Tax Tips – November 2009

Penalty Increases Imposed… Penalty Forgiveness Proposed

NEW YORK

Taxpayers are finding that some New York State auditors are less willing to abate penalties than would have been customary in previous audits...apparently, New York needs the money, so much so that the penalty rates have been dramatically increased:

(1) Civil penalty increased for failure to pay due to fraud

The Tax Law has been amended to increase the civil penalty under the various taxes for failure to pay tax due to fraud from 50 percent (50%) of the amount of tax due to two times the tax due (200%).

For income tax and corporation franchise taxes, the amendments relating to the fraud penalties apply to returns and other documents filed or required to be filed and actions taken and omissions occurring with regard to taxable years beginning on or after January 1, 2009. For all other taxes, including sales tax, these amendments apply to such fraudulent actions occurring on or after April 7, 2009.

(2) New false or fraudulent document penalty (personal income tax, corporation franchise tax and sales and use tax)

New penalties were added under the personal income tax, corporation franchise tax and sales and use tax for any taxpayer that submits a false or fraudulent document to the Tax Department. The new penalties are $100 for each false or fraudulent document submitted with a return, with a total maximum penalty of $500 for each return submitted with the false or fraudulent documents.

For personal income tax and corporation tax purposes, this new penalty applies to taxable years beginning on or after January 1, 2009. For sales tax purposes, this new penalty is effective for sales tax quarterly periods beginning on or after April 7, 2009.

While the state legislature has imposed new and increased penalties New York State Governor David Paterson has proposed to forgive certain penalties. On October 15th, Paterson announced that, as part of his $5.0 billion Deficit Reduction Plan (DRP), the Tax Department would partially forgive accrued penalty and interest on long-outstanding State tax liabilities in order to encourage individuals to resolve unpaid claims. For assessments between 3 years and 6 years overdue, penalties would be reduced by 50 percent. For assessments overdue more than 6 years, penalties would be reduced by 80 percent. It is expected that the limited forgiveness period would take place from January 15 to March 15, 2010. Accordingly, taxpayers with outstanding tax assessments should carefully consider this potential opportunity for penalty relief.

Cutting corners can be costly

INDIANA

When an examination is conducted by a taxing authority, the taxing authority will look at the facts and circumstances to determine the taxability of a transaction. Quite often shortcuts taken by a taxpayer will result in a completely different transaction than the one intended. This is demonstrated in a recent Letter of Finding published by the Indiana Department of Revenue (“the Department”). In its Letter of Finding No. 08-0655, Indiana, (Oct. 29, 2009) the Department used various inconsistencies in the taxpayer’s reporting and accounting to determine that a transaction was taxable.

The Department concluded payments made by a taxpayer to a wholly owned subsidiary for the use of the subsidiary’s trucks to deliver taxpayer’s products were subject to Indiana use tax. In concluding that the taxpayer’s payments were for the rental of the trucks and not for delivery services, the Department pointed to the federal income tax return of the subsidiary and the taxpayer’s accounting records to prove the subsidiary was not an independent delivery service.

The federal income tax return for the subsidiary had two lines: one line was for gross rent income; and one deduction line, which was for the rental of trucks. No other expenses were listed by the subsidiary. The subsidiary reported no gross profit.

The subsidiary maintained a separate checking account from which lease payments were made to the truck leasing companies. However, the taxpayer reported on its own books the initial rent for the trucks and all fuel and repair costs. The taxpayer used journal entries to allocate the truck rental charges. The Department included in its audit report a memorandum written to the taxpayer’s accountant explaining the taxpayer and subsidiary would not have separate accounting and all of the subsidiary’s accounts payable and accounts receivable would be automatically assumed to be the taxpayer’s. Also included in the audit report was a letter from a Certified Public Accountant to the taxpayer’s parent company discussing Indiana’s rules for lease payments between the taxpayer and subsidiary.

In its conclusion the Department stated the following:

“While Sub does possess some of the indicia of independence from Taxpayer, it also possesses some of the indicia of dependence on Taxpayer. The fact that Taxpayer's parent reported Sub as only collecting rents to the federal government, the fact that Taxpayer and Sub have a shared accounting process, and the fact that Taxpayer's parent company's accountants discussed the “leasing” arrangement between Taxpayer and Sub all support the Department's determination that Sub was not acting as an independent delivery services company.”

The taxpayer’s failure to establish and maintain a separate company with its own books and records allowed the Department to assert the transaction was not as intended.

Budget Shortfalls Result in Tax Rate Changes

CONNECTICUT

Connecticut’s Comptroller is projecting that the State will close the 2010 fiscal year with a budget deficit, jeopardizing the 6.0% to 5.5% state sales & use tax rate decrease scheduled to take effect on January 1, 2010. Although the Connecticut General Assembly enacted legislation in 2009 to decrease the rate, the rate adjustment was predicated on the stability of gross tax revenue in the General Fund. Any projected shortfall in gross tax revenue of more than 1% during the fiscal year will cancel the scheduled rate decrease. According to the Comptroller, estimated gross tax revenue is down by approximately $400 million, or more than double the amount of deficiency requiring the cancellation of the rate decrease.

The fact that Connecticut will likely have to cancel this sales & use tax rate decrease should not surprise anyone. Connecticut and many other states are continuing to experience budget shortfalls as the economy continues to struggle. According to a recent update by the Center on Budget and Policy Priorities, mid-year budget gaps have opened up in 26 states, accounting for almost $16 billion in additional shortfalls. This is on top of the estimated $162.5 billion budget gap, the Center reported on for all states for the 2010 fiscal year. In fact, a number of states enacted measures to increase their sales & use tax rates since January 1, 2009 to help boost their tax revenue and offset some of their estimated shortfalls:

State	Effective Date	Prior Rate	New Rate
California	4/1/09	6.0	7.0
District of Columbia	10/1/09	5.75	6.0
Massachusetts	8/1/09	6.0	6.25
Minnesota	7/1/09	6.5	6.875
Nevada	7/1/09	2.25	4.6
North Carolina	9/1/09	4.5	5.5
North Carolina	10/1/09	5.5	5.75
Utah	1/1/09	4.65	4.7

The above table only addresses increases in state rates and doesn’t account for the large number of localities (i.e., counties, cities, special taxing districts, etc.) that have increased their sales & use tax rates in 2009 as well. This includes two of the largest cities in the country, New York and Philadelphia, where local sales & use tax rates increased by 0.5% and 1% respectively this year. While rate increases bring in additional tax revenue and help fill the gap between budgeted and actual revenue, they alone cannot make up this difference. Look for states to step-up enforcement activities, impose tax on new products and services (including digital products), and find new ways to grow the taxpayer rolls in an effort to balance their budgets.

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