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Illinois Enacts Pass-Through Entity Tax to Help Partners and S Corporation Shareholders Avoid the $10,000 SALT Cap

Illinois enacted a pass-through entity tax (PTE Tax) that may be elected by partnerships and S corporations to permit a federal deduction of state income taxes that otherwise are limited to $10,000 per year from 2018 to 2025 by the Tax Cuts and Jobs Act of 2017 (TCJA). State income taxes paid by individuals, whether attributable to pass-through entity income or other income, are subject to the TCJA’s $10,000 “SALT Cap.”

In Internal Revenue Service (IRS) Notice 2020-75, the IRS announced its approval of the federal deduction of state PTE Taxes paid by the entity in circumstances where the partner or shareholder receives a state tax credit, and the PTE Tax essentially is paid in lieu of the state income tax otherwise imposed upon the partner or S corporation shareholder.

The new Illinois PTE Tax was signed into law by Governor JB Pritzker on August 27, 2021 (Public Act 102-658) and applies to taxable years ending on or after December 31, 2021, and prior to January 1, 2026. Eighteen other states have also enacted PTE Taxes and 14 of those (including Illinois) are effective for 2021.

TAX AT ENTITY LEVEL

The Illinois PTE Tax is imposed on electing partnerships and S corporations at a rate of 4.95%, the flat income tax rate applicable to individuals. The tax is imposed upon the Illinois net income of the partnership or S corporation, which is equal to Illinois base income after apportionment or allocation. As discussed below, partners and S corporation shareholders may claim a refundable Illinois credit equal to their distributive share of the Illinois PTE Tax paid by the partnership or S corporation. Illinois base income of a partnership or S corporation for purposes of the PTE Tax is computed without deduction of Illinois net loss carryovers or the standard exemption. It’s also computed after addback of the partnership subtraction modification for reasonable compensation of partners (including guaranteed payments to partners) and the subtraction modification for income allocable to partners or shareholders subject to the Illinois “replacement tax.” The PTE Tax does not affect the replacement tax computation.

The Illinois PTE Tax is paid by the partnership or S corporation on all of its Illinois net income after apportionment or allocation. As a result, any tax exempt owner of a partnership or S corporation may be required to file Illinois refund claims in order to recoup PTE Taxes paid at the entity level (including as estimated payments). In some cases, this may be avoided by forming an upper-tier partnership for partners that are not tax exempt. Other states have avoided this problem by permitting the PTE Tax to be elected on a partner-by-partner basis rather than for the entity as a whole (e.g., California) or by imposing the PTE Tax only upon income that is allocable to partners subject to the state’s personal income tax (e.g., New York State).

TIERED PARTNERSHIPS

In the case of tiered partnerships, if a lower-tier partnership makes the PTE Tax election, the upper-tier [...]

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Governor Newsom Announces New Relief for Remitting California Sales Tax

On Monday, November 30, 2020, Governor Gavin Newsom announced that California will provide temporary tax relief for eligible businesses impacted by restrictions imposed to control the COVID-19 pandemic.

The announcement indicates that the Governor will direct the California Department of Tax and Fee Administration (CDTFA) to:

  1. Provide an automatic three-month extension for taxpayers filing less than $1 million in sales tax on the return and extend the availability of existing interest- and penalty-free payment agreements to companies with up to $5 million in taxable sales;
  2. Broaden opportunities for more businesses to enter into interest-free payment arrangements; and
  3. Expand interest-free payment options for larger businesses particularly affected by significant restrictions on operations based on COVID-19 transmissions.

No information was provided as to how the CDTFA will expand interest-free payment options for larger businesses, or what constitutes “significant restrictions” on a business’ operations for purposes of this temporary tax relief. Nevertheless, we applaud the governor’s move to initiate this relief for California’s taxpayers, and we will keep readers up to date as additional details are revealed for this program.




Alert: California False Claims Expansion Bill Advances to the Senate

Like the days of the Old West, last week a masked gang held up local businesses demanding their wallets. Unlike the days of the Old West, this was not the hole-in-the-wall gang, but the California State Assembly who, on June 10, 2020, approved AB 2570, a bill that authorizes tax-based false claims actions. If passed, AB 2570 would expand the California False Claims Act (CFCA) to allow private, profit-motivated parties to bring punitive civil enforcement tax-based lawsuits. The bill now heads to the California Senate where its predecessor bill, AB 1270, failed last year.

According to the bill’s author, Assembly Member Mark Stone, there are two key differences between AB 2570 and last year’s AB 1270. First, AB 2570’s definition of “prosecuting authority” has been revised to remove the term “counsel retained by a political subdivision to act on its behalf.” In his comments on the Assembly floor, Stone explained that this amendment was “sought by the bill’s opponents” as it prevents local governments from contracting with private attorneys to bring tax CFCA lawsuits.

Second, AB 2570 mandates that a plaintiff’s complaint must be kept under seal for 60 days and can only be served on a defendant by court order. According to Stone, this second amendment will prevent qui tam attorneys from bringing suit if they send demand letters to the taxpayer before the expiration of this 60-day period.

Although these amendments are minor improvements upon last year’s bill, they are not enough to prevent the rampant abuse that will certainly accompany an expansion of the CFCA. Moreover, as Stone has acknowledged AB 2570 rests on the faulty premise that insider information is generally required to establish a “successful” tax enforcement claim. In his comments to the assembly, Stone stated:

No one questions the ability of the Franchise Tax Board and the California Department of Tax and Fee Administration (CDTFA) to skillfully administer the tax law within their respective jurisdictions. This bill, rather, rests on the premise that there are individuals—often current or former employees of a company—who have access to information establishing that tax authorities have been misled as to the amounts owed by the company. These cases are difficult to uncover without the cooperation of an insider because there is no other way to bring the relevant documents and information to light if a company is determined to commit fraud.

However, as evidenced by the states where an FCA has been expanded to tax cases, such as Illinois and New York, very few FCA tax cases involve internal whistleblowers, actual fraud or reckless disregard of clear law. Instead, they typically involve inadvertent errors or good-faith interpretations of murky tax law. As a result, expanding the CFCA to tax claims will only serve to hurt good-faith taxpayers who are already struggling to survive and recover from the economic impacts of COVID-19. Such legislation could force taxpayers to incur enormous costs or pressure them into settlements to make the case go away to avoid the [...]

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California Bill Would Make Taxpayer Information Available to the Public (Seriously!)

A concerning bill is pending in the California Senate. SB-972 would require the California State Controller’s Office (the Controller) to make taxpayer information publicly available. The bill would require that the Controller post on its website a list of all taxpayers subject to the California corporation tax with gross receipts of $5 billion or more and information about each taxpayer, including the tax liability of taxpayer and the amount of tax credits claimed by the taxpayer in the previous calendar year. We are hearing that the California Senate is likely to pass the bill. If the bill does pass in the Senate, it will head to the Assembly.

This bill is surprising (and alarming) because the usual policy of states and tax departments is to protect the confidentiality of taxpayer information. In fact, most states have statutory provisions ensuring that taxpayer information obtained through tax filings and audits is kept confidential, and disclosure is criminal in most states. If SB-972 is adopted, California will be one of the only states (if not the only state) to proactively make taxpayer information public. There does not appear to be a public benefit to releasing this historically confidential information, making the bill’s infringement on taxpayers’ privacy expectations concerning.

We understand that California may be looking to increase tax on corporations (possibly by repealing certain tax credits) as a means to raise revenue, and it seems likely that this bill is related to that goal, or at least embarrassing taxpayers who do not pay significant funds to the state. However, the bill simply goes too far; releasing information that is universally treated as confidential eviscerates taxpayer privacy and should not be permitted. The legislation is simply an effort to weaponize taxpayer information and shame taxpayers based on what they owe or do not owe to the state.




False Claims Never Die in California

Recently, AB 2570 has cleared the Assembly Appropriations Committee, which authorizes tax-based false claims actions—allowing private, profit-motivated parties to bring punitive civil enforcement lawsuits. The bill is now on the Assembly floor for consideration and faces a June 19 house-of-origin deadline for passage. The bill is similar to a bill that failed to pass last year (AB 1270) after encountering intense opposition.

California’s current False Claims Act (FCA) bars its use in tax cases, a similar practice followed by most states with FCAs. This leaves initiation of tax enforcement to tax agencies that interpret and enforce those laws. In states where a FCA has been expanded to tax cases, such as in Illinois and New York, very few cases involve internal whistleblowers, actual fraud or reckless disregard of clear law. Instead, they typically involve inadvertent errors or good-faith interpretations of murky tax law. FCA expansion undermines taxpayer reliance on tax agency interpretations and guidance, since alternative interpretations can be used by plaintiffs as the basis for their lawsuits against taxpayers.

Who brings FCA tax actions? Claims in the tax realm are primarily developed and driven by a cottage industry of plaintiffs’ law firms with profit-motivated incentives seeking to exploit an area of the law that leans in their favor. In a hearing before the Illinois House Revenue and Finance Committee, former Illinois Revenue Director Brian Hamer described the Illinois cases as being brought by a financially motivated third party adept at manipulating the qui tam process to victimize businesses that at most made an inadvertent mistake. At that hearing, several witnesses described being forced into settlements for amounts far exceeding any tax owed because the costs of litigation are so high. Mark Dyckman, the former General Counsel for the Illinois Department of Revenue, has said that “the cases have clearly interfered with the administration and enforcement of tax law and may have even ultimately cost the state money, though it’s impossible to quantify how much.” A 2007 study by Columbia Law Review concluded that 73 percent of qui tam actions are frivolous.

Why does FCA expansion to taxes lead to such rampant abuse? The treble damages financial incentive encourages profit-motivated bounty hunters to develop theories of liability not established or approved by the agency responsible for tax administration. In Illinois alone, the number of claims by one filer is in the thousands. Other problematic provisions in the California proposal that would tilt the playing field are a separate statute of limitations, a lenient burden of proof and use of sealed complaints, and extremely punitive damages (actual damages times three, plus $5,500 or more civil penalty for each alleged violation). The private attorneys deputized to act as tax enforcers get a percentage of the payment.

Supporters point to “tax gap” estimates of uncollected tax revenue and claim this bill will bring in billions in tax revenues. However, the vast majority of the “tax gap” consists not of missing corporate tax payments, but individual income taxes subject to little or no information reporting, with the Treasury Department particularly [...]

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Taxes, Like Temperatures, Going Up: California COVID-19 Budget “Revenue Solutions”

Yesterday Governor Gavin Newsom turned to a familiar gambit from California’s playbook to help tackle the budgetary hole wrought by COVID-19. In January, the Governor proposed his budget for the 2020-2021 fiscal year, which projected a $5.6 billion surplus. Indeed, revenues through March are reported as having run $1.35 billion above projections. But, as the Governor says in his May Revision to his January Budget, “[t]he COVID-19 pandemic and the resulting recession has changed the fiscal landscape significantly.” Without the various changes proposed by the May Revision, which includes the “revenue solutions” described below, the Governor’s Budget projects a $54 billion deficit.

The May Revision proposes two significant changes to business taxation. The Governor proposes suspending net operating losses for 2020, 2021, and 2022 for medium and large businesses. The Governor also proposes limiting business incentive tax credits from offsetting more than $5 million of tax liability per year for 2020, 2021, and 2022.

While it is not known what parameters were used for the May Revision revenue estimates, and the actual threshold for being a medium or large business subject to NOL suspension will be set during the legislative process should the Governor’s proposal be enacted, standards used for prior NOL suspension periods may provide a guide. For taxable years beginning in 2008 and 2009, California suspended the NOL carryover deduction for taxpayers with a net business income of $500,000 or more. For taxable years beginning in 2010 and 2011, California’s NOL suspension affected taxpayers with a modified adjusted gross income of $300,000 or more. In neither case were disaster losses affected by the NOL suspension rules.

The May Revision also includes two proposals to address the sales and use tax gap: (1) Used car dealers would have to remit sales tax to the Department of Motor Vehicles with the registration fees, and (2) Market value will be used to determine the price paid in private auto sales.

Also tagged as “revenue solutions” in the May Revision are three General Fund proposals from the Governor’s January Budget Proposal: (1) Extending the sales tax exemption for diapers and menstrual products through the end of 2022-23; (2) Extending the carryover period for film credits awarded under Program 2.0 from six years to nine years; and (3) Extending the current exemption from the minimum tax for first year corporations to first year LLCs, partnerships and LLPs. The May revision also maintains a new tax on e-cigarettes based on nicotine content and will be deposited in a new special fund.

Overall, the revenue solutions in the May Revision are projected to net $4.4 billion in 2020-21, $3.3 billion in 2021-22 and $1.4 billion in 2022-23. The Governor states, “These tax measures as a whole are intended to raise revenue, stimulate economic growth, and help those in need.”

He explains that his May Revision revenue solutions “recognize the disproportionate tax relief that has been provided to larger corporations, compared to small businesses, which has resulted in relatively lower tax payments.” And he adds that [...]

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False Claims Bill Advances in California – Taxpayers Beware!

California’s bill to authorize tax-based false claims actions—allowing private, profit-motivated parties to bring punitive civil enforcement lawsuits—cleared the Assembly Judiciary Committee on May 11 in a party-line vote. The bill, AB 2570, is sponsored by the committee’s chair, Assemblymember Mark Stone (D), and has strong backing from Attorney General Xavier Becerra. It now goes to the Assembly Appropriations Committee.

Proponents claim the bill only affects “tax cheats” but under similar laws in Illinois and New York, very few cases involve internal whistleblowers, actual fraud or reckless disregard of clear law. Instead, they typically involve inadvertent errors or good-faith interpretations of murky tax law. Moreover, while there often is an erroneous assumption that most tax false claims actions are brought by “by-the-books” whistleblowers acting in the interest of the taxing jurisdiction, claims in the tax realm are primarily developed and driven by a cottage industry of plaintiffs’ law firms with profit-motivated incentives seeking to exploit an area of the law that leans in their favor.

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Alert: California False Claims Expansion Bill Preparing to Advance

The revived False Claims expansion bill in California, A.B. 2570, is on the agenda to be heard by the Assembly Judiciary Committee on May 11 at 10:00 am PDT. The proposal would authorize tax-based false claims actions, allowing private, profit-motivated parties to bring punitive civil enforcement lawsuits—an abusive practice that is prohibited under current law consistent with the vast majority of other states with similar laws. A nearly identical bill sputtered out last summer but has now been revived, as our colleagues covered in February:

AB 2570 is replete with problematic provisions, including: (1) the imposition of a separate statute of limitations that will arguably trump any shorter limitations periods imposed by the Revenue & Taxation Code (See Cal. Gov’t Code § 12654(a) which permits claims under the CFCA to be pursued for up to 10 years after the date the violation was committed, compared to standard three or four years for tax audits); (2) a more lenient burden of proof for elements of an alleged violation; and, (3) extremely punitive damages—violators are subject to treble damages (i.e., three times the amount of the underreported tax, interest and penalties), an additional civil penalty of $5,500 to $11,000 for each violation, plus the costs of the civil action to recover the damages and penalties including attorney’s fees.

Few of these cases will involve internal whistleblowers, actual fraud, or reckless disregard of clear law. Instead, the cases in Illinois (a state that has adopted false claims expansion to tax) usually involve inadvertent errors or good-faith interpretations of murky tax law. With the party bringing the case able to keep up to 50% of the proceeds, the only winners in the proposal is the cottage industry of money hungry plaintiffs’ attorneys that will descend and harass good-faith taxpayers in an effort to pad their own pockets.




Governor Newsom Signs Executive Order Providing Last Minute Property Tax Relief

On Tuesday we authored a blog post commending San Francisco County Assessor Carmen Chu for moving the deadline for businesses to file their Business Property Statements (Form 571-L) to June 1 of this year. We noted that California statutory authority provides that if the property tax filing deadline falls on a date when the county assessor’s office is closed for the entire day, a property statement that is mailed and postmarked on the next business day is deemed to have been timely filed. We further explained, however, that despite the fact that most, if not all, county assessor offices across the state are closed due to COVID-19, most assessors have been reluctant to provide relief to the taxpayers struggling to meet the May 7 deadline. Consequently, we urged county assessors to follow the example set by the San Francisco County assessor and to likewise extend the business property tax deadline.

In April, we also authored a blog post encouraging the State Board of Equalization and county officials to issue clear, unambiguous guidance regarding the late-payment penalty waivers being offered to taxpayers who were unable to timely pay the second installment of their secured property taxes by the April 10th deadline due to hardship caused by COVID-19. We stated that although the provision of penalty waivers was an important first step, the ambiguity surrounding how a taxpayer might “prove” that he or she was “impacted by COVID-19” necessitated additional guidance.

Yesterday, on May 6, 2020, Governor Gavin Newsom announced that he had signed a new executive order (Executive Order N-6-20) as a means of providing certain property taxpayers with much-sought relief.

“The COVID-19 pandemic has impacted the lives and livelihoods of many, and as we look toward opening our local communities and economies, we want to make sure that those that have been most impacted have the ability to get back on their feet,” said Governor Newsom.

As a first step, the executive order suspends, until May 6, 2021, penalties for failing to pay certain property taxes that were not delinquent before March 4, 2020, for taxpayers who demonstrate they have experienced financial hardship due to the COVID-19 pandemic. This extension applies to residential property owners and businesses that qualify as a small business under the Small Business Administration’s Regulations Code. To be eligible for the penalty waiver, a taxpayer must demonstrate “to the satisfaction of the tax collector that the taxpayer has suffered economic hardship, or was otherwise unable to tender payment of taxes in a timely fashion due to the COVID-19 pandemic, or any local, state, or federal government response to COVID-19.”

Second, the order also extends the deadline for certain businesses to file their Business Personal Property Tax Statements (Form 571-L) from May 7 to May 31 of this year. Specifically, the order suspends California Revenue and Taxation Code (“RTC”) section 441, subdivision (b) and RTC section 463, subdivision (a) until May 31, 2020, to the extent that either imposes a penalty for failure to [...]

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Last Minute Relief for Filers of Business Property Statements

Once again, San Francisco has shown leadership in addressing property tax relief during the COVID-19 pandemic. On Monday, May 4, 2020, the San Francisco County Assessor announced that she was moving the deadline for businesses to file their Business Property Statements (Form 571-L) to June 1 of this year, due to physical office closure of the San Francisco Office of Assessor-Recorder.

Normally, under state law, a 10 percent penalty automatically attaches when a taxpayer’s business property statement is filed after May 7. But, if May 7 falls on a Saturday, Sunday or legal holiday, then a property statement that is mailed and postmarked on the next business day is deemed to have been timely filed. Under the applicable statue, legal holidays include days when the county’s offices are closed for the entire day.

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