This article is reproduced with permission from Spidell Publishing, Inc.
Taxpayers protected by Public Law 86-272 must still pay the $800 minimum franchise tax
A Wisconsin S corporation was required to pay $16,200 in a late fling per-shareholder penalty for failing to timely file a California franchise tax return to report and pay its $800 minimum franchise tax liability for the 2010 tax year.
The Board rejected the taxpayer’s claims that the penalties should be abated for reasonable cause because:
- It reasonably relied on its tax preparer’s advice that it had no California filing requirement; and
- California Franchise Tax Board (FTB) staff had provided contradictory information concerning the taxpayer’s filing requirements.
American Orthodontics Corporation (American) was headquartered in Wisconsin and manufactured and sold dental and orthodontic equipment around the world. At one time, American was qualified to do business in California but surrendered this right in 1982. Since 2003, it had employees in California, and in 2010, it had six sales people in California.
Although it was required to and did pay California employment taxes on the wages paid to the sales people, America was not required to pay corporate income taxes on its California-sourced income pursuant to the federal Interstate Income Act of 1959 (Public Law (P.L.) 86-272).
Under P.L. 86-272, taxpayers are not subject to corporate income taxes in states where their only activities involve the solicitation of sales of tangible personal property. However, P.L. 86-272 protections do not extend to the minimum franchise tax. Taxpayers who are “doing business” in California must pay the minimum franchise tax even if not required to file a corporate income tax return.
When American realized that it was required to file and pay the minimum franchise tax for the 2010 taxable year, it voluntarily filed a return on June 15, 2012, before it was even contacted by the FTB. On the return, it indicated that it had 75 shareholders.
Subsequently, the FTB assessed the per-shareholder late-filing penalty under California Revenue and Taxation Code (R&TC) Section 19172.5 against American, which imposes a penalty against late-filing S corporations equal to $18 per shareholder per month for a maximum of 12 months. As applied to American, this came to $16,200 (($18 x 75 shareholders) x 12 months).
Penalty applies to franchise tax
American argues that Section 19172.5 applies only to the late filing of the corporate income tax return and not the franchise tax return. It claimed that the purpose of the per-shareholder penalty was to encourage thetimely filing of the S corporation return so Schedules K-1 could be sent out in a timely fashion and the shareholders would have adequate time to prepare their returns. However, American’s assertion was not supported with any legislative analysis or other documentation. Therefore, the Board held that Section 19172.5 applies to the late filing of both the corporation income and franchise tax returns.
American also failed to supply any evidence to support its claim of reasonable cause for penalty abatement. As the Board has consistently held, ignorance of the law is no excuse for failure to file a return.
Reliance on improper substantive advice from a professional tax preparer may constitute reasonable cause if the taxpayer reasonably relied on the preparer’s advice, and the advice is based on the taxpayer’s full disclosure of all relevant facts and documents. However, American failed to explain or provide any evidence of:
- The information it disclosed to its tax advisor;
- The nature of the advice provided by the advisor; or
- When the advice from the advisor was obtained.
Its claim of equitable estoppel based on contradictory advice supplied by FTB employees was similarly rejected. American failed to provide any evidence that FTB representatives made incorrect or inaccurate representations to American with the intention that American would rely on that advice or that American actually detrimentally relied upon such representations. There was no evidence presented of American’s phone calls to the FTB, let alone the nature of the matters discussed or the dates of the calls.
Although American claimed that the late filing penalty is “excessive” and noted that other states impose either a flat penalty or a percentage of tax, the amount of $16,200 was calculated in accordance with California law and, due to American’s failure to demonstrate reasonable cause, was not eligible for abatement.
Note: California’s penalty is similar to the federal failure to file S corporation return penalty under Internal Revenue Code Section 6699. The only difference is that the federal penalty is $195 per month and is subject to inflation adjustments.
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