September Board Hearing Recap

By Diane Harkey

Due to early successes in favor of taxpayers at previous monthly Board Hearings, this month the cases were fewer and much more difficult to decide. It is my hope that appeals are being more closely scrutinized, and the more “iffy” cases are being resolved in favor of taxpayers, without a board hearing.

If it looks like a duck, and quacks like a duck then…

We heard a case involving an appellant that claimed a Qualified Small Business Stock (QSBS) exemption for 50% of the sale of an online hedge fund company. The question at hand was the online service merely a website or an investment service?

As a background, for taxpayers other than corporations, Section 1202 of the Internal Revenue Code excludes from gross income at least 50% of the gain realized on the sale or exchange of QSBS. The intent is to encourage venture capital in start-up companies to stimulate job creation. Certain corporations such as those in banking, investment, and legal services are excluded. Due to a legal challenge, in 2012, California’s Franchise Tax Board rescinded the state’s version of federal tax code.

While serving in the Legislature in 2013, we approved legislation in response to a decision by the California Court of Appeal, Cutler v. Franchise Tax Board, holding that California’s QSBS gain deferral and exclusion provisions violated the Commerce Clause of the U.S. Constitution because it favored California taxpayers.  We extended the exemption retroactively to allow the tax breaks for 2008 through 2012. While Congress has increased the amount of the exclusion at the Federal level, unfortunately, California has not reinstated the “angel investor” benefit beyond 2012.

But to the issue facing our Board, did the company qualify? The appellant claimed that the corporation was merely a website, no advice was given, no brokerage fees were charged, no brokers were hired, and therefore the company was not an investment company.

The company did, however, clear hedge transactions, hold client trust accounts through a separate banking institution, and the purpose of the website was to allow hedge fund investment transactions. While the entrepreneur made a good case, we did find that the sale of the company stock did not qualify for the QSBS.

What did you know, when did you know it and what did you pay?

We also reviewed a case involving bankruptcy and the delegation of a family member to serve as the “responsible party” for the debtor-in-possession (a furniture store chain) and the court. The son of one of the LLC members (appellant) was chosen, and agreed, to become the responsible party. Sales taxes that had been collected remained unpaid after the LLC filed for Chapter 11 and eventually liquidated inventory. The Sales and Use Tax Department claimed he was personally responsible to pay the delinquent taxes under R&T code 6829.

The appellant claimed he was not responsible for, nor involved in paying or reporting sales and use tax payments. However, the appellant did sign and certify monthly financial reports to the court, as required under a debtor in possession Chapter 11 bankruptcy case. The monthly reports clearly displayed an aging of the taxes payable, and also noted on page one of the reports that sales taxes were due and remained unpaid.

At question from my perspective was whether or not the appellant had the ability to pay the delinquent taxes, or was he under court order to pay debts in a predetermined sequence. In other words, who gets paid and in what order of priority in a Chapter 11 and when a liquidation commences?

To conclude, the appellant’s attorneys filed a stipulation with the court, which the court approved, for payment of various attorney’s fees, and a secured lender was noted as subordinate to the payment of the fees. No mention was made in the stipulation for payment of the outstanding sales taxes. It was also revealed at the hearing that the secured lender was actually an entity controlled by the appellant.

We determined unanimously that the appellant did have input into the process, was aware of the liability, and was, as asserted by the Department, the responsible party and personally liable for the payment of collected and unremitted sales taxes.

You may read the Unofficial Summary of Board Actions for September.

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