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There's No Such Thing as a Stupid Tax Question

Non-California Tax-free Interest

As you know, tax-free interest from non-California sources is taxable on California income tax returns even though it is tax-free for federal income tax purposes. Until recently, the Franchise Tax Board had been unable to discern whether or not taxpayers had met this obligation in all cases. Now, brokerage firms are required to report the non-California portion of tax-free interest received by California residents. As a result, the FTB has been sending corrective notices to taxpayers.

Dissolve or "Let It Die?"

No consensus has been reached on the ongoing TaxTalk listserve debate about whether to dissolve a corporation or let it die. However, more facts have been posted that should be considered when making a decision.

If the corporation is allowed to "go suspended" by not paying the minimum tax, the corporation will be unable to defend itself during an IRS or FTB audit, or in Tax Court. In addition, the corporation will lose its corporate name and its right to use the California courts.

The FTB will harass whichever corporate officers or shareholders it can locate, in an effort to collect the minimum taxes. The harassment. often continues for about five years. The FTB can't prevail if the officer or shareholder has withdrawn nothing (cash or inventories) from the corporation that should have gone for tax payment.

A listserve participant, who favors just letting corporations die, says that he changes the corporate address to his office address, and receives all of the PTB's notes and phone calls knowing that they can't do anything.

NOL'S Significance for S Corps

What is the significance of a California net operating loss computed for an S corporation? California S corps are subject to a California tax--1.5 percent of taxable income. The NOL for a year can be carried forward to reduce the subsequent year's taxable income.

Family Partnership with Realty

When forming a family partnership with realty, at what stage should the partnership be formed? The partnership should be formed first, followed by the contribution of the property. The reasoning is that in California this will preserve the Prop. 13 property tax basis, at least initially. And, it is easier to gift a partnership interest each year than to re-title the property.

Avoiding State Tax on an IRA

There is no such thing as a stupid question in the tax arena, and this was actually posted: Can taxpayers avoid California income tax on their IRAs by moving to a state that has no state income tax? Yes, since 1995, by federal law (HR 394 signed by President Clinton Jan. 10, 1996), IRA distributions may not be taxed by a state where the taxpayer is not a resident.

Inheriting IRAs

If a California resident inherits an IRA from an out-of-state beneficiary, do they have basis in that IRA equal to FMV at the date of death? After much discussion, the majority of the listserve participants have concluded that the answer is, "No."

A variant of the same question was whether or not the California resident had to pay income tax on the IRA income to the decedent's state of residence. The answer to this was a resounding, "No."

An analogy of this to other income producing investments is: The taxability of income from dividends, interest or stock sales is determined by the taxpayer's residency, not the location of the bank account or whatever produced the income.

Realty, of course, is different. Income from real estate, including capital gain on its sale, is taxable to both the state where it is located and the taxpayer's state of residence. Of course there's usually a credit on one state income tax return for the state tax paid to the other state on the same income, minimizing the double taxation.

Confusion on Moving Into the State

A taxpayer moved here from another state March 1. He had worked in the prior state, and received a W-2 from his employer there. California rules says that if an individual is in California more than nine months, then they have the tax status of a California resident.

When filing, should the state tax return be a full-year California return, with the prior state's W-2 included? Should a prior state, partial-year return be filed with a credit on the California return for the tax paid to the prior state on double taxed income?

The prevailing practice here is to file a part-year return for both California and the other state, with income items allocated by period of residency.

Other California Tax News

In late July, Gov. Davis signed California's $101 billion 2001-02 budget. The budget changed the FTB's filing enforcement and collection fees, effective this past July as follows:

* The bank and corporation filing enforcement fee increased from $73 to $197.

* The personal income tax filing enforcement fee increased from $69 to $109.

* However, the collection fees remained at $150 for corporations and $101 for personal income taxes.

Thanks to Cal CPA members Robert Cohen, Dave Flamer, Pat rick McDermott, Keith Plottel, Cherie Putman, William Sturgeon, Bob Trimm, and Professor Kitty Wright for their participation in these issues.

Leonard W. Williams, CPA, is a Sunnyvale-based sole practitioner. He is a member of CalCPA's Committee on Taxation, A/CPA Tax Division member and former Peninsula Chapter president. Williams can be reached at williams@lwwilliamscpa.com.