California Firms Risk Penalty When Using MTC Apportionment Option, FTB Warns

The Bloomberg BNA Tax Management Weekly State Tax Report filters through current state developments and analyzes those critical to multistate tax planning.

By Laura Mahoney  

SACRAMENTO, Calif.--Corporate taxpayers facing an Oct. 15 deadline to file state income tax returns risk a 20 percent understatement penalty if they assign income to California based on an Oct. 2 appellate court ruling that is not yet final, the Franchise Tax Board said in an alert to taxpayers. [Cal. Franch. Tax Bd., News Flash, 10/5/12]

The FTB issued the guidance in response to questions from taxpayers and practitioners about the appellate court ruling in Gillette v. Franchise Tax Board, Cal. Ct. App., No. A130803, 10/2/12. The taxpayers have asked the FTB to clarify the ruling's interaction with the large corporate understatement penalty (LCUP), as well as with legislation enacted in June regarding taxpayer options for apportioning income on their original or amended returns.

Under the court ruling, the FTB must allow taxpayers to use the income apportionment formula in the Multistate Tax Compact, which is a three-factor formula weighted equally on property, payroll, and sales in the state versus sales elsewhere.

The ruling overturned the FTB's position, which was that taxpayers must use a formula enacted in 1993 that deviates from the compact and requires apportionment based on property, payroll, and two-times sales.

Gillette Ruling Not Final Until Nov. 1.

Under court rules, the Oct. 2 opinion becomes final 30 days after it is issued, which is Nov. 1. Until then, the FTB's position that the double-weighted sales factor is the only valid apportionment formula is still state law, the tax agency said.

“Staff believes that taxpayers choosing to elect the use of the Compact method of apportionment on a timely filed original return for the 2011 taxable year, that is filed before the decision of the Court of Appeal in Gillette v. Franchise Tax Board is final, will run the risk of incurring the LCUP if that decision is subsequently vacated, reversed, or overturned,” the FTB spokeswoman Susan Maples said in an emailed statement.

Partially underpinning the FTB's position is S.B. 1015, a law enacted in June to repeal the Multistate Tax Compact as a hedge against a loss for the state in Gillette and with it a revenue loss of at least $500 million.

In S.B. 1015, lawmakers also said elections affecting the computation of tax must be made on original returns. If taxpayers elect the four-factor formula on an original return, then file an amended return claiming the three-factor formula in the compact, the election on the amended return would be invalid.

Lawmakers said S.B. 1015 did not change state law, but was declarative of existing law regarding the doctrine of elections.

Penalty Relief Provisions Do Not Apply.

In light of Gillette, taxpayers that might benefit from using the three-factor apportionment formula in the compact asked the FTB to clarify how the agency might apply the large corporate understatement penalty if taxpayers elect to use the compact formula on an original return. The LCUP is a 20 percent penalty levied on understatements of income tax greater than $1 million, or 20 percent of the total tax liability, on an original return. It is a strict liability penalty, with little discretion on the FTB's part in applying it to taxpayers.

The LCUP provision of the Revenue and Taxation Code that allows the FTB to relieve the penalty if it is imposed on an understatement due to a change in law occurring after a return is filed “is not applicable to the question raised because the state of the law on October 15, 2012 does not include the decision of the Court of Appeal in Gillette v. Franchise Tax Board, as it has not yet become final,” the FTB said. “Therefore, there is no 'change in law’ that will occur should the decision be vacated or overturned after October 15, 2012. The law would be the same as it was at the time the taxpayer filed the return.”

Maples told BNA that the FTB will be issuing more guidance soon to advise taxpayers how to file protective claims for refund if they want to use the compact's apportionment formula but cannot do so on an original return. Those refund claims will not be addressed until the Gillette case is completely resolved.

The FTB is expected to appeal the Oct. 5 appellate ruling to the California Supreme Court, and the case will eventually be sent back to state trial court to resolve issues that remain after appeals are exhausted.

The FTB's position on application of the LCUP to taxpayers with an Oct. 15 state income tax return deadline will be posted on the FTB website the week of Oct. 8.

Text of the guidance is available at https://www.ftb.ca.gov/professionals/tax_news_flash/2012/100512.shtml.

By Laura Mahoney  



Copyright 2012, The Bureau of National Affairs, Inc.