillhurtthereputationofthestate.8AproductionwithcontentthatportraysWestVirginiaina“significantlyderogatorymanner”isineligibleforWestVirginiafilmcredits.9Wyominglimitsthedefinitionofa“qualifiedproduction”tofilmedentertainmentthatwouldlikelyencouragemembersofthepublictovisitthestateofWyoming.10Similarly,Kentucky’sprogramrequiresadeterminationthattheproductionwillnotnegativelyimpactthetourismindustryoftheCommonwealthandPennsylvania’sapplicationguidelinesindicatethatthePennsylvaniaFilmOfficemayconsiderwhethertheprojectwilltendtofosterapositiveimageofPennsylvania.11

Themajorityofstatemotionpictureandtelevisionproductionincentiveprogramshavenotopenlyexpressedasimilarconcernaboutproductionsthatmayportray

astateinanegativefashion.However,statesnormallycarveoutbroadcategoriesofproductionsthatdonotqualifyfortaxincentives,suchasnews,sportsevents,awardprogramsandevendocumentariesandrealitytelevisionshows.12Itisalsotypicalforincentiveprogramstocontainsomemannerofprohibitiononproductionsthatcontainsexuallyexplicitorobscenematerial.13Byrequiringtaxincentiveapplicantstosubmitascript,screenplayorsynopsisoftheproduction,statefilmcommissionschargedwithadministeringincentiveprogramsarealsoabletoreviewthecontentofproposedmotionpictureandtelevisionproductions.Somestateincentiveprogramsactuallyrequireproductioncompaniestosubmitacopyofthefinalversionoftheproductiontoqualifyfortaxincentives.14

First Amendment Principles

AlthoughtheproducersofJersey ShoremayhavemorethanoneavenueforchallengingGovernorChristie’svetooftheirtaxcredits,theinterestingquestionwithmultistateramificationsiswhetherGovernorChristiecrossedaFirstAmendmentlinewhenhedeniedtaxcreditstoJersey Shorebaseduponthecontentoftheproduction.15TheFirstAmendmentprovidesthatCongressshallmakenolawabridgingthefreedomofspeechandismadeapplicabletothestatesthroughtheFourteenthAmendment.16FirstAmendmentjurisprudencerecognizes:

Underoursystemofgovernmentthereisanaccommodationforthewidestvarietiesoftastesandideas.Whatisgoodliterature,whathaseducationalvalue,whatisrefinedpublicinformation,whatisgoodart,varieswithindividualsasitdoesfromonegenerationtoanother....Butarequirementthatliteratureorartconformtosomenormprescribedbyanofficialsmacksofanideologyforeigntooursystem.17

IfweassumethattheFirstAmendmentprotectstherightofafilmmakertoproduceamotionpicturethatfeaturescannibalismorthatportraysTexasinanegative

Tax Incentives(Continued from page 1)


ToensurecompliancewithrequirementsimposedbytheIRS,Morrison&FoersterLLPinformsyouthat,ifanyadviceconcerningoneormoreU.S.federaltaxissuesiscontainedinthispublication,suchadviceisnotintendedorwrittentobeused,andcannotbeused,forthepurposeof(i)avoidingpenaltiesundertheInternalRevenueCodeor(ii)promoting,marketing,orrecommendingtoanotherpartyanytransactionormatteraddressedherein.

THE TExAS FILM COMMISSION rEFUSED TO PAY $1.75 MILLION

IN TAx INCENTIvES TO THE PrODUCErS

OF THE MOTION PICTUrE MACheTe, CITING A STATE LAW THAT ALLOWS THE STATE TO rEFUSE

TO PAY INCENTIvES FOr CONTENT THAT

POrTrAYS TExAS Or TExANS IN A NEGATIvE

FASHION.

3

Winter 2012State + Local Tax Insights

fashion,orboth,isthatrightviolatedbyTexas’refusaltoawardtaxincentivestothatfilmmaker?Whataboutrestrictionsinstatestatutesdenyingtaxincentiveprogrameligibilityforproductionsthataresexuallyexplicitorcontainobscenematerial?Istheanswerdifferentifstatesusea“carrot”ratherthana“stick”?Forexample,Floridaoffersanadditional5%taxcreditfor“family-friendlyproductions.”18

Obscenity Is Not Protected Speech

IntheareaofFirstAmendmentjurisprudence,onethingthatisclearisthatobscenityisnotprotectedspeech.19Nonetheless,theSupremeCourtrecognizesthatstatestatutesdesignedtoregulateobscenematerialsmustbecarefullylimited.20ProvidedthatstatesadopttheproperFirstAmendmentstandardsfordeterminingwhetherparticularmaterialisobscene,motionpictureandtelevisionproductionincentiveprogramsthatdenytaxbenefitstoproductionscontainingobscenematerialareprobablyfaciallyconstitutional.21Inanindividualcase,however,itwouldbenecessarytoconsidertheapplicationoftherelevant

standardtotheproductionseekingtoqualifyfortaxbenefits.

ManystatesrelyonthefederalstandardsetforthbytheChildProtectionandObscenityEnforcementActof1988todefinethecategoryofsexuallyexplicitcontentthatisnoteligibleformotionpictureandtelevisionproductionincentives.22Otherstateshavetheirowndefinitionof“obscenematerial”or“obscenecontent.”23Anydefinitionwilllikelybeinterpretedandappliedbyarelativelysmallgroupofpeoplewhoformthelocalfilmcommissionthatischargedwithreviewingandapprovingtaxincentiveapplications.AsevidencedbyarecentscandalinIowa’sFilmOfficeinvolvingimproperlyawarded



January 17 Tax Executives Institute (TEI) Dallas, Texas EricJ.CoffillHollisL.Hyans

January 18 Tristate CPA Conference New York, New York PaulH.Frankel

January 23 2012 Council on State Taxation (COST) Basics School Atlanta, Georgia AndresVallejo

January 24 New York State Bar Association New York, New York HollisL.Hyans

January 25 Ohio Tax Conference Columbus, Ohio PaulH.Frankel

February 2 – 3 The National Multistate Tax Symposium Orlando, Florida CraigB.FieldsPaulH.FrankelHollisL.Hyans

February 17 ABA Section of Taxation, 2012 Midyear Meeting San Diego, California DebraS.Herman

February 29 New York City Bar Association New York, New York HollisL.HyansDebraS.Herman

March 5 Council on State Taxation (COST) Sales Tax Conference Austin, Texas PaulH.Frankel

March 19 – 21 2012 ABA/IPT Advanced Income Tax Seminar New Orleans, Louisiana CraigB.FieldsPaulH.Frankel

May 3 Council on State Taxation (COST) Advanced Tax School Atlanta, Georgia PaulH.Frankel

May 11 New Jersey Tax Executives Institute (TEI) State Tax Day Morristown, New Jersey PaulH.Frankel

June 14 University of Wisconsin SALT Conference Milwaukee, Wisconsin PaulH.Frankel

August 7 Georgetown SALT Conference Washington, D.C. PaulH.Frankel

Upcoming 2012 Speaking Engagements

4


credits,statefilmcommissionshaveatremendousamountofdiscretionandaresusceptibletoerrorsinjudgment.24

Supreme Court Cases Considering the First Amendment and State Taxes

Outsideofobscenematerial,thestateofconstitutionallawwhenFirstAmendmentrightsareimpactedbygovernmentfunding(ordenialthereof)issomewhatunclear.OnoneendofthespectrumaretwoUnitedStatesSupremeCourtcasesextendingFirstAmendmentprotectionintheareaoftaxexemptions.

InSpeiser v. Randall,theCourtreviewedaCaliforniaruleenactedin1954thatrequiredveteransseekingpropertytaxexemptionstosignadeclarationstatingthattheydidnotadvocatetheforcibleoverthrowoftheGovernmentoftheUnitedStatesorofCalifornia.25Veteranswhorefusedtoexecutetheoathweredeniedtheexemption.TheSupremeCourtstruckdowntheoathrequirement,stating“whentheconstitutionalrighttospeakissoughttobedeterredbyaState’sgeneraltaxingprogramdueprocessdemandsthatthespeechbeunencumbereduntiltheStatecomesforwardwithsufficientprooftojustifyitsinhibition.”26InSpeiser,theSupremeCourtconcludedthatCalifornialackedacompellinginterestthatwouldjustifysuppressingthespeechatissue.Inreachingthisdecision,theSupremeCourtspecificallyrejectedCalifornia’sargumentthatbecauseataxexemptionisaprivilegeorbounty,itsdenialdoesnotinfringespeech.27TheSupremeCourtstatedthat“[to]denyanexemptiontoclaimantswhoengageincertainformsofspeechisineffecttopenalizethemforsuchspeech.Itsdeterrenteffectisthesameasifthestateweretofinethemforthisspeech.”28

Nearlythirtyyearslater,inArkansas Writers’ Project, Inc. v. Ragland,theSupremeCourtheldthatArkansas’selectiveapplicationofitssalestaxtomagazinesviolatedtheFirstAmendment’sguaranteeoffreedomofthe

pressbecauseitdifferentiatedbetweenmagazinesbasedontheircontent.29TheArkansasstatuteprovidedanexemptionforreligious,professional,tradeandsportspublications.AccordingtotheSupremeCourt,“[r]egulationswhichpermittheGovernmenttodiscriminateonthebasisofthecontent

ofthemessagecannotbetoleratedundertheFirstAmendment.”30Inordertojustifysuchdifferentialtaxation,theSupremeCourtstatedthatArkansasmustshowthatitsregulationwasnecessarytoserveacompellingstateinterestandwasnarrowlydrawntoachievethatend.31Arkansaswasunabletomeetthisstandard.

Arkansas Writers’ Projectwastechnicallynota“freedomofspeech”case.Rather,theSupremeCourtdecidedthattheArkansassalestaxschemeviolatedfreedomofpress.Nonetheless,Arkansas Writers’ Project iscitedincasesevaluatingfreedomofspeechclaimsandstandsfortheprinciplethatstategovernmentswanderintodangerousterritorywhenthegrantofataxexemptionrequiresgovernmentscrutinyofthecontentofspeech.32ThereasoningofArkansas Writers’ ProjectisparticularlyrelevanttostatemotionpictureandtelevisionproductionincentiveprogramsbecausetheSupremeCourthasheldthat

expressionbymeansofmotionpicturesisincludedwithinboththefreespeechandthefreepressguaranteesoftheFirstandFourteenthAmendments.33

Supreme Court Cases Considering the First Amendment and Government Spending

Ontheotherendofthespectrumarenon-taxcasesinwhichtheSupremeCourthasupheldgovernmentreviewofthecontentofspeechwhenthegovernmentisthespeakerorwhenthegovernmentactsasapatron.Attheoutsetitisimportanttonotethatthefollowingcasesbothinvolvedfacialchallengestolawsinvolvingspeechand,therefore,thechallengersoftheselawsfacedaheavierburden.Wedonotknowhowthesecaseswouldhavebeendecidedifachallengerpresentedan“asapplied”situationfortheSupremeCourt’sreview.

InRust v. Sullivan,theSupremeCourtconsideredafacialchallengetofederalregulationsthatprohibitedcounselingconcerningtheuseofabortioninfederallyfundedfamilyplanningprograms.34Petitioners,granteesanddoctorswhosupervisedthefamilyplanningfunds,arguedthattheregulationsviolatedtheirFirstAmendmentrightsbyimpermissiblyimposingviewpointdiscriminatoryconditionsongovernmentsubsidiesandthuspenalizingcertainspeech.35Inacontroversial5-4decision,theSupremeCourtrejectedtheFirstAmendmentchallenge,finding“[t]heGovernmentcan,withoutviolatingtheConstitution,selectivelyfundaprogramtoencouragecertainactivitiesitbelievestobeinthepublicinterest,withoutatthesametimefundinganalternativeprogramwhichseekstodealwiththeprobleminanotherway.”36

RustisdistinguishablefromtheJersey ShoresituationbecauseNewJersey



Morrison & Foerster’s State & Local Tax Group would like to welcome Debra S. Herman. Ms. Herman joins us as Of Counsel in the New York office.

MOFO ATTOrNEY NEWS

STATE GOvErNMENTS WANDEr INTO DANGErOUS

TErrITOrY WHEN THE GrANT OF A TAx

ExEMPTION rEqUIrES GOvErNMENT

SCrUTINY OF THE CONTENT OF SPEECH.

5


didnotenactitsfilmproductioncreditinordertoestablishaprogramforfundingmotionpictureandtelevisionproductionsthatmakeNewJerseylookgood.NewJersey’sincentiveprogram,likethoseofotherstates,wasenactedtospureconomicdevelopmentinthestate.

IfNewJerseydecidestohireaproductioncompanytomakeafilmfortheexpresspurposeofportrayingNewJerseyinapositivelight,thenunderRust,NewJerseycanexertsomelevelofcontroloverthecontentofthefilm.However,thisdoesnotmeanthatstatessuchasTexasorUtahcanconstitutionallydenyfilmcreditstoproductionsthatportraythestatesortheirresidentsinanegativemannersimplybecausetheirincentiveprogramshaveidentifiedsuchcontentasabasisfordenialofincentives.Thedecisiveinquiryshouldbewhethertheincentiveprogramrepresents“governmentspeech”inwhichthestateshouldhavesomesayaboutthemessagethatisbeingconveyed.

InNational Endowment for the Arts v. Finley,theSupremeCourtuphelda1990amendmenttofederallawrequiringthechairpersonoftheNationalEndowmentfortheArts(“NEA”)totakeintoconsiderationgeneralstandardsofdecencyandrespectforthediversebeliefsandvaluesoftheAmericanpublicwhenjudgingtheartisticmeritofgrantapplications.37ThelegislativehistoryindicatedthatthechangeinlawwasatleastinpartduetoaCongressionalreactiontotheuseofNEAgrantmoneytofunda1989retrospectiveoftheworksofcontroversialphotographerRobertMapplethorpe.

Originally,inFinley,agroupofartistswhoweredeniedNEAgrantschallengedthelawasbeingbothunconstitutionalasappliedtothem,aswellasunconstitutionalonitsface.However,duringthecourseofthelitigationtheas

appliedconstitutionalclaimsweresettled(withtheplaintiffsreceivingtheamountofthevetoedgrants,damagesandattorney’sfees)andthecaseproceededsolelyasafacialchallengetothelawundertheFirstAmendment.

ExpressingreluctancetoinvalidatelegislationonthebasisofitshypotheticalapplicationtosituationsnotbeforetheCourt,theSupremeCourtinFinleyfoundthatthenewrequirementtotake into consideration general standards of decencyseemedunlikelytointroduceanygreaterelementofselectivitythanthedeterminationof“artisticexcellence”alreadyrequiredbythelawforthejudgingofapplicationsforartisticgrants.38TheSupremeCourtalsorecognizedthatanycontent-basedconsiderationsthatmaybetakenintoaccountintheNEAgrant-makingprocessareaconsequenceofthesubjectivenatureofartsfunding.39TheNEAhaslimitedresourcesanditmustdenythemajorityofthegrantapplicationsthatitreceives,includingmanythatproposeartisticallyexcellentprojects.40Ultimately,themajorityopinioninFinleyheldthatthegovernmentmaytakeintoconsiderationgeneralstandardsofdecencyandrespectforthediversebeliefsandvaluesoftheAmericanpublicinconnectionwithallocatingcompetitivefunding,eventhoughsuchcriteriamightbeimpermissibleweredirectregulationofspeechoracriminalpenaltyatstake,becauseCongresshaswidelatitudetosetspendingpriorities.41Ineffect,thefederalgovernmentinFinleywas“actingaspatronratherthanassovereign.”42

AfterFinley,canaproductioncompanychallengethedenialofspecifictaxincentivesbasedonthecontentoftheproduction?Theanswershouldbe“yes.”WhileFinleyacknowledgesthatsomelevelofcontentreviewispermissiblewhenthegovernmentfundsthearts,statemotionpictureandtelevisionincentivesprogramswerenotenactedtosupportthearts,buttoencouragethecreationofjobsandspendingintheenactingstate.NewJerseyshouldnotbeconsidereda“patron”forJersey ShoreoranyotherproductionapplyingforNewJerseytaxcredits.Theendresultmaybeanartisticproduction,butthepurposeofmotionpictureandtelevisionincentiveprogramsistobringaproductiontothestatetofurtherthestate’sowneconomicinterests.Thus,eligibilityforcreditsshouldbebasedonsuchfactorsasthenumberofpersonsemployedintheproductionandspendinglevelswithinthestate,notonthecontentoftheproduction.

Additionally,akeycomponentoftheFinleyanalysiswasthelimitednumberofgrantsavailableforNEAapplicantsandthefactthatmany,ifnotmost,applicantswererejectedforwhollysubjectivereasons.Althoughstatesmayhavemoreapplicantsforfilmtaxcreditsthantheycanhonor,itisnotuncommonforstatestoadministertheirprogramsonafirst-come,first-servedbasis.43Forexample,inNewMexico,taxcreditsareawardedonafirst-come,firstservedbasisandwhentheprogram’s$50millioncapisreached,theremainingamountsareplacedatthefrontofaqueueandawardedinthenextfiscalyear.44

StateslikeNewMexicodonotlookattheentirepoolofapplicantstodeterminewhichproductionsaremostworthyofagrant,aswasthecaseinFinley.Thus,thehighlyselectivenatureoftheNEAgrantsthatmadecontentreviewapermissiblefactorinFinleydoesnotexistinmotionpictureandtelevisionproductionincentiveprogramswithafirst-come,first-servedfeature.

Evenwhenthestatemaybeconsideredapatronofthearts,apost-FinleydecisioninvolvinganasappliedchallengetothedenialofartsfundingbyNewYorkCityinterpretedFinleyasupholdingthe



NEW JErSEY’S INCENTIvE PrOGrAM, LIkE THOSE OF OTHEr STATES, WAS ENACTED

TO SPUr ECONOMIC DEvELOPMENT IN THE STATE.

6


“decency”and“respect”considerationsonlybyreadingthem,ontheirface,asnotpermittingviewpointdiscrimination.45Inthatcase,then-MayorGiulianiadvancedargumentssimilartothoseraisedbyGovernorChristie,statingthatNewYorkCitydidnothavetofundanartexhibitattheBrooklynMuseumthatitfoundtobeoffensiveandthatwhiletheexhibitcouldbeshownprivately,“thetaxpayersdon’thavetopayforit.”46Thefederaldistrictcourtrejectedthisargument,concludingthatwherethedenialofabenefit,subsidyorcontractismotivatedbyadesiretosuppressspeechinviolationoftheFirstAmendment,thatdenialwillbeenjoined.47

Conclusion

UntilcourtsareaskedtodecidetheextentofFirstAmendmentprotectionintheareaofstatemotionpictureandtelevisionproductionincentiveprograms,theindustrywillhavetooperateinanareaofuncertainty.Inthemeantime,thelessonforfilmmakerswhowanttoportrayTexasorUtahinanegativefashionistofilmyourmovieinNewJersey.MaybethereisapartforGovernorChristieinaremakeofA Fistful of Dollars.ItworkedforRonaldReagan,whynotChrisChristie?

1 NewJerseysuspendeditsfilmproductiontaxcreditprogramforfiscalyear2011.N.J.Stat.Ann.§54:10A-5.39a.Thetemporarysuspensionoftaxcreditsappliestotheauthorizationofnewcreditsandtheapplicationofpreviouslyauthorizedcreditsinthe2011fiscalyear.Itdoesnot,however,affectthecarryoverofunusedtaxcreditspreviouslyallowedorwhichmaybeallowedfollowingthesuspension.AssemblyBudgetCommitteeStatementtoAssemblyNo.3011(June24,2010).

2 http://www.state.nj.us/governor/news/news/552011/approved/20110926b.html.

3 Id.

4 MichaelCieply,State Backing Films Says Cannibal is Deal-Breaker,n.y. times,June14,2010,http://www.nytimes.com/2010/06/15/movies/15credits.html.

5 RussellGold,Vigilante Justice? Texas Refuses to Pay ‘Machete’ Producers,wall street journal,Dec.9,2010,http://blogs.wsj.com/washwire/2010/12/09/vigilante-justice-texas-refuses-to-pay-machete-producers/.

6 Tex.Gov’tCodeAnn.§485.022(e).

7 StateofUtahMotionPictureIncentiveFundFiscal

Year2011InformationandApplication,http://film.utah.gov/documents/MPIF-FY2011.pdf.

8 Wis.Admin.Code§133.30(4).

9 W.Va.Code§11-13X-3(b)(8)(F).

10 Wyo.Stat.Ann.§9-12-403(a)(v).

11 Ky.Rev.Stat.Ann.§148.546(9);FilmTaxCreditProgramGuidelinesOctober2009,http://filminpa.com/wp-content/uploads/2009/07/Film-Tax-Credit_Guidelines-09.pdf.

12 See,e.g.,Cal.Rev.&Tax.Code§23685(b)(15)(D).Thestatutestatesthat

“Qualifiedmotionpicture”shallnotincludecommercialadvertising,musicvideos,amotionpictureproducedforprivatenoncommercialuse,suchasweddings,graduations,oraspartofaneducationalcourseandmadebystudents,anewsprogram,currenteventsorpubliceventsprogram,talkshow,gameshow,sportingeventoractivity,awardsshow,telethonorotherproductionthatsolicitsfunds,realitytelevisionprogram,clip-basedprogrammingifmorethan50percentofthecontentiscomprisedoflicensedfootage,documentaries,varietyprograms,daytimedramas,stripshows,one-halfhour(airtime)episodictelevisionshows,oranyproductionthatfallswithintherecordkeepingrequirementsofSection2257ofTitle18oftheUnitedStatesCode.

Id.

13 See,e.g.,N.J.Stat.Ann.§54:10A-5.39.e(excludingproductionscontainingobscenematerial,asdefinedunderstatelaw,fromthedefinitionof“film”).

14 See,e.g.,ConnecticutguidelinespublishedbytheOfficeofFilm,Television&DigitalMedia,http://ct.gov/ecd/lib/ecd/3-5-10_lMediaMotionPictureTaxCreditGuidelines.pdf(requiringsubmissionofacopyofthefinalversionoftheproductioninDVDformat).InNorthCarolina,qualifyingexpensesaresubjecttoauditbeforethecreditisallowed.N.C.Gen.Stat.§105-130.47(d).AccordingtoNorthCarolinaFilmOfficeguidelines,acopyoftheproduction(rough-cutorfinishedcopyDVD)willberequestedataudit.Seehttp://www.ncfilm.com/uploads/downloads/Film%20Incentive%20Documents/NCFilmIncentive_Rev2010.pdf.

15 ItisquestionablewhetherGovernorChristiehasavetopowertorevokefilmcredits.NewJerseyregulationsprovidethatonlythemembersoftheNewJerseyEconomicDevelopmentAuthority(“EDA”)candenyanapplicant’seligibilityfortheprogram.N.J.Admin.Code§18:7-3B.5(c).WhenthemembersoftheEDAdenyarequestforfilmcreditstheirdecisionissubmittedtotheGovernorandtheEDA’sactioniseffective10daysaftertheGovernor’sreceiptoftheminutes,providednovetohasbeenissued.N.J.Admin.Code§18:7-3B.5(d).Basedontheplainlanguageoftheregulation,theGovernordidnothavethepowertovetothegrantofthefilmcredittoJersey Shore’sproducers.Byregulation,heonlyhadthepowertovetoafilmcreditdenialbytheEDA.However,invetoingtheJersey Shorecredits,GovernorChristierelieduponaconflictingstatuteprovidinggeneralvetopowerforactionstakenatEDAmeetings.N.J.Stat.Ann.§34:1B-4(i).

16 Gitlow v. New York,268U.S.652,666(1925).

17 Hannegan v. Esquire,327U.S.146,157(1946).

18 Fla.Stat.§288.1254(4)(b)(4).Thestatutestatesthat

family-friendlyproductionsarethosethathavecross-generationalappeal;wouldbeconsideredsuitableforviewingbychildrenage5orolder;areappropriateintheme,content,andlanguageforabroadfamilyaudience;embodyaresponsibleresolutionofissues;anddonotexhibitorimplyanyactofsmoking,sex,nudity,orvulgarorprofanelanguage.

Id.

19 Miller v. California,413U.S.15,23(1973).

20 Id.

21 AccordingtotheSupremeCourt,thestandardsfordeterminingwhethermaterialisobsceneare:(a)whethertheaverageperson,applyingcontemporarycommunitystandards,wouldfindthatthework,takenasawhole,appealstotheprurientinterest;(b)whethertheworkdepictsordescribes,inapatentlyoffensiveway,sexualconductspecificallydefinedbytheapplicablestatelaw;and(c)whetherthework,takenasawhole,lacksseriousliterary,artistic,political,orscientificvalue.Id.at24.

22 See,e.g.,Ala.Code§41-7A-42(8)(b);Ark.CodeAnn.§15-4-2003(8)(b)(iv);Cal.Rev.&Tax.Code§17053.85(b)(15)(D);Conn.Gen.Stat.§12-217jj(a)(3)(B);Ill.Comp.Stat.§16/10(7);Me.Rev.Stat.Ann.§13090-L(2-A)(D)(6);Md.CodeAnn.Tax-Gen.§10-729(a)(4);Mich.Comp.LawsAnn.§207.803(j)(1);OhioRev.CodeAnn.§122.85(A)(5);R.I.Gen.Laws§44-31.2-2(4);andS.C.CodeAnn.§12-62-20(3).

23 See,e.g.,Fla.Stat.§288.1254(1)(i)(2);Ind.Code§6-3.1-32-5(c);IowaCode§15.393(4);Ky.Rev.Stat.Ann.§148.542(15);Mo.Rev.Stat.§135.750(1)(2)(h);Mont.CodeAnn.§15-31-903(2)(b)(i);andPa.Stat.Ann.§8702-D.

24 OnOctober18,2011,anIowaDistrictCourtsentencedtheformerdirectoroftheIowaFilmOfficetotwoyears'probationforfeloniousmisconductinofficearisinginconnectionwithhisattemptstosecuretaxincentivesforamotionpictureproductioncompany.Iowa v. Wheeler,IowaDist.Ct.,No.CR-FECR-243355(Oct.18,2011).

25 Speiser v. Randall,357U.S.513(1958).

26 Id.at528-529.

27 Id.at518.

28 Id.

29 Arkansas Writers’ Project, Inc. v. Ragland,481U.S.221(1987).

30 Id.at230.

31 Id.at221.

32 See,e.g.,Simon & Schuster v.Members of the New York State Crime Victims Board,502U.S.105,115(1991).

33 Joseph Burstyn v.Wilson,343U.S.495,502(1952).

34 Rust v.Sullivan,500U.S.173(1991).

35 Id.at192.

36 Id.at193.

37 National Endowment for the Arts v. Finley,524U.S.569(1998).

38 Id.at584.

39 Id.at585.

40 Id.

41 Id.at587-88.

42 Id.at589(whereintheCourtalsodeniedtheFinleyplaintiffs’vaguenesschallengestothenewlaw).

43 See,e.g.,Ark.Stat.Ann.§15-4-2008(c)(2);Cal.Rev.&Tax.Code§23685(g)(1)(D);Fla.Stat.§288.1254(4)(a);W.Va.CodeSt.R.§110-13X-4.2;andWis.Admin.Code§133.34(1)(c).

44 http://www.nmfilm.com/filming/downloads/nm25PercentTaxCredit.pdf.

45 The Brooklyn Institute of Arts and Sciences v.City of New York,64F.Supp.2d184,202(E.D.N.Y.1999).

46 Id.at200.

47 Id.


http://www.state.nj.us/governor/news/news/552011/approved/20110926b.htmlhttp://www.state.nj.us/governor/news/news/552011/approved/20110926b.htmlhttp://www.nytimes.com/2010/06/15/movies/15credits.htmlhttp://www.nytimes.com/2010/06/15/movies/15credits.htmlhttp://blogs.wsj.com/washwire/2010/12/09/vigilante-justice-texas-refuses-to-pay-machete-producers/http://blogs.wsj.com/washwire/2010/12/09/vigilante-justice-texas-refuses-to-pay-machete-producers/http://blogs.wsj.com/washwire/2010/12/09/vigilante-justice-texas-refuses-to-pay-machete-producers/http://film.utah.gov/documents/MPIF-FY2011.pdfhttp://film.utah.gov/documents/MPIF-FY2011.pdfhttp://filminpa.com/wp-content/uploads/2009/07/Film-Tax-Credit_Guidelines-09.pdfhttp://filminpa.com/wp-content/uploads/2009/07/Film-Tax-Credit_Guidelines-09.pdfhttp://filminpa.com/wp-content/uploads/2009/07/Film-Tax-Credit_Guidelines-09.pdfhttp://ct.gov/ecd/lib/ecd/3-5-10_lMediaMotionPictureTaxCreditGuidelines.pdfhttp://ct.gov/ecd/lib/ecd/3-5-10_lMediaMotionPictureTaxCreditGuidelines.pdfhttp://www.ncfilm.com/uploads/downloads/Film%20Incentive%20Documents/NCFilmIncentive_Rev2010.pdfhttp://www.ncfilm.com/uploads/downloads/Film%20Incentive%20Documents/NCFilmIncentive_Rev2010.pdfhttp://www.ncfilm.com/uploads/downloads/Film%20Incentive%20Documents/NCFilmIncentive_Rev2010.pdfhttp://www.nmfilm.com/filming/downloads/nm25PercentTaxCredit.pdfhttp://www.nmfilm.com/filming/downloads/nm25PercentTaxCredit.pdf

7


Individualsthathave“responsible”positionsinacompanycouldbefoundtobepersonallyliableforthecompany’sunpaidtaxesincertainstates.Statetaxingjurisdictionsareincreasinglyturningtoresponsiblepersonlawstocollectunpaidliabilities.1Thistrendisdueinparttotheincreaseincompanybankruptciesduringthelastfewyears.From2007to2010,thenumberofU.S.companiesfilingforChapter7orChapter11bankruptcyalmostdoubled.2

Responsiblepersonliabilitymayapplyinthecontextofsalesandusetaxes,withholdingtaxesandcorporateincometaxes,aswellasallothertaxesadministeredbyastatetaxingauthority.Althoughresponsiblepersonissuesoftenarisefollowingbankruptcy,suchissuesmayalsopresentthemselvesfollowingdissolutionsandliquidations.Thetopicisimportantforofficers,membersandemployeeswhomaybepersonallyliableforsuchtaxesaswellasforin-housetaxdepartmentpersonnelwhomanagetaxreportingandpayment.

Inthisarticle,weaddress:(1)thetypesoftaxesandpenaltiesthatcouldbeatissue;(2)thetypesofindividualswhohavebeenfoundtoberesponsiblepersons;and(3)proceduralissuesthatmayarise.Onethingiscertain.Thatis,thestatesarenotuniforminthetaxesforwhichanindividualcouldberesponsible,theindividualswhocouldberesponsiblepersonsandtheapplicableprocedure.

Applicable Taxes and Penalties

Statesmayholdindividualsliableforsalesandusetaxes,withholdingtaxes,corporateincometaxesandeven,insomestates,alltaxesadministeredbythestatetaxingagency.Individualsmayalsoincurcivilpenaltiesorcriminalpenalties.Furthermore,jointandseveralliabilitymayapplytomultipleresponsiblepersonswithinacompany.

Sales and Use Taxes

Stateresponsiblepersonlawsoftenapplytosalesandusetaxes.Forexample,Californiaholdsresponsiblepersonsliablefor“anyunpaid[salesanduse]taxesandinterestandpenaltiesonthosetaxes,ifthe[responsibleperson]willfullyfailstopay[those]taxes.”3InadditiontoliabilityfortheCaliforniasalestaxthatshouldhavebeencollectedonacompany’ssales,anindividualmayberesponsibleforsalesandusetaxesthatthecompanywasresponsibleforpayingasaconsumeronitspurchases.4

Otherstates,suchasConnecticut,NewJersey,NewYorkandNorthCarolina,donotuselanguagethatisassuccinctastheCalifornialanguagetoimposepersonalliability,butprovideforliabilitybyincludingresponsiblepersonsinthedefinitionsofpersonsrequiredtocollectsalesandusetax.5

Withholding Taxes

Responsiblepersonlawsmayalsoapplytowithholdingtaxes.Forexample,theMassachusettstaxstatutesprovidethatanyofficeroremployee“whofailstowithhold[personalincometaxes]shallbepersonallyandindividuallyliablethereforetothecommonwealth.”6InSouthCarolina,aresponsiblepersonmaybe“individuallyliablefortheamountof[personalincometax]notwithheldorpaid.”7

All Taxes

Insomestates,individualsmaybeliableforalltaxesofacompany.Forexample,Virginialawprovidesthatanyofficeroremployeewhowillfullyfailstopay“anytaxadministeredbytheDepartment”maybeliableforthetax.8TheVirginiaDepartmentofTaxationadministers23taxesincludingcorporateincometax,salesandusetax,withholdingtax,bankfranchisetax,cigaretteexcisetaxandtelecommunicationstax.9

TheColoradostatuteissimilarlywordedandappliesresponsiblepersonliabilitytoanytaxadministeredbyArticle21.10TheColoradoDepartmentofRevenueadministers13taxesunderArticle21includingcorporateincometax,salesandusetax,withholdingtax,cigarettetaxandgasolinetax.11

Penalties and Interest

Inadditiontothetaxliability,astatemayprovidethatresponsiblepersonscanbeliableforpenaltiesandinterestthatwouldotherwisebeassessedonthecompany.12Forexample,inthesalestaxcontext,Connecticutexpresslyholdsresponsiblepersonsliableforthe15%latefilingpenaltythatistypicallyassertedagainstthecompany.13AresponsiblepersonunderConnecticutlawisalsoliableforinterestattherateof1%permonthrunningfromtheduedate.14

Statesmayalsoimposepenaltiesthatarespecifictoresponsiblepersons.IfaresponsiblepersonwillfullyfailstoremitColoradotaxes,suchasthecorporateincometaxorsalesandusetax,aresponsiblepersonmaybesubjecttoapenaltyof150%ofthetaxdue.15

Joint and Several Liability

Astatemayassertjointandseveralliabilityforacompany’sunpaidtaxes.NewYorkcaselawprovidesforjointandseveralliabilityforresponsiblepersons.16TheRhodeIslandDivisionofTaxation’spositionisalsooneofjointandseveralliability.17

Individual Liability for Company TaxesBy Mitchell A. Newmark and Richard C. Call


[IN COLOrADO], A rESPONSIBLE PErSON MAY BE SUBJECT TO A

PENALTY OF 150% OF THE TAx DUE.

http://www.mofo.com/mitchell-newmark/http://www.mofo.com/richard-c-call/

8


Thus,responsiblepersonsmaybefullyliablefortheunpaidtaxestotheextentthatthetaxliabilityhasnotbeensatisfiedbyanotherresponsibleperson.Forinstance,aNewYorkStateAdministrativeLawJudgerejectedtheargumentthat,becausetherewerethreeotherofficersthatwerealsoresponsibleforsubmittingtheunpaidtaxes,aresponsiblepersonshouldbeheldliableforonly25%ofacompany’sunpaidNewYorkwithholdingtax.18

Criminal Penalties

Beyondfinancialpenalties,somestatesimposecriminalliabilityonresponsiblepersonswhoknowinglyfailtocollectandremitacompany’staxestothestate.ItisaClassDfelonyinIndiana,forexample,foraresponsiblepersontoknowinglyfailtoremitsalestaxestothestate.19AClassDfelonyinIndianamayresultinimprisonmentofuptothreeyears.20

InVirginia,awillfulfailuretoremitsalesorwithholdingtaxcouldresultinanindividualbeingfoundguiltyofamisdemeanor.21CertainpersonswhowillfullyfailtofileaWisconsincorporateincometaxreturnmaybeguiltyofamisdemeanorinthatstate.22

Who Could Be a Responsible Person?

Thestatesvaryintheirdefinitionsofaresponsibleperson.Thedeterminationofwhoisaresponsiblepersonmaydependmerelyontheperson’stitleormaybeafact-intensiveinquiry.

Title-Based Liability

Somestatesconsideronlyanindividual’stitleinacompanytodeterminepotentialindividualresponsibility.Statesmayalsolooktowhetheranindividualisapartnerormemberinaflow-throughentity(forincometaxes)todeterminewhethertheindividualcouldbeliableforunpaidtaxes.

Forexample,theMarylandstatutesextendtheliabilityforMarylandsalesandusetaxesto“anypresident,vicepresidentortreasurer.”23TheMarylandstatutesdonotcontainlanguagethatwouldrequiresuchofficerstooverseeormanagefinancialortaxmattersofthecorporation.24

Alsotitle-based,theOhioregulationsprovidethatofficersofacorporationwhoown,collectivelyorindividually,morethana50%interestinthecorporationareliableforOhiowithholdingpaymentsandsalestaxifthecorporationfailedtofilewithholdingreportsorsalestaxreturnsorfailedtoremitpaymentwithafiledreportorreturn.25

UndertheNewYorkstatutes,apartner(whethergeneralorlimited)ofapartnershipandamemberofalimitedliabilitycompanymaybeheldstrictlyliableforthecompany’sNewYorksalestaxobligationsevenifthepartnerormemberdidnothaveadutytoremitthetaxonbehalfofthecompany.26Recently,theNewYorkStateDepartmentofTaxationandFinanceadoptedapolicythatrelievesqualifyinglimitedpartnersandmembersoflimitedliabilitycompaniesfromper seliabilityforsomeoralloftheunpaidNewYorksalesandusetaxesofthelimitedpartnershiporlimitedliabilitycompanyifspecificconditionsaremet.27

DefensestoTitle-BasedLiability

Instatesinwhichresponsibleperson

liabilityisbasedsolelyonaperson’stitle,stateorfederalconstitutionalprotectionsmaybeavailableasadefensetopersonalliability.Forexample,WestVirginiastatutesimposeliabilityoncorporateofficersforunpaidandunremittedWestVirginiasalestaxesanddonotcontainlanguagesettingforthanyotherstandardsforimpositionofsuchliability.28Nevertheless,theWestVirginiaSupremeCourtofAppeals,thestate’shighestcourt,statedthatdueprocessprotectionsintheWestVirginiaConstitutionmayabsolveacorporateofficerfrompersonalliabilityforacompany’sunpaidandunremittedsalestaxes,asfollows:

[I]ntheabsenceofstatutoryorregulatorylanguagesettingforthstandardsfortheimpositionofpersonalliabilityforunpaidandunremittedsalestaxesonindividualcorporateofficers...suchliabilitymaybeimposedonlywhensuchimpositionisinanindividualcasenotarbitraryandcapriciousorunreasonable,andsuchimpositionissubjecttoafundamentalfairnesstest.29

Recently,aWestVirginiaadministrativelawjudgeappliedthisfundamentalfairnesstestandrelievedanindividualofpersonalliabilitywhereitwasshownthattheindividualwasreleasedfromhispositionasavice-presidentbeforetheWestVirginiataxliabilitywasincurredandtheindividualhadnofinancialresponsibilitiesinthecompany.30

responsibility-Based Liability

Insomestates,aperson’stitleisnotdeterminativeofwhethertheindividualmaybearesponsibleperson;rather,anofficeroremployeecouldbeheldliableforthecompany’sunpaidtaxiftheindividualis“underaduty”toactforthecompanyincomplyingwithitstaxpaymentobligations.31Whetheranindividualisunderadutytoactmaybeafact-intensiveinquiryandmayinvolvethequestionofwhetherthepersonhadknowledgeof,orintenttoevade,thetaxliability.

DutytoAct?

Courtsmaylooktoavarietyoffactorstodetermineifataxpayerhasadutytoact.


Individual Liability(Continued from page 7)

IT IS A CLASS D FELONY IN INDIANA,

FOr ExAMPLE, FOr A rESPONSIBLE PErSON

TO kNOWINGLY FAIL TO rEMIT SALES

TAxES TO THE STATE. A CLASS D FELONY IN

INDIANA MAY rESULT IN IMPrISONMENT OF UP

TO THrEE YEArS.

9


Courtsmayalsolooktootherstatesthathavesimilarprovisions.

TheTaxCourtofNewJersey,inCooperstein v. Director, Division of Taxation,lookedtothefollowingninefactorstodeterminewhetherthepersoninquestionhasadutytoact:

(1)thecontentsofthecorporatebylaws;(2)statusasanofficerand/orstockholder;(3)authoritytosignchecksandactualexerciseofthisauthority;(4)authoritytohireandfireemployeesandactualexerciseofthisauthority;(5)responsibilitytoprepareand/orsigntaxreturns;(6)day-to-dayinvolvementinthebusinessorresponsibilityformanagement;(7)powertocontrolpaymentofcorporatecreditorsandtaxes;(8)knowledgeofthefailuretoremittaxeswhendue;and(9)derivationofsubstantialincomeorbenefitsfromthecorporation.32

TheCoopersteinTaxCourtadoptedtheaforementionedfactorsfromNewYorkcaselaw.33TheNewYorkcaselawrelieduponfactorssetforthbyafederaldistrictcourt.34

StatesotherthanNewJerseyhavereliedonfactorsthatincludewhethertheindividualisresponsibleformaintainingthecorporatebooks35orwhethertheindividualhadknowledgeofthetaxliabilitythroughaneducationalbackgroundorworkexperience.36

KnowledgeMayNotBeRequiredandMayTrumpGoodIntentions

Knowledgeof,orintenttoevade,ataxliabilitymaybeafactorindeterminingwhetheranindividualisaresponsibleperson.

TheTaxCourtofNewJerseyconsidersknowledgetobeonefactorintheanalysis,butdoesnotconsiderknowledgetobeanecessaryindicia

ofaresponsiblepersonliability.Forexample,theTaxCourtofNewJerseyfoundthattwocorporateofficerswereunawareoftheoutstandingsalestaxliabilityanddidnothaveanintenttoevadethesalestaxlaw.37Nevertheless,itfoundtheindividualofficersliableforacompany’soutstandingsalestaxobligations.38

Bycontrast,Texaslawimposesliabilityonanindividualforacompany’sunpaidsalestaxobligationsonlyiftheindividualwillfullyfailstopaythetax.39Aresponsiblepersonacts“willfully”iftheperson:

(1)“hasknowledge”thattaxesareowedandyetpaysothercreditors;or(2)“recklesslydisregardstherisk”thatthetaxesmaynotbepaidtothestate.40

In2010,thefederalFifthCircuitCourtofAppealsappliedTexaslawandfoundthetrusteeofacompanyinbankruptcyliableforthebankruptcompany’sunpaidsalestaxdespitethetrustee’sargumentthathisdutytomaximizetheestate’svaluesupersededhisdutytotimelypaythesalestaxliability.41Thecourtwasnotpersuadedbythetrustee’s“goodintentions”inasmuchasthetrusteeknewofthesalestaxliabilityandchosetopayothercreditorsinordertokeepthecompanyoperatingasagoingconcern.42

Procedural Issues

Twoproceduralissuesmeritconsideration:(1)extendedstatutesoflimitationsperiodsforassessmentsagainstresponsiblepersons;and(2)theidentificationofresponsiblepersonsonformsandreports.

Statute of Limitations

Thelimitationsperiodapplicabletoresponsiblepersonassessmentsmayexceedtheperiodwithinwhichataxauthoritymayassessthecompanyforthatsameliability.

TheCaliforniasalestaxlimitationsperiodforacompanyisthreeyearsfromthedatethatthereturnisfiled(exceptinenumeratedsituations).43However,theCaliforniastatutesauthorizeassessmentsagainstaresponsiblepersonwithineightyearsfromacompany’sdissolutiondateiftheCaliforniaStateBoardofEqualizationdoesnothaveactualknowledgeofthecompanydissolution.44

NorthCarolinahasamoregenerallyapplicableextensionthatappliesforashorterperiodthanCalifornia’sextensionperiod.TheNorthCarolinastatutespermittheDepartmenttoassessaresponsiblepersonduringaperiodthatextendsoneyearfromtheexpirationofthecompany’slimitationsperiod.45

Self-Identification as a responsible Person

Somestatetaxformsandreturnsrequirethattheprepareridentifyresponsiblepersons.Forexample,Californiarequiresidentificationofcorporateofficersforsalesandwithholdingtaxes.46InMichigan,ifthecompanyhiresapayrollprovidertoremitpayrolltaxes,thecompanymustfileForm3683,whichmustbesignedbythecorporateofficeronalinethatreads“[s]ignatureofCorporateOfficer,Partner,orMemberresponsibleforreportingand/orpayingMichigantaxes.”47Furthermore,NewYorkauditorshaverequestedthatcompaniescompleteresponsiblepersonquestionnairesaftersendingassessmentnoticestocompanies.48



THE COUrT WAS NOT PErSUADED BY THE TrUSTEE’S “GOOD

INTENTIONS” INASMUCH AS THE TrUSTEE

kNEW OF THE SALES TAx LIABILITY AND

CHOSE TO PAY OTHEr CrEDITOrS IN OrDEr

TO kEEP THE COMPANY OPErATING AS A GOING

CONCErN.

10


Conclusion

Individualliabilityforcompanytaxesisagreatconcernthatshouldnotbeoverlooked.Weencouragecompaniestocloselyreviewtheresponsiblepersonsprovisionsinthestatesinwhichtheyconductbusiness.Asdiscussedabove,thefactorstobeconsideredforindividualliabilityandthetaxesforwhichanindividualcouldbeliablevarybystate.Responsiblepersonlawsarelikelytocontinuetobeusedoftenbystatetaxingagenciestopursueindividualsforcompanyliabilities.

1 Althoughstatestatutesthatimposeindividualliabilityforacompany’sunpaidtaxesusevaryingterms,wewillrefertosuchlawsas“responsiblepersonlaws”andtheliableindividualsas“responsiblepersons,”unlessreferringtoastate’sspecificlaws.CompareN.Y.TaxLaw§1131(1)(providingthatacorporateofficeroremployeeisliableforsalestaxiftheindividualisundera“dutytoact”forthecorporationincomplyingwithitssalestaxobligations),withTex.TaxCodeAnn.§111.016(providingthatanindividualwho“controlsorsupervisesthecollectionoftax”fromanotherperson(e.g.,salestax,withholdingtax)isliableasa“responsibleindividual”).

2 AmericanBankruptcyInstitute,U.S.BankruptcyFilings1980-2010,www.abiworld.org(lastvisitedDec.29,2011).

3 Cal.Rev.&Tax.Code§6829(a).See alsoFla.Stat.§213.29;La.Rev.Stat.Ann.§47:1561.1.

4 Cal.Rev.&Tax.Code§6829(c).

5 SeeConn.Gen.Stat.§12-414a;N.J.Stat.Ann.§54:32B-2(w);N.Y.TaxLaw§§1131(1)&1133(a);N.C.Gen.Stat.§105-242.2(b).

6 Mass.Gen.Lawsch.62B,§5.See alsoAriz.Rev.Stat.Ann.§43-435;N.C.Gen.Stat.§105-242.2(b);UtahCodeAnn.§59-1-302(2).

7 S.C.CodeAnn.§12-8-2010(A)&(D).

8 Va.CodeAnn.§58.1-1813.

9 Va.CodeAnn.58.1,SubtitleI.ThetelecommunicationstaxistheVirginiaCommunicationsSalesandUseTaximposedbyVirginiaCodeAnnotatedsection58.1-648.

10 Colo.Rev.Stat.§39-21-116(2).

11 Colo.Rev.Stat.§39-21-102(1)&(2).

12 Statestatutesregardingpenaltiesforresponsiblepersonsshouldbereadcarefullyinasmuchasastatestatutemayusetheterm“penalty”torefertotheactualtaxliabilitythatisimposedonresponsiblepersons.See,e.g.,Ala.Code§§40-29-72(b)&40-29-73(a).

13 Conn.Gen.Stat.§§12-414a;12-419(a).TheCommissionermaywaivealloranypartofthepenaltiesif“failuretopayanytaxwasduetoreasonablecauseandwasnotintentionalorduetoneglect.”Conn.Gen.Stat.§12-419(c).

14 Conn.Gen.Stat.§§12-414a;12-419(a).

15 Colo.Rev.Stat.§39-21-116.5.

16 See Matter of Marchello,DTANo.821443(N.Y.S.TaxAppealsTribunal,Apr.14,2011)(interpretingN.Y.TaxLaw§§1131(1)&1133(a)).

17 SeeRhodeIslandAdmin.HearingDecision,2011-03(Feb.11,2011)(interpretingRhodeIslandGeneralLawsSection44-19-35toprovideforjointandseveralliabilityonresponsiblepersons).

18 See,e.g., Matter of Weinblatt,DTANo.819934(N.Y.S.Div.ofTaxApp.,Jan.19,2006)(statingthattheNewYorkDivisionofTaxationcouldpursuecollectionfromoneoralloftheresponsiblepersonssolongastheDivisiondidnotattempttocollectmorethanthetotalamountoftaxowed).AlthoughdeterminationsofNewYorkStateadministrativelawjudgesarenotprecedentialandmaynotbecitedinNewYork,theydoreflecttheviewsofanadministrativelawjudgewhoisknowledgeableoftheNewYorkTaxLawandareindicativeofhowanadministrativelawjudgemayruleonanissue.SeeN.Y.TaxLaw§2010.5;N.Y.Comp.CodesR.&Regs.tit.20,§3000.15(e)(2).

19 Ind.Code§6-2.5-9-3(2).

20 Ind.Code§35-50-2-7(a).

21 Va.CodeAnn.§58.1-1815.

22 Wis.Stat.§71.83(2)(a).

23 Md.CodeAnn.,Tax-Gen.§11-601(d).See Fox v.Comptroller,728A.2d776,779(Md.Ct.Spec.App.1999).

24 Md.CodeAnn.,Tax-Gen.§11-601(d).

25 OhioAdmin.Code5703-7-15(F)(withholdingliability);5703-9-49(F)(salestaxliability).

26 N.Y.TaxLaw§1131(1).

27 New Policy Relating to Responsible Person Liability Under the Sales Tax Law,TSB-M-11(17)S(N.Y.S.Dep’tofTaxation&Fin.Sept.19,2011).ForadditionalanalysisandinsightontheNewYorkDepartmentofTaxationandFinance’snewpolicy,seeIrwinA.Slomka,Update on Partial Relief from Responsible Person Liability for Limited Partners & LLC Members,Vol.2,iss.10mofo new york tax insightsp.2(Morrison&FoersterLLP,NewYorkOctober2011);IrwinA.Slomka,New Policy Offers Partial Relief from Controversial Responsible Person Liability,Vol.2,iss.5mofo new york tax insightsp.1(Morrison&FoersterLLP,NewYorkMay2011).

28 W.Va.Code§11-15-17.

29 Schmehl v.Comm’r,222W.Va.98,108(1998).

30 WestVirginiaAdministrativeDecision10-332W,WVSt.TaxRep.(CCH)P2001621029(May27,2011)(findingverbalreleasefromhispositionwasasufficientrelease).

31 See, e.g.,Mass.Ann.LawsCh.64H,§16;N.J.Stat.Ann.§54:32B-2(w);N.Y.TaxLaw§1131(1);Matter of Cohen,TSB-H-85(234)S(N.Y.S.TaxComm.,Oct.3,1985)(statingthatforNewYorkStatesalesandusetaxpurposes,“theholdingofcorporateofficedoesnot,per se,imposepersonalliabilityupontheofficeholder”).

32 Cooperstein v.Director, Div. of Taxation,13N.J.Tax68,88(TaxCt.1993),aff’d,14N.J.Tax192(App.Div.1994).

33 Id.

34 Id.at84.

35 20N.Y.Comp.CodesR.&Regs.526.11(b(2);Matter of Steinberg,DTANo.822971(N.Y.S.Div.ofTaxApp.Sept.9,2010)(findingpersonallyliableaCEOwhowasthechairmanoftheboardofdirectors,wasa“majorstockholder”ofthecorporation,wasresponsibleforthemanagementofthecompany’soperations,hadaccesstothebooksandrecords,hadtheauthoritytohireandfireemployeesandhadtheauthoritytosigntaxreturnsandchecksonbehalfofthecompany).ForadditionalanalysisonMatter of Steinberg,seeHollisL.Hyans,Executives Beware: Responsible Officer Liability,Vol.1,iss.1mofo new york tax insightsp.3(Morrison&FoersterLLP,NewYorkNov.2010).

36 Dellorfano v. Comm’r of Revenue,Mass.ATBFindingsofFactandReports2010-972,993(Mass.App.TaxBd.Oct.27,2010)(consideringitrelevantthatanofficerhadanLL.M.intaxationandhadpreviouslyworkedasataxcounselforacertifiedpublicaccountingfirmindeterminingwhethertheindividualhadadutytoact).

37 Skaperdas v. Director, Div. of Taxation,14N.J.Tax103(TaxCt.1994),aff’d,16N.J.Tax454(App.Div.1996).

38 Id.

39 Tex.TaxCode§111.016(b).

40 State v. Crawford,262S.W.3d532,542(Tex.Ct.App.2008).

41 Tex. Comptroller of Pub. Accounts v. Liuzza,610F.3d937(5thCir.2010).

42 Id.at942.

43 Cal.Rev.&Tax.Code§6487(a).

44 Cal.Rev.&Tax.Code§6829(f).ThelimitationsperiodislimitedtothreeyearsfromthedatethattheCaliforniaStateBoardofEqualizationobtainsactualknowledgeofthedissolution.Id.See also Ilko v. California State Board of Equalization,BAPNo.SC-09-1119-JuRMo,2009Bankr.LEXIS4541(B.A.P.9thCir.2009),aff’d without op.,651F.3d1049(9thCir.2011)(upholdingaresponsiblepersonassessmentmademorethantwoyearsafterthecompanydissolvedandmorethaneightyearsafterthesalestaxreturnsweredue).

45 N.C.Gen.Stat.§105-242.2(e).

46 CaliforniaSeller’sPermitApplication,available athttp://www.boe.ca.gov/pdf/boe400spa.pdf;RegistrationforCommercialEmployers,available at http://www.edd.ca.gov/pdf_pub_ctr/de1.pdf.

47 MichiganTaxForm3683,available at http://www.mi.gov/documents/3683f_2907_7.pdf.

48 See, e.g.,Matter of Crescent Beach,DTANo.822080(N.Y.S.TaxAppealsTribunal,Sept.22,2011)(theauditorrequestedthatthecompany’sCPAsubmitaresponsiblepersonquestionnaireforfourspecificemployeesatthecompanyafterissuingaStatementofProposedAuditChange);Matter of Grillo,DTANo.823237(N.Y.S.Div.ofTaxApp.,Nov.3,2011)(theauditorrequestedthecompletionofaresponsiblepersonquestionnaireforanumberofthecompany’sexecutiveofficers).


http://www.abiworld.orghttp://www.boe.ca.gov/pdf/boe400spa.pdfhttp://www.boe.ca.gov/pdf/boe400spa.pdfhttp://www.edd.ca.gov/pdf_pub_ctr/de1.pdfhttp://www.edd.ca.gov/pdf_pub_ctr/de1.pdfhttp://www.mi.gov/documents/3683f_2907_7.pdfhttp://www.mi.gov/documents/3683f_2907_7.pdf

11


“Businessincome”hasbeenastatutorilydefinedconceptsinceCalifornia’sadoptionoftheUniformDivisionofIncomeforTaxPurposesAct(“UDITPA”)in1965.1BywayofthreeclassicdecisionsfromtheCaliforniaStateBoardofEqualization(“SBE”),thisarticleexplorestherelationshipbetweenbusinessincomeandtheunitarybusinessconceptinthecontextofthedispositionofassetsthathadonlythe“potential” tobeincorporatedintoaunitarybusiness.Finally,thisarticlediscussesrecentCaliforniadecisionsanddevelopmentsinthearea.

Thedefinitionof“businessincome”foundinCaliforniaRevenueandTaxationCodeSection25120provides:

“Businessincome”meansincomearisingfromtransactionsandactivityintheregularcourseofthetaxpayer’stradeorbusinessandincludesincomefromtangibleandintangiblepropertyiftheacquisition,managementanddispositionofthepropertyconstituteintegralpartsofthetaxpayer’sregulartradeorbusinessoperations.2

ThisdefinitionhasnotbeenamendedbytheCaliforniaLegislaturesinceitsadoption.Administrativeandjudicialdecisionallawhasmadeclearthatthisstatutorydefinitioncontainstwoseparateandindependenttestsforbusinessincome:a“transactional”testanda“functional”test.3Rarelydoesthetransactionaltestcausedifficultiesinitsapplication,asitisusuallyclearwhetherornotincomearises“fromtransactionsandactivityintheregularcourseofthetaxpayer’stradeorbusiness.”4Incomparison,problemsaboundinapplyingtheseparatefunctionaltesttodetermineifandwhenincomearisesfromtheacquisition,managementanddispositionofpropertywhich“constituteintegralpartsofthetaxpayer’sregulartradeorbusiness

operations.”5RecallthatUDITPAisamodelapportionmentformulawhichcontainsnoprovisionsaddressingthetaxbase.Accordingly,thatapportionmentformulaisequallyapplicabletoasinglecorporation,aconsolidatedgroupofcorporationsoraunitarygroupofcorporations.InCalifornia,afiercelyunitarystate,anespeciallytroublesomeproblemarisesattheconvergenceofthefunctionaltestwiththeunitarybusinessconceptwhereassetshavebeenacquiredwiththeintent,albeitultimatelyfrustrated,tointegratethemintoaunitarybusiness.

Three Classic California State Board of equalization Decisions

Threedecisionsillustratethis“potential”tointegrateissue.

ThefirstdecisionisAppeal of Standard Oil,decidedbytheSBEin1983.6Therethetaxpayerreceivedapproximately$160millionofdividendsfromtwoentities.ThefirstentitywasArabianAmericanOilCo.(“Aramco”),inwhichthetaxpayerowneda30%interest.ThesecondentitywasP.T.CaltexPacificIndonesia(“CPI”),inwhichthetaxpayerowneda50%interest.Since1958,thetaxpayer’sproductionentitlementsinAramcoandCPIrepresentedatleast50%ofthetaxpayer’sworldwidesupply.

RelyingupontheCaliforniaFranchiseTaxBoard’s(“FTB”)regulationsandcaselaw,theSBEheldinStandard Oilthatthedividendswerebusinessincomeunderthefunctionaltest.TheSBEexplainedthefunctionaltestrequiresanexaminationoftherelationshipbetweentheintangiblepropertyandthetaxpayer’sunitarybusiness:

Iftheincome-producingpropertyinquestionisintegrallyrelatedtotheunitarybusinessactivitiesofthe

taxpayer,theincomeisbusinessincome...if the income-producing property is unrelated to the unitary business activities of the taxpayer, the income is nonbusiness income subject to specific allocation.7

TheSBEthenproceededtopointoutthetaxpayer’s“fundamentalpurpose”increatingtheAramcoandCPIoperationswastoensureanavailablesupplyofcrudeoilandnaturalgasliquidsforitsworldwidepetroleumoperations,thatthetaxpayer’s“regularuseofthesecrudeoilsupplyrightsembodiedinitsAramcoandCPIstockholdingsprovidedanecessaryandessentialelementofitsworldwideoiloperations,”thatwithouttheseinterests,thetaxpayer’s“competitivepositioninthepetroleumindustryanditsabilitytoeffectivelyutilizeitsrefiningandmarketingcapacitieswouldhavebeensubstantiallyimpaired,”andthatthetaxpayer’sinterestinthesetwooperations“contributedmateriallytotheproductionofoperatingincomefromtherestofappellant’sunitarybusinessandclearlyservedtofurthertheoperationsoftheintegratedpetroleumenterpriseconductedwithinandwithoutthisstate.”8

Thus,Standard Oil framedthebusinessincomeinquirybyjuxtaposingitagainsttheunitarybusinessinquiry:income“unrelated”totheunitarybusinessisnotbusinessincome.

ThesecondclassicSBEdecisiononthisissueisAppeal of Occidental Petroleum Corporation,whichwasdecidedlessthanfourmonthsafterStandard Oil.9 ThesignificanceofOccidental PetroleumisthatittooktheStandard Oil“related-unrelated”linkbetweenthebusinessincomeissueandtheunitarybusinessissueandapplieditinthecontextofassetswhichhadonlythe“potential”tobepartoftheunitarybusiness.

TherelevantfactsinOccidental Petroleumareasfollows:Inkeeping

Potential Unity and Business Income in CaliforniaBy Eric J. Coffill and Timothy A. Gustafson


http://www.mofo.com/eric-coffill/http://www.mofo.com/timothy-gustafson/

12


withitsexpansionprograminthenaturalresourcesarea,OccidentalwasinterestedincombiningthebusinessofKernCountyLand(“KCL”)withitsown.AfterfailingtoinduceKCL’smanagementtodiscussamerger,OccidentalinitiatedatenderofferforaportionofKCL’sstock.AlthoughOccidentalultimatelyacquiredover20%ofKCL’soutstandingstock,KCLthwartedOccidental’stakeoverbyagreeingtobeacquiredbyTenneco.Asaresultofthattakeover,OccidentalreceivedTennecostockinexchangeforitsKCLstock.OccidentalthensoldtheTennecostockforagainsothatitcouldredeployitsassetsintootherventures.

OccidentalalsoundertookafriendlyacquisitionofIslandCreekCoalCo.(“IslandCreek”).Priortotheacquisition,OccidentalhadacquiredsomeofIslandCreek’sstock.InordertoensurethattheInternalRevenueServicewouldclassifythemergerasatax-freereorganizationforfederaltaxpurposes,OccidentalwasrequiredtodisposeofitsIslandCreekstockpriortoconsummatingthemerger.AfterOccidentalsoldthestockforagain,themergerwithIslandCreekwassuccessfullyconsummated.

TheSBEinOccidental Petroleumnotedthattheevidenceclearlyshowedthatbothofthestocksalesinquestionwere“madepursuanttoaspecificcorporateplantoconsolidateorexpandtheunitarybusinessinaccordancewithanestablishednaturalresourcesorientation.”10However,eventhoughOccidental’spurposeinacquiringtheKCLandIslandCreekstockwastoexpanditsunitarybusiness,theSBEstatedthat

neitherthestockholdingsnortheassetsandactivitiestheyrepresentedconstitutedintegralpartsofappellant’sexistingunitaryoperationsatthetimesappellantdecidedtosellthem.In fact, at no time did they possess more

than the potential for actual integration into appellant’s ongoing business, and we believe that mere potential is insufficient to support a finding that the gains on these sales were business income under the functional test.11

Forthis“potential”versus“actual”distinction,theSBEinOccidental PetroleumdrewitssupportnotonlyfromStandard Oil,butalsofromF.W. Woolworth Co. v. Taxation & Revenue Department of New Mexico,wheretheUnitedStatesSupremeCourtstated“thepotentialtooperateacompanyaspartofaunitarybusinessisnotdispositivewhen,lookingat“the‘underlyingeconomicrealitiesofaunitarybusiness,’”thedividendincomefromthesubsidiariesinfactis“[derived]from‘unrelatedbusinessactivity’whichconstitutesa‘discretebusinessenterprise.’”12

ThelastofthethreedecisionsisAppeal of Mark Controls Corporation,anSBEdecisionfrom1986,whichprovidesaclassicillustrationoftheapplicationoftheOccidental Petroleum“potential”tointegratetest.13InMark Controls,theSBEdeterminedthatthetaxpayer’spurchaseofstockintwocorporationswiththeintenttointegratethecompaniesintothetaxpayer’scorebusinesswasinsufficientforafindingthatincomefromthestocksaleswasbusinessincomewhenthetaxpayerneverpossessedmorethanthepotentialforactualintegrationofthecompaniesintothetaxpayer’songoingunitarybusinessoperations.

TherelevantfactsofMark Controlsareasfollows:In1971,MarkControlspurchased49.5%ofthestockofWeirPacificValves,Ltd.(“Weir”)withanoptiontopurchaseadditionalsharesownedbytheWeirGroup.MarkControlsacknowledgedthepurposeforthepurchasewastoallowittoexpanditsmarketingandmanufacturingoperationstotheUnitedKingdom.Afterthepurchase,MarkControlsandWeirexecutedalicensingagreementthatallowedWeirtomanufacturesomeofMarkControls’productsandtherewereapproximately$200,000inannualintercompanysales.MarkControls

alsoreceivedaseatontheboardofdirectorsofWeir.AfteracquiringtheWeirstock,MarkControlsrealizedthatWeirwasmismanaged.MarkControlsthenattemptedtoimproveWeir’smanagementandprovidedtwoexecutivesinanattempttoimproveWeir’sperformance.However,theeffortsfailedandMarkControlssolditssharesin1976foragain.

Inaseparatetransactionin1975,MarkControlspurchased20%oftheoutstandingsharesofWalthon-WeirP.S.A.(“Walthon”).MarkControlsandWalthonexecutedalicensingagreementsimilartotheagreementwithWeir.MarkControlsalsoreceivedaseatonWalthon’sboardofdirectors.ConcernedwiththeproprietyofWalthon’sbusinessdealings,MarkControlssoldthestockin1977foragain.

TheSBEinMark ControlsbeganbyanalyzingtherelationshipbetweenWeirandMarkControls.WhiletheSBEobservedthepurchaseofalargeminorityblockinabusinesssimilartothebusinessofMarkControlssuperficiallyappearedtocreateanintegratedoperation,particularlycoupledwiththeintentofMarkControlstoexpanditsbusinessintheUnitedKingdom,theSBEconcludedtheactionsandintentofMarkControls“didnotresultinthestockholdingsnortheunderlyingassetsoractivitiesofWeirbecominganintegralpartofappellant’sbusiness.”14TheSBEfoundthatallofMarkControls’actions“were,atmost,preparatorytointegratingWeir”intotheunitarybusiness.15WhileMarkControlsplacedanemployeeontheboardofdirectorsofWeir,therewasnoevidencethisemployeehadanyinfluenceoverWeir’scorporatepolicyorday-to-dayoperations.ThiswasevidentbythefailureofattemptsmadetorepairWeir’smismanagement.Intercompanysalesbetweenthetwocompaniesalsofailedtoshowanyfunctionalintegrationastherewasnoindicationof“anyspecialeconomicadvantagegained”byMarkControlsbydoingbusinesswithWeir.16Asaresult,theSBEfoundthat“atnotimedidWeirpossessmorethanthepotentialforactualintegrationintoappellant’s

Potential Unity(Continued from page 11)


13


ongoingunitarybusinessoperations”and,citingOccidental Petroleum,foundthat“merepotentialisinsufficienttosupportafindingthatthegainsonthesestocksaleswerebusinessincomeunderthefunctionaltest.”17TheSBEthenconcludedthatthegainfromthesaleofWeir’sstockwasproperlyclassifiedasnonbusinessincome.

Similarly,theSBEfoundnointegrationbetweenMarkControlsandWalthon.AtnotimeduringtheownershipofthestockdidMarkControlsattempttocontroltheday-to-dayoperationsofWalthonandatnotimedidMarkControlsattempttointegrateWalthon’sactivitiesintoitsunitarybusiness.Theexistenceofthelicensingagreementmighthavecreatedapotentialforactualintegrationwiththeownershipofthestock,but,again,theSBErepeatedtheruleoflawfromOccidental Petroleumthat“merepotentialisinsufficienttosupportafindingthatthegainsonthesesaleswerebusinessincomeunderthefunctionaltest.”18

Accordingly,theSBEruleoflawunderOccidental PetroleumandMark Controlsisthatincomegeneratedbyanassetthathasonlythe“potential”tooperateasapartofataxpayer’sunitarybusinesscannotbebusinessincome.ThepointmadeinOccidentalPetroleum(aswellasinMark ControlsandearlierbytheUnitedStatesSupremeCourtinWoolworth)isthatincomefromassetsnot actually integratedintothetaxpayer’sbusinessdoesnotgiverisetobusinessincome.Inotherwords,ifthestockonlyhasthepotentialtobeintegrated,butisnotintegrated,thestockisnotanintegralpartofthetaxpayer’sregulartradeorbusiness.Thus,asinOccidentalPetroleuminvolvingOccidental’sstockinterestsinKCLandIslandCreekandinMark ControlsinvolvingMarkControls’stockinterestinWalthonandWeir,a“potential”unitaryassetproducesnonbusinessincome.

HowaretheseclassicdecisionsbeingappliedbytheSBEinmorecontemporarytimes?Tworecent,nonprecedentialSBEdecisions,Appeal of Crane Co. (2009)andAppeal of Rheem Manufacturing (2011),providesomeguidance.19

InCrane,thetaxpayer,CraneCo.&Subsidiaries(“Crane”),wasadiversifiedmanufactureroperatinginfivemajorsectors:EngineeredMaterials,MerchandisingSystems,Aerospace,FluidHandlingandControls.In1994,CraneacquiredELDECCorporation(“ELDEC”)asawholly-ownedsubsidiary,whichoperatedanindustrialwirelessbusinesssegment.ELDECsoughtastrategicpartnershipwithPOWEC,amanufacturerofproductsandpowersystems.ELDECenteredintoanagreementwithPOWEC,thetermsofwhichprovidedthatELDECwouldbePOWEC’sexclusivedistributorandELDECwouldacquirea47%interestinPOWEC.Thetwocompaniesalsoagreedtosharetechnology,informationandknow-howandenteredintoadistributionandlicensingagreementandashareholders’agreementwherebyELDECreceivedtherighttoappointtwoofPOWEC’sfiveboardmembers.In2000,ELDECsolditsinterestinPOWECandCranetreatedthegainonthesaleasnonbusinessincome.TheFTBdisagreed.

OnappealbeforetheSBE,CraneconcededthatboththeacquisitionanddispositionofPOWEC’sstockwereintegralpartsofitsbusinessunderthefunctionaltestbutarguedtheelementofmanagementwaslackingbecauseELDECheldonlyaminorityinterestinPOWECandcouldonlyappointtwooutoffivePOWECboardmembers.Thus,Craneargued,ELDECnevercontrolledPOWEC’sbusinesssuchthatitbecameinterwovenwithandinseparablefromCrane’sbusiness.CranealsoarguedELDEC’sintentionofaccomplishingbusinessintegrationnevercametofruitionandcitedtobothOccidental Petroleum andMark Controlsforthepropositionthatthemerepotentialforintegrationdoesnotgeneratebusinessincome.

TheSBEdisagreed.TheSBEconcludedthat“ELDECgeneratedbusinessincomeasaresultof[the]strategicbusinessrelationship”betweenELDECandPOWEC.20Accordingly,theSBEfound“thegainfromthesaleofthepropertyusedtogeneratethebusinessincome,i.e.,thePOWECstock,isalsobusinessincome.”21Indistinguishingitsformerdecisions,theSBEfound“there[was]noindication...thatELDECpurchaseditsinterestinPOWECasaninitialsteptowardbusinessintegrationwithPOWEC”andthat“theevidencedoesnotdiscloseanintentionby[Crane]tointegrate”thePOWECstockacquisitionintoitsbusiness.22

InRheem,thetaxpayerwasamanufacturerofwaterheating,airconditioningandheatingproductsthataresoldthroughdistributorstocustomers.RheemandWatsco,Inc.(“Watsco”)eachacquiredownershipinterestsinthreeotherdistributors.RheemsubsequentlyexchangeditsinterestinthesethreedistributorsforsharesinWatsco.In2003,RheemsolditsinterestinWatscoforagainofover$24million,whichitreportedasnonbusinessincome.TheFTBsubsequentlyauditedandassessedRheemandtheappealfollowed.

Onappeal,RheemarguedthefunctionaltestwasnotmetbecauseRheemandWatscowerenotunitary,operatedasseparatecompaniesandsharedneithercorporateofficersnoremployees.Rheemassertedithadnomanagementorotherdecision-makingcontroloverWatsco,holdingnomorethana4.3%ownershipinterestinWatscoatanytime.WhileWatscoaccountedfor24%ofRheem’sairconditioningsales,RheemstressedthatWatscoenteredintoagreementswithRheem’scompetitorswhichresultedinasignificantreductionofWatsco’spurchasesofRheem’sproducts.Initsbriefing,RheemcitedtobothOccidental Petroleum andMark Controlsforthepropositionthatasaleofstockwasnonbusinessincomewherethetaxpayerhadnotintegratedthestockintoitsunitarybusinessatthetimeofsale.

TheFTBrespondedthatthefunctionaltestwasmetbecauseRheem’s



14


acquisition,managementanddispositionoftheWatscostockcreatedaflowofvaluebetweenthetwocompanies.TheFTBarguedthatWatsco’sskillasadistributorledtoincreasedsalesofRheem’sproductsandbecauseWatscoaccountedfor24%ofRheem’sairconditioningsales,thestockwasintegraltoRheem’sbusiness.TheFTBassertedRheemhadnointentiontoacquireacontrollinginterestinWatscoandpointedtothelong-standingoperationalrelationshipithadwithWatscoandotherdistributorswithexclusivedistributionagreements.

TheSBEultimatelyrejectedRheem’scontentions,findingtherewasampleevidenceforconcludingthestockwasintegraltoRheem’sbusiness.23TheSBEnotedtherepresentationsmadebyWatscoindocumentsfiledwiththeU.S.SecuritiesandExchangeCommission,includingstatementsthatWatsco“maintain[ed]auniqueandmutuallybeneficialrelationship”withRheemandthatRheemhadacquiredanownershipinterestinthreedistributors“asajointventurepartner”withWatsco.24

Observations and Themes

Tosomeextent,theSBE's“potentiality”tointegrateissuedatingtoStandard OilandOccidentalhasnowbecomeusurpedbythegreaterissueofunity.Thatisbecause,likebeauty,“potentiality”isintheeyesofthebeholder,especiallywhenthoseeyesareattheFTB.Theanalysisnowseemstofocusmoreonabinaryinquiry,i.e.,whetherornotanassetispartofthetaxpayer’sunitarybusiness,withthegrayareaof“potential”integrationremovedfromtheinquiry.Perhapsputdifferently,theFTBseesactualitywheretaxpayersseepotentiality.Partofthisshiftmaybeexplainedbya2001decisionbytheCaliforniaSupremeCourt.

SubsequenttothethreeclassicSBEdecisionsaddressedabove,theCaliforniaSupremeCourtdecidedHoechst Celanese Corp. v. Franchise Tax Board.25TheretheCourtreiteratedthestatutorystandardthat,“[u]nderthefunctionaltest,corporateincomeisbusinessincome‘iftheacquisition,managementanddispositionofthe[income-producing]propertyconstituteintegralpartsofthetaxpayer’sregulartradeorbusinessoperations.’”26Thecourtwentontoexplainthatthe“criticalinquiry”forpurposesofthefunctionaltestis“thenatureoftherelationshipbetweenthispropertyandthetaxpayer’s‘businessoperations.’”27ThecourtexplainedthatthestatutorylanguageofSection25120requiresatwo-partinquiry.28First,thestatutoryphrase“‘acquisition,managementanddisposition’directsustoexamine‘thetaxpayer’sinterestinandpowerovertheincome-producingproperty.’”29Ifthetaxpayerhasasufficientinterestintheincome-producingpropertyunderthatstandard,onethenmovestothesecondinquirywhichiswhether“thetaxpayer’scontrolanduseoftheproperty[are]an‘integralpartofthetaxpayer’sregulartradeorbusinessoperations.’”30

Sofar,thatanalysisseemsstraightforwardandconsistentwiththelanguageofthestatutedefiningbusinessincome.ButtheCelaneseCourtthenwentontostate“that‘integral’requiresanorganicunitybetweenthetaxpayer’spropertyandbusinessactivitieswherebythepropertycontributesmateriallytothetaxpayer’sproductionofbusinessincome.”31Thus,thebusinessincomeanalysisappearstocomefullcirclebacktounity,orwhateverismeantby“organicunity”inthewordsoftheCelaneseCourt.

DoesCelanesechangetheanalysisunderStandard OilandOccidental?Theanswershouldbe“no,”becausethesame(un-amended)statuteisthebasisforandthesubjectofallthesedecisions.Plus,the“potential”standarddidnotoriginatewiththeSBE,butisrootedintheUnitedStatesSupremeCourtdecisioninWoolworth,whichmost

certainlycannothavebeenchangedoroverruledbytheCaliforniaSupremeCourtinCelanese.Inanyevent,donotbesurprisedtofindadiscussionwiththeFTBregardingthebusinessincome“potential”issuetobecomelitteredwithreferencesto“flowsofvalue”underContainerandtherelationbetweentheincomeandtheactivitiesinthetaxingstateunderASARCOandAllied Signal.32PerhapsnoweveryCaliforniastatutorybusinessincomeissue,includingthe“potentiality”issue,willbecomeanissueoftheFTB’sconstitutionalpowertotax.Ifso,thenthespecificlanguageofSection25120nolongerhasmeaningandthestatutebecomesonlya“long-arm”statuteinterpretedbytheFTBtomeanitcantaxcorporateincomeonanapportionedbasistothefullestextentpermittedundertheFederalConstitution.

Themostrecentexampleoftheissuesbrewingaroundthe“potential”tointegrateissueisthePacific Bellcase,whichwasdecidedbytheSBE,withoutanywrittendecision,inSeptember2011.33

InPacific Bell,thetaxpayeroperatedaregionaldomestictelephonecompanyin13states.PacificBellbegantoinvestinforeigntelecommunicationscompaniesinthe1990sandsentapproximately60employeestotheforeigncountrieswhereinthosecompanieswerelocatedtofunctioninanadvisorycapacitypursuanttoarm’s-lengthmanagementagreements.SomeoftheseagreementsalsoprovidedforPacificBelltoappointmemberstoaforeigncompany’sboardofdirectors.PacificBellbegandivestingitselfofitsforeigninvestmentsinthelate1990sandearly2000sbecauseitneededcapitaltogrowitsdomestictelecommunicationsbusiness.Atissueinthiscasewerethegainsfromthesaleofitsinvestmentinsevenforeigncompaniesduring2001and2002.

InarguingthefactsofthecasedidnotmeetthefunctionaltestunderCelanese,particularlywithregardtothestatutoryterm“integral,”PacificBellclaimedCelaneserequiredan



15


“organicunity”betweenthetaxpayer’spropertyandbusinessactivitiessuchthatthepropertycontributesmateriallytothetaxpayer’sproductionofbusinessincome.Additionally,PacificBellarguedCelanese heldthatthepropertymustbesointerwovenintothefabricofthetaxpayer’sbusinessoperationsthatitbecomes“indivisible”fromthetaxpayer’sbusinessactivitieswithbothgivingvaluetotheother.PacificBellalsoargueditneverhadaplantointegratetheforeigninvestmentsintoitsregularbusinessandthatvariousregulatory,logisticalandtechnologicalimpedimentspreventeditfromdoingsoifithadwantedto.Moreover,PacificBellarguedthatbecauseitonlyhadaminorityinterestintheforeigncompanies,itcouldnotexercisesufficientcontrolovertheinvestmentstointegratethemintoitsdomestictelephoneoperations.Also,PacificBellclaimedithadnomaterialintercompanysalesorlicensingagreementswiththeforeignentities.

TheFTBrespondedinpartthattheinvestmentswereintheidenticallineofbusinessasPacificBell’sregularbusinessoperations(i.e.,thetelecommunicationsindustry)andassuchwereacquired,maintainedanddisposedofasanintegralpartofthatbusiness.TheFTBalsoarguedPacificBell,throughitsemployeesactinginadvisorycapacitiesanditsrepresentativesservingontheboardsofthevariousforeigncompanies,wasactivelyinvolvedinthedailyoperations,includingthemanagement,oftheforeigninvestments.Further,theFTBarguedthatPacificBellgainedbusinessadvantagesthroughitsforeigninvestments,havingenteredintocooperationagreementsandagreementsregardingthesharingofinformationtechnologywiththeforeignentitiesandthatsuchbenefitsconstitutedaflow

ofvaluebetweenPacificBellandtheforeignentitiesundertheUnitedStatesSupremeCourtdecisioninContainer.34Moreover,theFTBarguedthatPacificBell’srelationshipwiththeforeignentitieswasaunitaryrelationshipandthatPacificBell,asoneoftheworld’slargesttelecommunicationscompanies,wasnotapassiveinvestorintheseentities.

AttheSBEhearing,thepartiesentertainedquestionsfromtheBoardMembersonvariousissues,including:whethertheforeigninvestmentswereinthesamegenerallineofbusinessasPacificBellandwhetherandtowhatextenttheforeigninvestmentswereindivisibleandinseparablefromPacificBell’sbusiness;therelationshipbetweentheforeigninvestmentsandPacificBell’sactivitiesinCalifornia;whatwastheappropriatelegalstandardunderthelanguageofCelanese andContainer;andwhetherPacificBell’scontrolanduseoftheforeigninvestmentscreatedaflowofvaluetoPacificBell’sproductionofbusinessincome.Afteralengthydiscussionofthefactsandthelaw,theSBEvoted5-0infavorofPacificBellonthisissue.35

Interestingly,anddespitetheopportunitytoprovidemuchneededguidanceonthisissue,theSBEchosenottopublishanywrittenopinion,formalorotherwise,inPacific Bell.Thus,taxpayersdealingwiththe“potential”tointegrateissuearestilllefttospeculateexactlywhichfactualscenariosorlegalargumentsultimatelywontheday.Anecdotally,atleasttwoothercasesaresetforhearingintheupcomingmonthsbeforetheSBEonthisissue.ItremainstobeseenwhethertheFTBortheSBEwilltakeamoredefinitivepositionunderthelawgoingforward.

1 Cal.Rev.&Tax.Code§§25120-25139.

2 Cal.Rev.&Tax.Code§25120(a).Conversely,nonbusinessincomeisdefinedas“allincomeotherthanbusinessincome.”Cal.Rev.&Tax.Code§25120(d).

3 SeeHoechst Celanese Corp. v. Franchise Tax Bd.,25Cal.4th508,526-527(Cal.2001);see alsoAppeal of Occidental Petroleum Corporation,Cal.St.Bd.ofEqual.,June21,1983.

4 Cal.Rev.&Tax.Code§25120(a).

5 Id.Thefunctionaltest“focusesonwhetherthepropertyservesanoperationalfunctioninthetradeorbusiness.”Cal.FranchiseTaxBd.,LegalRuling05-2(July8,2005).

6 Appeal of Standard Oil Company of California,Cal.St.Bd.ofEqual.,Mar.2,1983.

7 Id.(emphasisadded).

8 Id.

9 Appeal of Occidental Petroleum Corporation,Cal.St.Bd.ofEqual.,June21,1983.

10 Id.

11 Id.(emphasisadded).

12 Woolworth,458U.S.354,362(1982),quotingMobil Oil Corp. v. Commissioner of Taxes of Vermont,445U.S.425(1980).

13 Appeal of Mark Controls Corporation,Cal.St.Bd.ofEqual.,Dec.3,1986.

14 Id.

15 Id.

16 Id.

17 Id.(internalcitationsomitted).

18 Id.,citing Appeal of Occidental Petroleum Corporation.

19 Appeal of Crane Co. & Subsidiaries,Cal.St.Bd.ofEqual.,June30,2009(nonprecedentialsummarydecision);Appeal of Rheem Manufacturing Company,op’nonpet.forreh’g,Cal.St.Bd.ofEqual.,Apr.27,2011(nonprecedentialletterdecision).

20 Appeal of Crane Co. &Subsidiaries,Cal.St.Bd.ofEqual.,June30,2009(nonprecedentialsummarydecision).

21 Id.

22 Id.

23 Appeal of Rheem Manufacturing Company,op’nonpet.forreh’g,Cal.St.Bd.ofEqual.,Apr.27,2011(nonprecedentialletterdecision).

24 Appeal of Rheem Manufacturing Company,Cal.St.Bd.ofEqual.,hearingheldMay25,2010(nonprecedentialHearingSummary).

25 Celanese,25Cal.4th508(Cal.2001).

26 Id.at527.

27 Id.(internalcitationsomitted).

28 See Celanese,25Cal.4that528;see also Jim Beam Brands Co. v. Franchise Tax Bd.133Cal.App.4th514,524(2005).

29 Celanese,25Cal.4that528.

30 Id.

31 Id. at530.

32 Container Corp. v. Franchise Tax Board,463U.S.159(1983);ASARCO Inc. v. Idaho State Tax Commission,458U.S.307(1982);Allied Signal, Inc. v. Director, Division of Taxation,504U.S.768(1992).

33 Appeal of Pacific Bell Telephone Company & Affiliates,Cal.St.Bd.ofEqual.,CaseNo.521312,heardSept.20,2011(nonprecedentialdecision).

34 See Container,supra,463U.S.at179.

35 Appeal of Pacific Bell Telephone Company & Affiliates,Cal.St.Bd.ofEqual.,CaseNo.521312,heardSept.20,2011(nonprecedentialdecision).TheSBEvotedagainstPacificBellonanunrelatedtreasuryfunctiongrossreceiptsissue.


16


Taxmanagersandpayrolladministratorsincompanieswithemployeestravelingtomanystatesonbusinessfaceaformidableburdeninlearningandcomplyingwithdifficultwithholdingrequirementsinvariousstates.Stateincometaxstatutestypicallyimposewithholdingandreportingobligationsonemployerswhoseemployeestraveltothestateonbusiness,eveniftheemployees’visitstothestateareinfrequent.Althoughsomestatesprovideademinimisthresholdbeforerequiringtaxwithholdingfornonresidents(e.g.,14daysorfewerinNewYorkand60daysorfewerinHawaii),1suchthresholdstypicallydonotexemptemployeesfrompersonalincometax.Inaddition,currentsafeharborstendnottoapplytosituationsinvolvingdeferredcompensationorstockoptionsinasmuchasthatincometypicallyrelatestomultiyearcompensationarrangements.2

Determiningtheamountofwithholdingonincomefromdeferredcompensationandstockoptionsisparticularlychallenginginthecaseofnonresidentsgiventhedifficultlyindeterminingwhenincomeaccruesrelativetotheperiodthatthenonresidentemployeeperformsservicesinthestate.States’approachestoallocatingdeferredincomeandstockoptionincomevaryandleadtoconflictingresults.Inaddition,inmostcases,whenindividualsreceiveretirementandotherkindsofdeferredcompensation,theyarenolongeremployeesofthecompany.

CongressiscurrentlyconsideringtheMobileWorkforceStateIncomeTaxSimplificationActof2011,underwhichanemployee’swageswouldnotbesubjecttopersonalincometaxorwithholdingandreportingrequirementsinanystateother

thantheemployee’sstateofresidenceandinastateinwhichtheemployeeispresentandperformingemploymentformorethan30daysduringacalendaryear.3Unfortunately,theproposaldoesnotadequatelyaddressthewithholding(andpersonalincometax)complexitiesraisedbydeferredcompensationandstockoptionincome.Untilfederallegislationisenactedormodelstaterulesareadopted,employersmustunderstandvaryingstatewithholdingrequirementsondeferredcompensationandstockoptionincome.Inmanystates,inadditiontobeingliableforthetax,anemployerispotentiallysubjecttopenaltiesforfailuretoproperlywithhold4andemployees,ownersandofficersmaybeheldpersonallyliablefortheunpaidwithholdingtaxes,interestandpenalties.5However,employerscanreducetheirwithholdingtaxexposurewithcarefulmonitoringofstateincomeallocationapproaches,managementofemployeemovement,implementationofrecordkeepingsystemsandcommunicationwithemployees.Thisarticlebringsyouanupdateonthelatestallocationapproachesstatesareusingtodeterminetheamountoftaxwithholdinganddiscussestheissuesandpracticescorporatetaxmanagersandpayrolladministratorsshouldconsiderwhenmanagingthistypeofwithholdingfortheirmobileworkforce.

Deferred Compensation

Deferredcompensationisgenerallyincomethatispaidatalaterdatethanwhenitisearned.Commonexamplesofdeferredcompensationincludepensionandretirementincomeandstockoptionincome.Therearetwoprimaryissuesthatariseatthestatetaxlevelwithrespecttodeferredcompensation.Firstiswhetherastateisprohibitedfrom

taxingsuchincomeunderfederallaw.And,second,ifastateisnotprohibitedfromtaxingtheincome,whatisthepropertimingforwithholdingandtheproperamountofincomethatissubjecttowithholding?

Federal Preemption of Taxation of Certain retirement Income

In1996,Congressenactedafederalstatute(P.L.104-95)thatprohibitsstatesfromimposingincometaxonthe“retirementincome”ofnonresidents.6Thus,underP.L.104-95,thestatewheretheincomeisearned(the“sourcestate”)maynottax(orrequirewithholdingfor)someonewhoisanonresidentofthesourcestateon“retirementincome.”“Retirementincome”isbroadlydefinedtoincludepaymentsfromseveralcategoriesoffederallyqualifiedplansmeetingtherequirementsofspecificprovisionsoftheInternalRevenueCode(“I.R.C.”),including401(k)andpensionplans,annuities,IRAs,anddeferredcompensationofstateandlocalgovernmentsandtaxorganizations.7Inaddition,protected“retirementincome”includesbenefitsfromnonqualifieddeferredcompensationplansdescribedinI.R.C.Section3121(v)(2)(C),asdefinedforpurposesoftheFICA(socialsecurity)taximposedwithrespecttoemployment,providedthatthepayments


Managing Withholding for a Mobile Workforce: Special Treatment of Deferred Compensation and Stock OptionsBy Paul H. Frankel and Debra S. Herman

EMPLOYErS MUST UNDErSTAND vArYING STATE WITHHOLDING

rEqUIrEMENTS ON DEFErrED

COMPENSATION AND STOCk OPTION INCOME.

http://www.mofo.com/paul-frankel/http://www.mofo.com/debra-s-herman/

17


arepartofaseriesofsubstantiallyequalperiodicpaymentsmadeatleastannuallyforeitherthelifeorlifeexpectancyoftherecipientoraperiodofatleast10years.8In2006,10yearsafterP.L.104-95’senactment,Congressamendedthelawtocoverpaymentsreceivedfromnonresidentretiredpartners,asseveralstatestookthepositionthatthelawasoriginallyenacteddidnotprohibitastatefromimposingitsincometaxonpaymentsreceivedbyretiredpartnersunderdeferredcompensationplans.9

TheNewYorkStateDepartmentofTaxationandFinance(“Department”)recentlyconsideredwhetheranemployerhadanobligationtowithholdondistributionsfromanonqualifieddeferredcompensationplantotwononresidentformeremployeesofthecompany.10Astheemployeeselectedtotakeannualdistributionsfromtheplanaspartofaseriesofsubstantiallyequalinstallmentpaymentsovera10-yearperiodandtheplanqualifiedasaplandescribedinI.R.C.Section3121(v)(2)(C),theDepartmentconcludedthatthedistributionswerenotsubjecttoNewYorkStateincometaxandNewYorkStateincometaxwithholding.Instead,theemployerwouldwithholdinthetwoemployees’statesofresidence.

InaletterrulingissuedinMassachusetts,theCommissioneroftheDepartmentofRevenueadvisesemployersthatherequiresthemtoobtainaMassachusettsWithholdingExemptionCertificateforPension,AnnuityandOtherPeriodicPayments(FormM-4P)whendeterminingifMassachusettswithholdingisrequiredforretirementpayments.11TherulingfurtherprovidesthatanemployercanrelyontheinformationsetforthinFormM-4Pregardingstateofresidence,unlesstheemployerhasknowledgethatsuchinformationisfalse.12

Employersshouldconsiderobtainingarulingfromrelevantstatesontheissueof

federalpreemption.AlthoughP.L.104-95coversincomefrommostpensionandretirementplansdefinedintheI.R.C.,manytypesofdeferredcompensationincomearenotcoveredandarepotentiallysubjecttotaxbystateswheretheincomewasearned.Furthermore,whenstatetaxation(andwithholding)isnotbarredbyfederallaw,employersshouldconsiderwhetherthereareanystatespecificexemptionsthatcouldapply.Forexample,inNewYork,deferredcompensationthatqualifiesasanannuityisnotsubjecttopersonalincometaxandwithholding.13Ifnoexemptionapplies,thenemployersshouldconsiderthepropertimingforwithholdingandtheamountofwithholding.

Timing and Amount of Withholding

Moststatesfollowthetimingofincomerecognitionusedforfederalincometaxpurposes.Thisisprimarilybecausemoststatesstartwithfederaladjustedgrossincomewhendetermininganemployee’spersonalincometaxes.14Manystatesalsoadoptthefederaldefinitionofwagesforpurposesofstateincometaxwithholdingandrequirewithholdingbasedonthesamepayrollperiodusedforfederalincometaxwithholding.15Thus,inmoststates,withholdingofstatepersonalincometaxesisrequiredwhenthedeferredcompensationisproperlyincludableinthetaxpayer’sfederaladjustedgrossincome.Usuallythisiswhenthedeferredcompensationispaid(i.e.,thestockisdistributedtotheemployee).However,therearesomeexceptions.Forexample,inPennsylvania,withholdingmayberequireduponthedeferraloftheincome(i.e.,whenthecontributionismadetotheplan)underaconstructivereceipttheory.16Asnotedabove,somestatesprovidesafeharborprovisions,basedeitheronathresholdnumberofdaysanemployeeispresentinastateorondollaramounts,thatrelievetheemployerofwithholdingobligationsuntilthethresholdistriggered.17Severalstatesalsohavereciprocalagreementsthatexemptanemployerfromwithholdingtaxonanonresidentemployeewhoworksinthatstateiftheemployee’shomestatehasareciprocalagreementwiththestatethattheemployeeworksin

andthatstateexemptsasimilarlysituatedemployerfromawithholdingrequirement.18

Theamountofdeferredincomesubjecttostatewithholdinggenerallywillconformtotheamountincludableinfederalgrossincome.However,theportionofthatamountthatwillbesubjecttopersonalincometax,andthuswithholdingtax,dependsonwhethertheemployeeisaresidentandwheretheemployeeearnedtheincome.Statesgenerallytaxresidentsonallincomereceived,regardlessofthesourceoftheincome(i.e.,wheretheincomeisearned).19Thus,thegeneralruleisthatwithholdingisrequiredonallofaresidentemployee’scompensationincome.Iftheresidentemployeeperformedservicespartlywithintheresidentstateandpartlywithinanotherstate,thestateofresidencegenerallyprovidesacreditfortaxespaidtothesourcestateandwithholdingisrequiredonlytotheextentthattheresidentstate’swithholdingtaxliabilityisgreaterthanthetaxthathasbeenwithheldforthesourcestate.

States’personalincometaxationandwithholdingfornonresidentsaremorecomplex.Moststatestaxnonresidentindividualsonlyonincomethatisderivedfromsourcesinthestate(“sourceincome”).20Withrespecttowages,theinquiryiswhethertheincomeisattributabletoservicesperformedinthestate.Inmoststates,theportionofcompensationthatisattributabletoservicesperformedinthestateisdeterminedbasedontheratioofdaysworkedinthesourcestatetothetotaldaysworkedduringtherelevantperiod.21Ofcourse,statesvaryindetermininghowadayshouldbecalculatedandthescopeofthecompensableperiod,inparticularwhenstockoptionsareinvolved.22

Stock Option Income

Ingeneral,therearetwotypesofstockoptionplans:statutoryandnonstatutory(fromafederaltaxperspective).Statutorystockoptionsincludeincentivestockoptions.23Employeeswhoreceivestatutorystockoptionsdonotrealizeincomewhentheyaregrantedtheoptionorwhentheyexercisetheoption.Instead,employeescandefertaxuntiltheysellorexchangethestock.24Nonstatutorystock


Managing Withholding(Continued from page 16)

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optionsdonotreceivethesamefavorabletimingandcharacterofincometreatmentasstatutorystockoptions,butemployeeswhoreceivetheseoptionsmaybeabletodeferthetaxunderI.R.C.Section83.Ingeneral,anemployeerecognizesgainonthegrantofthenonstatutorystockoptionsiftheoptionshaveareadilyascertainablefairmarketvalue.25Morecommonly,employeesrecognizeordinaryincomeupontheexerciseofthestockoptions,measuredbytheexcessofthefairmarketvalueoftheoptionedsharesovertheoptionexerciseprice.26Thereafter,theappreciationrecognizedonthesaleofthestockistreatedasgainderivedfromthesaleofthestock(investmentincome)andistypicallyofnoconcerntotheemployer.27Moststates’rulesfollowthesefederalprinciples;however,complexityarisesoverhowtodeterminetheproperamountofincomethatshouldbeallocatedtoaparticularstatewhenthetaxpayerisanonresidentandhasperformedservicesinmultiplestatesovertheyearsatissu