California Rules on Out-of-State Business Taxes Put to the Test
The California Office of Tax Appeals (OTA) recently issued a precedential decision in the case of Appeal of Mather,ianum a case highlighting the complexities of claiming credits against California taxes for taxes paid to other jurisdictions.
The case centered around whether New York City’s Unincorporated Business Tax (UBT) and the New York State Metropolitan Commuter Transportation Mobility Tax (MCTMT) qualified for California’s Other State Tax Credit (OSTC).
At the heart of the dispute was the key requirement that for a tax to qualify for the OSTC under California law, it must indeed be "imposed by and paid to another state," and must be classified as a net income tax.
The taxpayers in Appeal of Mather – two California residents and members of LLCCs operating in multiple states, including New York. Both New York’s UBT and MCTMT impacted their income, leading to a dispute over whether these taxes could be offset against their California tax liability.
The taxpayers argued that despite being termed a “city” tax, the UBT should qualify for the OSTC because New York State, and not New York City, effectively levied the tax. They argued that New York’s constitution and supporting legislation obligated New York City to impose the UBT, making it fit the definition of a state-level tax. They also argued that New York City functioned primarily as a mere administrative agent acting on behalf of the State.
The Franchise Tax Board opposing the claim argued that, in fact, the UBT was truly a local levy, imposed and administered solely by New York City, and not by New York State. As such, the FTB contended, it didn’t meet the requirement to be "imposed by and paid to another state" as mandated by California law.
The OTA sided with the FTB, finding that the UBT, while authorized by New York State, ultimately was within the discretion of New York City to impose.
Crucially, the UBT revenue went directly to New York City, not to the state, ultimately leading the OTA to find that the UBT did not meet the statutory requirement for the OSTC.
The case then turned to the MCTMT. The taxpayers argued that it was a state-imposed tax under New York law, with revenue flowing to a state agency, the Metropolitan Transportation Authority. The FTB argued that because the MCTMT was a special-purpose tax directed at a specific region rather than a general statewide tax, it shouldn’t qualify.
The OTA agreed with the taxpayers, finding the MCTMT eligible for the OSTC since it met the “imposed by and paid to another state" criteria. It’s levied by New York State and paid to a state agency, fulfilling the conditions for the OSTC. The OTA also classified the MCTMT as a net income tax because it allowed deductions for traditional expenses like return of capital and common, ordinary, and necessary business expenses.
However, the taxpayers’ refund claim was ultimately denied.
Although the MCTMT met the initial requirements for the OSTC, the OTA found that taxpayers failed to quantify the amount eligible for the credit.
The taxpayers had not used the correct sourcing guidelines under California law.
California utilizes a single-sales factor formula and specific sourcing rules for non- residentes
Instead of using these California standards, the taxpayers relied on New York State’s three-factor apportionment formula and sourcing rules. The resulting calculations garnered an inaccurate estimate of the tax liability.
In essence, the OTA argued, the taxpayers failed to prove the amount of MCTMT they were entitled to offset, highlighting how precise adherence to California’s sourcing rules is crucial.
The decision lays bare a key takeaway for taxpayers navigating the intricacies of the OSTC: understanding both the nuances of the tax itself and the complex tapestry of state-specific sourcing rules.
The OTA’s decision serves as a potent reminder: carefully examining
