Taxpayer Wins Appeal in Case Involving ‘Annual’ LLC Tax Levied Three Times in One Year

A taxpayer who was required to a pay California’s “annual” tax on limited liability companies three times in one calendar year had reasonable cause for not filing timely returns, the Office of Tax Appeals ruled in a unanimous opinion released this week.

The decision in the Appeal of Dermatology Management LLC, dated November 27, was one of 18 posted February 4 on the OTA’s website.

The opinions posted this week included the two that denied the Franchise Tax Board’s petitions to rehear residency appeals decided mostly in favor of Nevada Gilbert Hyatt by the State Board of Equalization in 2017. These January 15 opinions were published in the media several weeks before they were posted by the OTA.

In the Dermatology Management decision, Administrative Law Judges Jeffrey Margolis (lead), Andrew Kwee and John Johnson held that the LLC’s late filings and payments for three reporting periods “were due to reasonable cause and not willful neglect.”

The LLC had multiple ownership changes in 2014, and determined in 2015 that it was required to file returns for three separate short reporting periods that occurred in 2014 (January 1 through May 1, May 2 through October 31, and November 1 through December 31). When the returns were filed in September of 2015, the first two were untimely, and the third was timely thanks to the state’s automatic extension of the due date.

After paying tax and various penalties to the FTB, the taxpayer sought a refund of late-filing penalties and interest based on reasonable cause. The FTB denied the refund, claiming the taxpayer did not meet the standard of proving that the failure to file on time occurred despite the exercise of ordinary business care and prudence, and that an ordinarily intelligent and prudent businessperson would have acted similarly under the circumstances.

“(I)n the situation here, appellant’s obligation to file three different returns and pay three separate ‘annual’ LLC tax amounts and ‘annual’ LLC fees is not at all clear,” the OTA wrote. “Most taxpayers file returns and pay their franchise and income taxes on an annual basis, not three times a year.”

In a footnote, the OTA added that the issue “is not something FTB has provided clear guidance upon.”

The FTB prevailed on one issue, however, as the OTA sustained a penalty for underpayment of an estimated LLC “fee.” The applicable statute “does not provide for a reasonable cause defense to imposition of the penalty,” the OTA noted, and the taxpayer did not qualify for the only defense authorized by statute – a “safe harbor” provision that says the penalty will not be imposed if the estimated LLC fee payment is equal to or exceeds the LLC fee assessed in the prior tax year.

In the Appeal of Smartmake Inc., the OTA issued a 3-0 decision in favor of the FTB in a corporate income tax dispute for the 2013 through 2015 tax years – but the taxpayer still benefited from filing the appeal. In its opening brief to the OTA, the FTB conceded that the taxpayer was not subject to the minimum tax penalty the agency assessed for the 2013 tax year, resulting in a $1,095 refund for that year. The OTA’s opinion does not discuss why the FTB didn’t make this concession earlier in the process. The refund claims were filed in 2017.

Taxpayers in several of the other appeals posted this week failed to convince the OTA they had reasonable cause for not filing and/or paying personal income taxes on time. Arguments were based on factors including bad advice from a tax professional, technological problems while attempting to make an electronic payment, and inability to pay tax on a $180,000 withdrawal from a 401(k).

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