For over 50 years, Bloomberg BNA’s renowned flagship daily news service, Daily Tax Report® has helped leading practitioners and policymakers stay on the cutting edge of taxation and...
Aug. 31 — The fiduciaries for a family trust that lost its second appeal before the State Board of Equalization over the amount of its California taxable income are weighing whether to go to state court to continue an argument that would upend 80 years of state taxation of trusts.
The appeal of Paula Trust (SBOE No. 759422) involving the family of Century Theaters Inc. founder Raymond Syufy hinged on tax laws and regulations from the 1930s, referenced a dispute over taxation of Marilyn Monroe's estate and prompted state employee labor unions to lobby the board out of concern that it would create a new opportunity for tax avoidance.
The unanimous Aug. 30 SBOE ruling against Paula Trust capped two years of appeals and two oral hearings before the five-member elected board, and resulted in the same outcome: all of the trust's income is taxable in California.
According to the Franchise Tax Board, the state could have lost billions of dollars in revenue if the board reversed itself and ruled in favor of the trust.
Edwin Antolin and Prentiss Willson, attorneys for Paula Trust, told Bloomberg BNA Aug. 30 that the family might take its appeal to state court. The family will decide its next steps after the SBOE decision becomes final in 30 days.
In 2007, Paula Trust “realized a substantial amount of income” resulting from sale of stock in Century Theaters. It was a partner in a limited partnership that owned shares in Century Theaters, which Cinemark USA Inc. acquired in 2006.
Some, but not all, of the income was distributed to the trust's sole, contingent beneficiary in 2007. All of the trust's income was from California and the beneficiary lived in California. One of its trustees lived in California and the other lived out of state.
The board members rejected arguments from Antolin and Willson that because one of the fiduciaries lived outside California, only 50 percent of the trust's income should be apportioned to California in 2007.
The attorneys argued that rules for taxation of trusts adopted by the Legislature in 1937 call for the sourcing of trust income to be determined based on the location of the beneficiary, not the trust and its fiduciaries. Regulations adopted by the FTB in 1936, based on a 1935 version of the law that called for sourcing of income at the trust level, conflict with the existing law enacted in 1937, they said.
Antolin said the case was a matter of timing: California would ultimately receive the same amount of tax revenue because the income would be taxed when the trust distributed it to the beneficiary in California, rather than at the trust level.
California has taxed trust income at the trust level for the past 80 years by improperly knitting together various provisions of the state Revenue and Taxation Code to impose nonresident sourcing rules on trusts, Antolin told the board. No clear provision of the code says nonresident sourcing rules apply to trusts.
If the code is ambiguous, it must be construed in favor of the taxpayer, he said.
FTB Attorney Sonia Woodruff argued that under California law, trusts are subject to tax on California-source income just as individuals are. Paula Trust's position would lead to an absurd result under which California property owners could place property in a trust for their own benefit, name an out-of-state trustee and avoid California tax when the property is sold. An individual selling the same property would be subject to California tax.
“The appellant's interpretation would allow the easiest California tax shelter ever to exist,” she said.
The California Tax Reform Association (CTRA) and two of its member organizations, the California Professional Firefighters and the California School Employees Association, submitted letters to the board in advance of the hearing with the same concerns.
“This appeal is nothing but an attempt to concoct a wholly new tax avoidance scheme, based on interpretations which somehow argue, in contradiction to federal law and state law, that income to a trust should be treated differently than it has been historically,” the CTRA said in an Aug. 25 letter to the SBOE members. “To the contrary, the history of sound tax policy is that income should be treated equally, unless there are explicit exceptions made.”
Woodruff refuted Antolin's arguments that the case was about the timing of taxation, saying nothing in the law allows trusts to defer tax on California source income. FTB attorney Doug Powers told the board such a deferral would give trusts and fiduciaries time to sever all ties to California, and when income is ultimately distributed to a nonresident beneficiary, it would be difficult for the tax agency to track.
According to an SBOE staff summary of the case, the FTB pointed in its briefs to the SBOE's 1975 ruling in a dispute over the estate of Marilyn Monroe. In that case, the board found that Monroe's estate was still taxable in California, even though she wasn't a California resident and the beneficiaries lived elsewhere, because the source of income was in California.
The board's holding in the Monroe case is contrary to Paula Trust's argument that it wouldn't be taxed in California on income that would be taxed if it was received by an individual or an estate, or indirectly received through a partnership, the FTB said in its briefs to the SBOE.
Before voting to sustain the FTB's position, some board members said they doubted the Legislature would have intended to set up such an obvious tax avoidance mechanism.
SBOE Chair Fiona Ma (D) said during her six years in the Legislature she only saw lawmakers trying to capture as much income as possible.
“The argument that the Legislature deliberately created this new exception where you can now move all the trustees out of state, the contingent beneficiaries out of state, and therefore not recognize any income on the trust where … the FTB now has to keep track of when this income is being distributed to these out of state trustees and out of state beneficiaries basically to me sounds like a loophole that wasn't necessarily intended by the Legislature,” Ma said.
More likely, the Legislature was looking for a way to be sure it captured income from nonresident trustees and beneficiaries, she said.
The board's vote was the third in the case. Members voted 3-2 after an oral hearing in 2014 to uphold the FTB, with member George Runner (R) and former member Michelle Steel (R) in the minority and former Deputy State Controller for Taxation Marcy Jo Mandel for Controller John Chiang (D), SBOE Chair Jerome Horton (D) and member Betty Yee (D) in the majority.
The board voted 5-0 in 2015 to grant a petition for rehearing from Paula Trust, with new members Fiona Ma (D) and Diane Harkey (R) joining Runner, Horton, and Yee, who shifted to the role of State Controller.
About $150,000 was at issue in the Paula Trust case, but the SBOE noted that 171 other appeals with $27 million at issue have been deferred pending the resolution of the case.
Antolin told Bloomberg BNA Aug. 31 that all 171 of the pending appeals on the same issue come from the Syufy family, which has individual trusts for many of its family members. He said he is unaware of other appeals pending at the FTB with the same claims.
An FTB spokesman told Bloomberg BNA Aug. 31 the board can't confirm whether all pending claims stem from the Syufy family due to taxpayer confidentiality rules.
“In terms of potential lost revenue, the FTB believes that had the case been decided against the state, the potential future revenue impact could have been in the billions of dollars,” FTB spokesman Chris Smith told Bloomberg BNA in an e-mail.
The board isn't required, and chose not to, issue a written ruling in the case.
Antolin is with Antolin Law Group in Walnut Creek, Calif. Willson recently retired from Sutherland Asbill & Brennan LLP in Sacramento and represented Paula Trust as a consultant.
To contact the reporter on this story: Laura Mahoney in Sacramento, Calif., at firstname.lastname@example.org
To contact the editor responsible for this story: Ryan Tuck at email@example.com
The SBOE staff summary is at http://www.boe.ca.gov/meetings/pdf/hearingsummaries/2016/B_Paula_Trust_759422_Sum_083016.pdf.
Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to firstname.lastname@example.org.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to email@example.com.
Put me on standing order
Notify me when new releases are available (no standing order will be created)