Nevada LLCs: plus, 'Difficult' Residency issues and 'memo to file'.

A California resident client established a Nevada LLC that holds stocks and mutual funds. Its only activity is investing in the stocks and funds, receiving interest and dividends, paying the expenses of the fund, and distributing cash.

The CPA believed this constituted doing business in California.

The client's attorney believed otherwise, and wrote: "The LLC is not doing business in California. It simply invests in publicly traded securities. It will report its income to its California partners/members."

The questions to the listserve were who is right and what should the CPA do?

The sense of the listserve members was that if the investments are made under the direction and control of California situs members, then the CPA is right, and the FTB will consider the entity as engaged in business in California.

At this point, the CPA has four alternatives:

1) Contact the attorney and discuss it more fully with a goal to gain the attorney's agreement that a return should be filed, thus eliminating the conflicting advice and creating a win-win situation for everyone.

2) Refuse the engagement. This, though, might result, unnecessarily, in an unhappy client.

3) Have the attorney provide a formal legal opinion that the entity isn't subject to the California LLC tax, and that the client "may rely on this opinion for purpose of not preparing a California LLC return for the venture."

Follow up to the attorney's letter with a letter to the client stating that "We are not preparing, and understand that you will not be filing, a California LLC return based on the opinion of your legal counsel (place name here), that the LLC is not engaged in business directly or indirectly attributable to the activities of any member."

4) Check with CAMICO (or other errors and omissions insurance carriers) for guidance.

Speaking of Checking with CAMICO

Recently, at a CalCPA Committee on Taxation meeting, a CAMICO attorney discussed various types of claims situations that CAMICO encounters.

The attorney made an interesting point regarding the types of documentation used to defend a client's claim against a CPA: each method of documentation has a different level of evidentiary value. Because notes to the file are unilateral (the client has not seen or approved them), they have low evidentiary value. E-mails sent to the client provide a higher degree of evidentiary value. E-mails which have received a response from the client or letters which the client has signed provide the highest evidentiary value because it is clear that the client has received the document.

Therefore, it's best to always send a written communication to the client stating the issue and the advice given. A spotty record of sometimes sending a memo, and other times not, weighs against the CPA.

The attorney's discussion also emphasized that clients' alleged great tax strategies can actually be muddled beyond belief. In the claim discussed, the client was interested in a specific tax treatment and the client proffered a page to his CPA from an IRS publication and a private letter ruling allegedly substantiating the proposed tax treatment.

This so-called substantiating material, while similar, didn't address the subject at hand. In addition, as readers of this column undoubtedly know, Private Letter Rulings are just that, rulings that are only binding with respect to the taxpayer who requested them. They may not be cited as authority or precedent, although they do provide a good idea of the IRS' thinking on a particular situation when no published authority exists.

California Isn't the Only State That's 'Difficult' When it Comes to Residency Issues

A taxpayer whose work made him change jurisdictions every few years, last worked in State X for several years before being reassigned to the Philippines. The last year that he worked in State X was 2003, before departing for the Philippines mid-year, and a part-year State X return was duly filed.

[ILLUSTRATION OMITTED]

In early 2007, State X sent an assessment based on his full annual income for the year, along with penalties for not having filed a State X tax return.

So the first thing to do was to inform State X its records were in error. They removed the non-filing penalties, but included the full W-2 income on the State X return.

The state's reasoning was (no kidding) that his wife remained in State X for a few months before joining him in the Philippines, plus his mother and grandmother both lived in State X. A specialist within the high-tech world on residency issues now works for the CPA and was brought in. The specialist produced a book on these issues from one of the national CPA firms, and within that book it stated that State X is one of the more difficult states to deal with on such issues.

The Council on State Taxation periodically issues a report card on various states' tax and appeals procedures requirements. The latest such ratings appeared in "State Tax Notes," published by Tax Analysts May 14. Its criteria included such items as adequate time to file a protest, and a due date for corporate income tax returns at least 30 days beyond the federal due date. Some sample ratings are: Alaska, Arizona, Hawaii, Idaho, Iowa and Montana got A's: Alabama, California and Texas got C-minuses; and N. Carolina, Connecticut, Louisiana and Rhode Island got D's.

Appreciation is extended to CPAs Kip Dellinger, Frank Miltenberger, Lew Wiener, JD, Reuven I. Robinson and Tuyet Vu for their contributions to these discussions.

[ILLUSTRATION OMITTED]

By Leonard W. Williams, CPA

Leonard W. Williams, CPA is a Sunnyvale-based sole practitioner. A member of CalCPA's Committee on Taxation, the AICPA Tax Division and a former Peninsula Chapter president, you can reach him at [e-mail].