On Jan. 12, 2016, the California Franchise Tax Board (FTB) issued Technical Advice Memorandum (TAM) 2016-01, informing individual income taxpayers that they are not eligible to claim a credit for net income tax paid to other states (generally referred to as the other states tax credit or OSTC) to offset the California individual income tax liability for Revised Texas Franchise Tax (RTFT) paid because the RTFT is a tax on, or measured by, gross receipts and not net income. Additionally, the FTB indicated that it intends to issue a ruling in the third quarter of 2016 to address this matter in more detail, as well as other issues related to credits and deductions for taxes paid to other states.
Pursuant to California revenue and tax code sections 18005 and 18006, resident individuals, nonresident individuals, part-year resident individuals, dual resident estates and trusts, beneficiaries of estate and trusts, partners in partnerships, members of limited liability companies (LLCs) classified as partnerships, and shareholders of S corporations may claim a credit against individual income tax for net income taxes paid to other states. Furthermore, under California Rev. and Tax Code sections 17201 and 17220, individuals are not allowed to deduct, and therefore must add back, gross income and net income taxes paid to other states in their individual capacity or by a pass-through entity on their behalf. This addback requirement does not apply to gross receipts taxes.
FTB Notice 2010-2 (superseding FTB Notice 2009-06) addressed the application of these credit and addback provisions to the RTFT, stating that, due to significant variations in RTFT taxpayers and the computation of the tax base, “[the] FTB cannot provide a definitive characterization of the different methods of the RTFT that applies to each and every taxpayer.” Accordingly, the FTB required the use of a facts and circumstances analysis, under which each taxpayer would need to determine whether the RTFT was a creditable net income tax, a deductible gross receipts tax, or a non-creditable and non-deductible gross income tax.
Reference to this notice was subsequently included in the FTB’s instructions to Schedule S (Other State Tax Credits) of the California individual income tax return. However, this reference was deleted in the 2014 version of the FTB’s instructions to Schedule S, leading practitioners that additional guidance would be forthcoming. TAM 2016-01 represents the FTB’s first step in clarifying this issue, and taxpayers can now expect the FTB to issue additional guidance reflecting the determination that the RTFT is a deductible gross receipts tax, and not a creditable net income tax or a non-creditable and non-deductible gross income tax.
The FTB’s approach in TAM 2016-01 should be considered in contrast to the 2014 decision of the Georgia Tax Tribunal in H. Alan Rosenberg v. Douglas J. Macginnittie, Commissioner, Georgia Department of Revenue, holding that a Georgia resident individual taxpayer who indirectly owned an interest in a flow-through entity that paid the Texas franchise tax was entitled to adjust his federal taxable income under Ga. Code Ann. section 48-7-27(d)(1)(C) for the amount of entity-level tax paid to Texas because the Texas franchise tax is a tax "on or measured by income." If litigation arises out of TAM 2016-01, it is anticipated that the approach of the parties is likely to follow that of the taxpayer and Georgia’s Department of Revenue in this case. For more information regarding the Rosenberg decision, please read our alert.
Lastly, from a California corporation income (franchise) tax perspective, pursuant to California Rev. & Tax Code section 24345, the state does not allow a corporation income (franchise) tax deduction for any taxes on, or measured by, income imposed by any taxing jurisdiction. FTB Notices 2010-02 and 2009-06 applied equally to individual income tax and corporation income (franchise) tax, and, accordingly, a similar facts and circumstances analysis was required, resulting in the taxpayer-by-taxpayer treatment of the RTFT as either a deductible gross receipts tax or a non-deductible net or gross income tax. It is anticipated that this mirrored approach will continue to apply post-TAM 2016-01, and that all corporation income (franchise) taxpayers will be required to to treat the RTFT as a deductible gross receipts tax.
Please note that there is no indication in TAM 2016-01 regarding whether the FTB views that the guidance provided in the memorandum is going to be treated as a policy change that is prospective only or as a clarification that is applicable to prior years. Taxpayers that previously filed California individual income tax or corporation income (franchise) tax should review positions taxen in relation to the RTFT on their returns, and should consider whether an amended filing is appropriate.
