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California: CDTFA’s Application of Differing Audit Methods was Arbitrary

The California Office of Tax Appeals (OTA) recently ruled in a taxpayer’s favor in a case addressing whether the Department of Tax and Fee Administration (CDTFA) appropriately applied different audit methods to determine the taxpayer’s unreported sales. The taxpayer, a perfume retailer, did not keep adequate books and records to verify sales data reported on its sales and use tax returns. As such, the CDTFA appropriately applied an indirect audit method to compute the taxpayer’s unreported sales. The auditor applied two methods, the bank deposits method and a method based on the taxpayer’s federal income tax returns (FITR method). Notably, for each tax year, the CDTFA applied the indirect audit method that resulted in a higher amount of unreported sales, as opposed to applying the same method for the entire period. If the CDTFA had used either the bank deposits method or the FITR method for the entire period, the two methods resulted in similar calculations of unreported taxable sales: $886,746.00 and $870,024.00, respectively. Instead, by selectively choosing which indirect audit method to use each period, the CDTFA increased unreported taxable sales to $941,442.00.

The OTA noted at the outset that when CDTFA is not satisfied with the amount of tax reported by the taxpayer, it may determine the amount required to be paid based on any information which is in its possession or may come into its possession. In the case of an appeal, CDTFA has a minimal, initial burden of showing that its determination was reasonable and rational. Once CDTFA has met its initial burden, the burden of proof shifts to the taxpayer to establish that a result differing from CDTFA’s determination is warranted. On appeal, the OTA determined that the use of the two different audit methods was not rational or reasonable in this instance. In the audit work papers, the CDTFA explained that it had alternated between the two methods based on which method would result in higher audited taxable sales. In the OTA’s view, when the CDTFA alternated between indirect audit methods because one method produced a higher result, the CDTFA was no longer attempting to estimate the correct measure of tax but instead was arbitrarily increasing the tax measure. The OTA found that the use of the bank deposits method for the entire liability period was reasonable and rational, and adjusted the computation of the appellant’s taxable sales accordingly. One OTA panel member dissented from the majority on the basis that the initial burden test is a minimal threshold for CDTFA to meet. In the dissenting member’s view, there may be more than one method which is reasonable and rational, and CDTFA may select any reasonable and rational method.  Please contact Jim Kuhl with questions on Appeal of Colambaarchchi.

New Jersey: Convenience of the Employer Rule Enacted

Recently enacted New Jersey Assembly Bill 4694 is intended to alleviate the tax burdens imposed on New Jersey residents who are assigned to work locations outside of the state. First and foremost, the bill adopts a so-called “convenience of the employer� test for sourcing nonresident employee wages if the nonresident’s state of residence applies a convenience of the employer rule to source similar wages to their state. Currently five states, Connecticut, Delaware, Nebraska, New York and Pennsylvania have convenience of the employer rules in affect.  Residents of these states, except Pennsylvania, are covered under this recently enacted legislation.   New Jersey and Pennsylvania have an existing reciprocity agreement which exempts nonresident withholding of a resident of either state for services performed in the other state.  The provisions of Assembly Bill 4694 shall not affect any agreement entered into by the Division of Taxation for such reciprocity.  For example, New York currently applies a convenience of the employer rule, which results in nonresident employees having New York income taxes withheld on days when employees are working remotely (other than when the remote work is at the necessity of the employer). Under the bill, if a resident of New York is working for a New Jersey employer from their home for the employee’s own convenience (and not out of necessity of the employer), the income or wages earned by the New York resident are allocated to the employer’s location in New Jersey. The convenience of the employer rule is effective retroactively to tax years beginning on or after January 1, 2023.

Assembly Bill 4694 also provides tax credits to incentivize New Jersey residents to file legal actions against other states that collect taxes from them for services they perform while physically located in New Jersey. Specifically, a refundable tax credit will be available to resident taxpayers who: (1) pay any income tax or wage tax imposed for the taxable year by another state of the United States, or political subdivision of such state, or by the District of Columbia; (2) apply for and are denied a refund from such state or jurisdiction for taxes paid to that state or jurisdiction on income derived from services rendered while the resident taxpayer was within New Jersey; (3) file an appeal with a tax court or tribunal through which the resident taxpayer formally protests the denial by another state or jurisdiction of the refund requested by the resident taxpayer for taxes paid on income derived from services rendered while the resident taxpayer was within New Jersey; and (4) obtain a final judgement from the tax court or tribunal resulting in the resident taxpayer being refunded taxes paid to another state or jurisdiction on income derived from services rendered while the resident taxpayer was within New Jersey.  The amount of the tax credit is equal to 50 percent of the amount of taxes that are owed to New Jersey because of adjusting the credit for taxes paid to another state. Finally, the bill establishes a pilot program to award grants to businesses that assign New Jersey resident employees to New Jersey business locations. Other than the retaliatory “convenience of the employer� provision, all provisions take effect upon enactment. Please contact John Montgomery with questions on New Jersey Assembly Bill 4694.

Oklahoma: Guidance Issued on Repeal of the Franchise Tax

The Oklahoma Tax Commission recently reminded taxpayers that the 2023 tax year is the last year that franchise tax returns will need to be filed. Beginning with the 2024 tax year, the franchise tax is repealed and there is no longer a filing requirement. The due date for 2023 tax year returns varies. Taxpayers that file a Form FRX 200 and who remit the maximum amount of franchise tax ($20,000 in the preceding tax year) are required to remit the tax annually by May 1. The final franchise tax return must be remitted on or before June 1, 2024, to avoid being delinquent. Other Form FRX 200 filers are required to remit by July 1, 2024 and must do so by September 15, 2024 to avoid being delinquent. Taxpayers that have elected to pay as part of the corporate income tax return will remit the franchise tax liability with the filing of the 2023 corporate income tax return. Currently, the Tax Commission collects a Registered Agent’s fee on behalf of the Secretary of State and taxpayers are required to file an Officer’s list with the franchise tax return. Additional information will be issued as to how payment of the Registered Agent’s fee will be handled in light of the franchise tax repeal, as well as whether taxpayers will still be required to file an Officer’s List. Please contact Asad Markatia with questions on Oklahoma’s franchise tax repeal.

Texas: No Tax Due Reports Eliminated for Certain Entities

Recently enacted Texas Senate Bill 3 increases the franchise (margin) tax exemption from $1.0 million to $2.47 million effective for reports originally due on and after January 1, 2024. This amount is adjusted periodically for inflation. Furthermore, also effective for reports originally due on or after January 1, 2024, the bill repeals the requirement that certain businesses that fall under this exemption file an No Tax Due Report information with the Comptroller.  Certain entities, including passive entities, and REITs, will continue to have a requirement to file the No Tax Due Report. Further, there are no changes around the requirements to file a Public Information Report under Texas Tax Code §171.203, or the Ownership Information Report under Texas Tax Code §171.202.  As a reminder, for the 2023 report year, an entity that has total annualized revenue less than or equal to the current inflation adjusted no tax due threshold of $1,230,000 must file a No Tax Due Report. Please contact Jeff Benson with questions.