The Office of Tax Appeals posted 143 opinions to its website this week, including one involving the University of California Board of Regents’ participation in a transaction determined to be designed solely to help a donor avoid income tax.

In the Appeal of the Estate of Tony D. Stelliga, the OTA unanimously upheld a noneconomic substance transaction (NEST) penalty of $86,174, an interest-based penalty of $58,523, and applicable interest. Additionally, the OTA upheld the Franchise Tax Board’s decision to disallow Stelliga’s deduction for a charitable contribution of $150,000 to the University of California.

The case involved a complicated transaction in which the appellant reported the sale of his term income interest in a charitable remainder trust to the UC Board of Regents for zero gain, resulting in the UC system receiving a $150,000 contribution and the appellant not paying tax on a realized gain of more than $2.1 million.

The appellant “has not articulated or substantiated a business purpose for engaging in the sale of the interest in the Trust to the UC Regents other than tax avoidance,” the OTA wrote.

The opinion explained:

“The only reasonable motive on the part of the UC Regents for engaging in this transaction was to earn a profit on the investment of $2,963,838 that it received and held during the 30-day holding period and to receive $150,000 from appellant for participating in the transaction. In turn, the only reasonable motive on the part of appellant for engaging in this transaction was to create the fiction of a sale of the entire interest in the Trust to avoid paying income tax on any portion of the gain realized from the liquidation of his pro rata share of the Trust’s assets prior to the transfer of funds to the UC Regents, as indicated by appellant’s 2007 return, which reports zero realized gain. Appellant has not substantiated that the sale was objectively capable of creating a profit or otherwise affecting appellant’s financial situation. He thus failed to satisfy the objective economic substance factor. Because the sale to the UC Regents lacked both a business purpose and economic substance, we conclude that FTB properly disregarded this transaction for income tax purposes.”

The agreement “acknowledged appellant’s intent to support acquisition of lab equipment by the Department of Electrical Engineering and Computer Science in the College of Engineering at the University of California with the $150,000 set aside from the purchase price,” the OTA found.

While the UC received the contribution, the FTB was justified in refusing to allow the taxpayer to claim it as a charitable contribution, the OTA ruled.

“Appellant has offered nothing to refute FTB’s contention that appellant paid the UC Regents $150,000 as an accommodation fee for engaging in the transaction so that appellant could obtain tax benefits,” the OTA wrote. “Appellant has offered nothing to refute the contention that the transfer was motivated primarily by the incentive of substantial tax benefits and not detached and disinterested generosity. Consequently, the transfer does not qualify for a charitable contribution deduction.”

The opinions posted to the OTA’s website August 3 include 123 franchise and income tax opinions (the majority of which deal with routine cases of failing to file on time and/or disputing the FTB’s calculation of unpaid taxes based on information received from the IRS) and 20 business tax opinions. Twelve of the opinions are “pending precedential” decisions.

In other noteworthy opinions:

OTA Decides Several Disputes Over California Source Income, Residency and Domicile. The OTA decided several disputes over whether income was derived from California sources and whether the taxpayer was a California resident or domiciled in the state:

  • In the Appeal of Benemi Partners LP, the OTA ruled that “it appears to be the case under Swart and/or Finanz” that the appellant did not have a California filing requirement,” but will not receive a refund of taxes paid in response to demands from the FTB. “Notwithstanding the fact that appellant’s tax was erroneously paid and not owed in the first place, we must nevertheless find that appellant is not entitled to a refund of taxes paid for 2009 through 2012 due to the expiration of the statute of limitations,” the OTA wrote in its unanimous decision.
  • In the Appeal of G. Stabile, the taxpayer argued that the FTB wrongly determined that a portion of the gross income from the vesting of long-term incentive plan mirror shares in 2012 was California source income. The taxpayer was awarded shares in 2010 while working in California, and received $73,455 in income upon the vesting of shares in 2012, when he was working in London for a related company. In its pending precedential opinion, the OTA wrote that the income “is properly treated as compensation for appellant’s services, and because appellant performed a portion of these services in California, we conclude a portion of this income is California source income.”
  • In the Appeal of A. Dakers, the appellant is a sole proprietor who moved to Texas and continued performing staffing services for a company based in California. “The record shows that appellant received California source income … [from] a California-headquartered company, for services rendered as a sole proprietor while he resided in Texas,” the OTA wrote. “Although appellant performed his staffing services in Texas and apparently he was never physically present in California during 2016, there is no statutory requirement that he must have a physical presence in California for the state to impose a tax.” However, the OTA significantly reduced the amount of income that should be sourced to California ($7,369, down from the $22,108 computed by the FTB).
  • In the Appeal of Matthew E. Donovan, the OTA unanimously upheld the FTB’s position that the taxpayer was domiciled in California and “therefore is subject to taxation on his entire taxable income, including the taxable income earned while living in Florida for approximately five months in 2014.” The taxpayer argued that he intended his move to Florida to be permanent, but ended up moving back to California for a new job. The FTB argued that he was in Florida for a temporary purpose, and thus remained domiciled in California, and the taxpayer was unable to overcome the legal presumption that the FTB’s interpretation of his intent is correct. The OTA opined: “Because of the lack of evidence, other than the act of relocating to Florida under his employer’s authorization, there are no other acts that can support appellant’s intention. During appellant’s protest …, respondent requested information such as opening a ‘new bank account, lease agreement, voting registration or possession of a Florida driver’s license’ in order to support and substantiate his intention. Such information may have been helpful to this panel as we attempt to gather appellant’s intention from a review of his actions. But based on the lack of evidence, the insufficient acts (or facts) do not support such an intention.”
  • In the Appeal of C. Alexander, the appellant was a part-year resident of California in 2015, having moved to California from Texas in August 2015. The FTB “appears to have ignored the allegations contained in appellant’s protest letter as to appellant’s part-year residence in California during 2015,” the OTA wrote, and imposed $1,226 in additional tax on unreported income. The OTA unanimously ruled that the tax should be reduced to $455.

Appeals on these issues could gain attention as more California businesses consider relocating to lower-cost states and more individuals are allowed to work from home, creating opportunities for them to move out of California without switching jobs.

Taxpayer Who Prevailed Before the BOE Loses When Appeal Is Reheard by the OTA. The state’s decision to create new tax agencies in 2017 was not helpful for the taxpayers in the Appeal of S. Bachor, dba Carmel Mountain Cabinetry.

In July 2017, the State Board of Equalization ruled in the taxpayer’s favor in a precedential 4-1 decision (see the Appeal of Shawn Victor Bachor ). Subsequently, the new California Department of Tax and Fee Administration successfully petitioned the new Office of Tax Appeals to rehear the dispute, and the OTA issued a pending precedential decision that reversed the BOE’s ruling. Thus, the taxpayer now is liable for almost $400,000 in tax and interest that would not have been owed if the BOE’s decision had become final prior to the OTA being created and authorized to rehear cases decided by the BOE.

The issue was whether the taxpayer operated one business with operations in California and Mexico or separate corporations in each country – a distinction that would determine whether he owed more than $570,000 in tax and interest on his cost of fabricating cabinets in Mexico.

There was no dispute that the taxpayer is a construction contractor who owned both the California sole proprietorship that installed the cabinets and the Mexican corporation that fabricated the cabinets, and no dispute that tax would not apply to his costs of fabricating the materials he performed the fabrication labor in-house.

The CDTFA argued that the taxpayer had two businesses: a sole proprietorship doing business in Riverside County as Carmel Mountain Cabinetry, and a corporation in Mexico also named Carmel Mountain Cabinetry. The taxpayer argued that the two entities are the same company. He said the facility in Mexico is not a corporation, as alleged by the tax agency, but a “maquiladora” – a factory that operates under preferential tariff programs established and administered by the United States and Mexico. The taxpayer additionally testified that the facility in Mexico was established in response to the high cost of doing business in California. He would have gone out of business, he said, if he had continued trying to fabricate cabinets in California.

In its pending precedential opinion, the OTA wrote: “The fact that appellant chose to treat CMC as if it was simply a foreign location of his wholly-owned California cabinet business when it suited his purposes to do so does not persuade us that we should ignore the fact that CMC was at all times a legal entity separate and distinct from appellant.”

No Uniformity in Decisions on FTB’s Application of Demand Penalty. In the past year, the OTA has repeatedly rejected the FTB’s position on the application of the “demand penalty,” with a majority of OTA administrative law judges ruling that the tax agency improperly stretched the meaning of the phrase “during the preceding four taxable years” to include a longer period of time. In several cases – most decided unanimously, but some in 2-1 decisions – the OTA removed the penalty on the grounds that it was imposed improperly. The FTB unsuccessfully petitioned for a rehearing of each case.

There were changes this month, however, as the OTA upheld the FTB’s position in two cases (the Appeal of M. Kohl and V. Kohl and the Appeal of A. Baez, both decided on 2-1 votes).

In other cases, the OTA continued to rule that the demand penalty was improperly imposed (the Appeal of Matthew Goldman and the subsequent denial of the FTB’s petition for rehearing, both unanimous; and the Appeal of Adam M. Berman and Alejandro Scotta, in which the penalty was removed on a 2-1 vote but the FTB’s petition for rehearing was denied on a 3-0 vote – the first time the vote on the petition for rehearing didn’t match the vote on the underlying opinion).

In the Appeal of C. Giordano, the FTB lost on the issue but didn’t petition for rehearing – another first.

The results of the appeals indicate that two taxpayers challenging the demand penalty with identical facts could receive different rulings depending on which ALJs are assigned to the case.

First Names of Appellants No Longer Used. The OTA, created by the Taxpayer Transparency and Fairness Act of 2017, has listed the first and last names of appellants – and often middle initials – in most opinions since it began issuing decisions in 2018, but appears to have transitioned to just using a first initial and last name.

Since opinions often are very light on other identifying information, the change makes it nearly impossible to determine the identity of appellants with common last names, or to determine if an appellant with the last name of an elected official or public figure is indeed that person.

OTA Regulation 30430 relates to public transparency and notes that there is no right to confidentiality as to relevant information that the agency includes in a written opinion that is required to be published.  Recent proposed amendments to this regulation note while that oral hearings before a panel are open to the public, this waiver of confidentiality does not apply to an individual’s personal information including the person’s address, telephone number, Social Security number, federal identification number, full financial account numbers, full names of minor children or full dates of birth. Full names of adult taxpayers are not included in this exclusion.

BOE Member Gave Erroneous Advice, OTA Rules. In the Appeal of Priscilla’s Gourmet Coffee Inc., the owners of the company said they met with Jerome Horton – then a member of the State Board of Equalization – and his staff and received oral advice to adopt a sales tax reporting method used by a large coffee house franchise, and they relied on this advice. The advice was erroneous, the OTA found, because the reporting method was authorized only under certain circumstances that were not met in this case (including a prior audit, five or more selling locations and a written request).

The OTA upheld the tax liability but granted interest relief, writing: “We believe this erroneous advice, which resulted in an incorrect reporting of the liability, constitutes an unreasonable error by a board member and/or his staff, acting in their official capacity, and we find that it is appropriate to grant interest relief under the unique circumstances of this case.”