If you think it’s easy to structure the sale of a business to minimize taxes, think again. Over the last four decades, RJI CPAs has noticed a disturbing trend in California.
When an owner sells the assets of a California company, they are going to pay California taxes. However, the sale of the stock of a company is generally characterized as the sale of an intangible asset, subject to tax in the owner’s state of residency. In the old days, we would have recommended that the owner relocate for six months and a day in another state to establish non-California residency; today owner’s need to meet a myriad of ever evolving “closer connection” tests.
California will attempt to categorize a business owner as “temporarily leaving the state” if they return within four years of their initial departure. If the owner successfully wins their residency examination, they will have to undergo a second gauntlet of tests designed to scrutinize the structure of their transaction, regardless of what has been documented and executed.
The California Franchise Tax Board (FTB) recently asserted that one business structured their deal in a way that allowed them to avoid California tax, considering this to be evasion. These types of experiences explain an increase in the volume of cases headed to the Office of Tax Appeals (OTA) and court.
Hopeful?
The OTA published its rejection of the – FTB’s extremely narrow interpretation and application of the Swart Enterprises, Inc. v FTB, 7 Cal.App.5th 497, “doing business in California standard”. The conclusion was that foreign corporations holding a 25% passive, non-managing member interest in an LLC in California, simply because of ownership percentage, was not itself doing business in California (Appeal of Satview Broadband, Ltd. Case No.18010756). The OTA was created as a result of the Taxpayer Transparency and Fairness Act of 2017 and stripped the Board of Equalization of its appellate powers.
The OTA’s holding in the Satview case indicates the appellate body’s willingness to discern applicable law and not just follow California tax agencies litigation positions.
Conclusion
Taxpayers will need to consult tax advisors and legal counsel to ensure – their transaction is well documented and will be respected by California tax authorities. They will also need to bring a willingness to defend their transactions through an audit, appeal, OTA appeal, and possibly court if any significant potential California tax amount is involved. The M&A and Multi-state teams at RJI CPAs are available to help you navigate potential California tax traps for your growing company.
Manuel J. Ramirez, CPA MST FABFA
Manuel is Chairman/International Tax Partner at RJI CPAs, with specific experience in international and multi-state taxation, M&A transactions, and representation before the IRS and state regulatory agencies. Manuel can be reached at 949-852-1600 or MRamirez@rjicpas.com.
About RJI CPAs
Established in 1980, RJI specializes in audit, accounting, corporate and international tax issues for publicly traded and privately held companies. RJI is PCAOB registered and the Southern California member firm of DFK International, the 7th largest global accounting network. RJJ CPAs paid for space in the Orange County Business Journal and is solely responsible for its content.
