Thursday, March 21 2013
Legislation Would Require Treasury to Publish and Make Available Technical Advice Letters, Audit Manuals, Training Manuals, Internal Policy Statements, Bulletins, Memos, or Other Documents
On Wednesday, March 20, 2013, I testified before the House Taxation Committee on five bills currently before the committee. This Blog is the third of three which will discuss the proposed legislation. I urge CPAs, your clients and others to become familiar with the bills and to support their enactment with your local legislators. Today I will discuss House Bill 4290 which would amend the Revenue Act.
House Bill 4290 requires the Department of Treasury to publish and make available technical advice letters, audit manuals, training manuals, plus all internal policy statements, bulletins, memos, or other documents that would prove helpful to taxpayers trying to understand the law. The publishing of these documents, electronically or otherwise, would create a process that leads to a better understanding of the law, greater consistency and fewer controversies.
In a use tax audit recently decided by the Tax Tribunal, two companies "brother/sister" with all facts and circumstances identical (sales, customers, accounting practices) were determined to be one.a contractor, the other a retailer! Had they had proper guidance they could have been treated in a consistent manner.
On an issue of great importance now; cloud computing, the Department issued several private letter rulings stating that such services were not taxable. However, on current audits, such services are being subject to tax. Publication of such letter rulings, while keeping taxpayer identity safe, would avoid such inconsistent treatment of taxpayers. The taxpayer has a right to privacy but the taxpaying community at large has the right to consistent and fair treatment between taxpayers.
Wednesday, March 20 2013
Treasury Audits to Follow Generally Accepted Governmental Auditing Standards
Sampling Must Comply With the AICPA Audit Guide, Audit Sampling
On Wednesday morning, March 20, 2013, I testified before the House Taxation Committee on five bills currently before the committee. This Blog is the second of three which will discuss the proposed legislation. I urge CPAs, your clients and others to become familiar with the bills and to support their enactment with your local legislators. Today I will discuss House Bill 4291 which would amend the Revenue Act.
House Bill 4291 would provide better guidance for auditors, and therefore taxpayers as well, by requiring Treasury auditors to follow Generally Accepted Government Auditing Standards (GAGAS). This is not a new requirement as Treasury had, in the past, followed GAGAS. The 2006 Taxpayer's Rights Handbook, Page 27 Audit Standards required this, but interestingly, it was eliminated from the 2010 version. GAGAS mandates, among other things, that auditors be independent, free of bias, adequately trained and supervised, their audits must be supported by adequate documentation and their work is subject to review.
HB 4291 would require sampling, if done, be in accordance with the AICPA Audit Guide, Audit Sampling. I believe this one of the greatest areas of potential improvement. Statistical sampling is an excellent tool which benefits both the Treasury as well as the taxpayer. But, only if done correctly. Audit sampling simply means the application of an audit procedure to less than 100 per cent of the items within the population. The results, an error factor, of the audit procedure is projected to the entire population.
HB 4291 would also require the Department to provide to the taxpayer, in the case of audit, a copy of the complete audit work papers, the audit report findings, plus all correspondence and documentation the audit was based on. It's hard to believe that this is not done. One taxpayer was successful in obtaining this information through a Disclosure Officer Request. On appeals at the Tax Tribunal or the Court of Claims, the taxpayer can obtain such information through Discovery. Even the IRS provides taxpayers with documentation regarding their own audit.
Tuesday, March 19 2013
Use Of Indirect Audit Procedures, Sampling and Sample Projections Limited
On Wednesday, March 20, 2013 I will be testifying before the House Taxation Committee on five bills currently before the committee. This Blog is the first of three which will discuss the proposed legislation. I urge CPAs, your clients and others to become familiar with the bills and to support their enactment with your local legislators. Today I will discuss House Bill 4288 - Sales Tax, House Bill 4292 - Use Tax and House Bill 4289 - Unclaimed Property.
Michigan is making great strides to improve the tax climate; however, while it is critically important to get the tax structure correct, and the tax rate competitive, it is also very important that the actual "administration" of taxes is simple, fair and efficient, and with an emphasis on compliance rather than other factors.
Taxpayers deserve a clear understanding of what to expect when audited. Unfortunately, there is no clear statutory guidance of what audit methods are acceptable and when. Auditors are increasingly reliant on the use of indirect methods and projection sampling (extrapolation). HB 4288-Sales Tax, HB 4292-Use Tax and HB 4289-Unclaimed Property would provide Treasury auditors with clearer guidance on conducting audits. At the same time, taxpayers would have a better understanding of what to expect while under audit. Better guidance equals less confusion, less costly litigation, and more good will.
The bills would codify standards and procedures for conducting an audit and prohibit the Michigan Department of Treasury from using any "indirect audit procedure", which is defined as a procedure which relies on circumstantial evidence and therefore more than one possible conclusion exists, unless the Department has documented reason to believe that any records or returns filed are inaccurate or incomplete and that additional taxes are due.
Further, the bills attempt to eliminate "arbitrary" audits by codifying that an audit must include a review of the taxpayer's books and records, require written approval from the taxpayer to use an indirect audit procedure or sampling, and require the Department to provide to the taxpayer the evidence they used in determining tax liability.
There are many real-life examples which illustrate how the use of an indirect audit procedure combined with a sample and sample projection (extrapolation) resulted in arbitrary conclusions. Without formal procedures, taxpayers are left with audit assessments that do not accurately reflect their business activities or transactions.
In two 2011 Tax Tribunal decisions [Fradco, Inc. v Dep't of Treasury and SMK, LLC v Dep't of Treasury] the Tax Tribunal found in favor of both taxpayers. The Tribunal stated: "The process and procedures followed by Respondent's auditor cannot be relied upon. ...Respondent's calculations and methodologies result in imperfect estimates because they are based on an incomplete sample of purchases invoices for two months, extrapolated over an almost four-year period, using an estimated "average" mark-up."
The sad fact in regard to both of these cases, although decided in 2011, the Department of Treasury; 1) is appealing both cases to the Supreme Court on jurisdictional issues, and 2) continues to use indirect audit procedures combined with an inadequate sample and biased sample projections. There are also two cases pending before the Tax Tribunal where the Department picked two months, both winter months for a seasonal business, and used an indirect audit procedure to project the results for four years. In short, the Department is not following good, reasonable audit procedures in their use of indirect audit procedures, sampling and sample projections and the courts are agreeing.
Saturday, March 16 2013
Overpayment Interest Starts 45 Days after the Claim is Filed
In Ford Motor Company v. Department of Treasury, Michigan Court of Appeals, No. 306820, February 26, 2013 the Michigan Court of Appeals found that when a taxpayer checked the "disagrees with determination" box on the audit determination letter for an audit under the former single business tax (SBT), it did not constitute a "claim for refund" under state law. Because it was not a claim for refund, the lower court improperly allowed interest to begin accruing 45 days later.
After an SBT audit for tax years 1997-2001, the Department of Treasury sent an audit determination letter dated August 3, 2005, to the taxpayer, who checked the "disagrees with determination" box and returned the letter. The department argued that this was not adequate notice for a refund claim. Reversing the lower court, the court reasoned that a refund claim was filed when the department received adequate notice of the claim, not when the department has enough information to process the claim. The taxpayer did not provide any indication of a refund amount with its check-the-box response. Rather, the check-the-box response was a statement of such broad disagreement with the department's determinations that it could not be considered to notify the department of a refund claim. State law allows interest to be added to a refund starting at the later of 45 days after the claim is filed or 45 days after the date for filing a return. Thus, interest began to accrue 45 days after the taxpayer filed the complaint, as filing the complaint gave the department adequate notice of the refund claim.
The taxpayer and the department had an informal agreement regarding deposits: the taxpayer made deposits to prepay potential tax liabilities in order to avoid penalties and interest. Affirming the lower court, the court determined that the date the funds were made available to the department was the date on which the deficiency interest accrual should stop. This was without regard to whether the funds were deposited with specific instructions about which particular tax liability the funds should be used for. Finally, the award of attorney fees for the taxpayer was vacated and remanded.
This opinion was issued after a motion for reconsideration was granted, and the earlier opinion was vacated. While the original opinion reached the same result for all issues, for the notice of a refund claim issue, it included analysis of a statute subsection (MCL 205.21(5)) that was not in effect when the dispute arose.
Friday, March 15 2013
Principal Originated With Nontaxable 403(b) Retirement Account
In Magen v. Department of Treasury, Michigan Court of Appeals, No. 302771, February 21, 2013, the Michigan Court of Appeals has held that the distributions from a private IRA whose principal wholly originated in a nontaxable 403(b) retirement account were not subject to the personal income tax. The Department of Treasury argued that because the distributions came directly from a private IRA the distributions must be taxed regardless of the fact that the IRA principal came from a tax-free retirement plan. Private IRAs were not normally tax-free, but rather tax-deferred. At retirement, state retirees received tax-free benefits in the form of periodic annuity payments or in a single lump-sum payment. The lump sum could be deposited into an investment account or a bank account, but the amount deposited was not taxable when it was withdrawn. In this case, the income placed in the IRA was not state tax-deferred income but, rather, state nontaxable income. Obtaining deferral on the applicable tax by rolling the money over into an IRA did not create a deferred obligation to pay state income tax on the money that was not subject to personal income tax to start with.
Thursday, March 14 2013
Single Business Tax Treatment Must be Consistent with Federal Treatment
In Lear Corporation v. Department of Treasury, Michigan Court of Appeals, No. 309445, February 21, 2013, the Michigan Court of Appeals held that a C Corporation taxpayer that elected under federal law to amortize research experimental expenses over 10 years was prohibited from deducting the entire amount for the year in which the expenses were incurred under the single business tax (SBT).
The taxpayer manufactured and sold systems for automotive seating, interior, and electrical power management and incurred research and experimental expenses related to this business. The taxpayer elected to amortize over 10 years the $205 million in expenses for its federal income tax return, and used the same calculation on its SBT return. However, after the SBT was repealed, the taxpayer tried to amend the SBT return and claim the entire deduction in the year in which the expenses were incurred. Under the SBT law, the tax base meant business income and business income meant federal taxable income. The taxpayer's tax base was required to reflect federal taxable income, including its election to amortize the expenses. Therefore, the court reasoned, the taxpayer should have used the amortized amount as the starting point to determine its SBT base. Also, the taxpayer was not guaranteed that it would realize the full deduction under the SBT. The applicable statute did not provide for an adjustment for this particular situation, so the taxpayer was not entitled to make such an adjustment.
Wednesday, March 13 2013
Taxpayer Leased Employees From a Professional Employment Organization
In Orthopaedic Associates of Grand Rapids, PC v. Department of Treasury, Michigan Court of Appeals, No. 308319, February 19, 2013, a Michigan taxpayer's payments of continuing medical education expenses and medical malpractice insurance premiums on behalf of its employee physicians were considered compensation and were added back to the taxpayer's tax base under the single business tax (SBT). To calculate the tax base under the SBT, compensation was included. The applicable statute defined "compensation," in pertinent part, to be wages, salaries, or other payments made on behalf of or for the benefit of employees, including, but not limited to, payments exempt from federal income tax withholding.
The taxpayer argued that the payments were for its own benefit, and not the employees' benefit. Physicians were legally obligated to attend continuing medical education classes in order to remain licensed. Also, medical malpractice insurance was issued only to individual physicians. Given this, the court reasoned that regardless of whether the taxpayer benefited, the payments benefited the physicians, who would otherwise have had to pay their own continuing medical education expenses and medical malpractice insurance premiums.
Additionally, the statutory language did not support the proposition that the payments made must be primarily, substantially, or totally on behalf of or for the benefit of the taxpayer's employees in order to constitute compensation. Accordingly, the payments were compensation and were added back to the taxpayer's tax base for SBT purposes.
The Court of Appeals remanded the case back to the Tax Tribunal to implement its order. However, a complicating factor exists in that the taxpayer leased employees from a Professional Employment Organization in three of the four years examined.
Tuesday, March 12 2013
Property Was "unoccupied" and Thus Eligible for the Principal Residence Exemption
In Compson v. County of Mecosta, Michigan Court of Appeals, No. 310011, February 21, 2013, the Michigan property taxpayers were entitled to the principal residence exemption because the property was "unoccupied" according to law. The small cabin had no septic system, no running water, no heating system (other than a wood stove), and was used to store furniture.
The taxpayers admitted to staying in the cabin for two days during hunting season. The lower court concluded that the property was occupied because any occupancy, whether temporary or more permanent in nature, was sufficient. However, the applicable statute did not have a temporal requirement. The appellate court reversed and held that the property was "unoccupied." Examining a similar case, the court noted that "unoccupied" meant without human occupants or residents, but that "vacant" meant completely empty. Thus, the key to determining whether the property was "unoccupied" was to consider if it was occupied by a tenant or resident. In this case, the property was "unoccupied" and thus eligible for the principal residence exemption.
Monday, March 11 2013
Property Was Not the Taxpayer's Principal Residence
In Drew v. County of Cass, Michigan Court of Appeals, No. 309557, February 14, 2013, residential property that was located on an island was denied a local Michigan property tax principal residence exemption because the property claimed was not the taxpayers' principal residence. The county presented evidence supporting its position that the taxpayers' property was utilized as a summer or seasonal home. The property was inaccessible by road and was less than 600 square feet in size. The county also submitted utility bills for the property that indicated low utility usage, and a long-time resident of the area testified that no one permanently lived on the taxpayers' island. In addition to the property at issue, the taxpayers also owned multiple residential properties.
Sunday, March 10 2013
New Office and New Address
After Skiing Around the world, I'm back in my office at a new location in the same building.
This year has been a great year for downhill skiing because there was so much snow. Unlike the previous year, snow covered the mountains around the world. I started my winter of snow by skiing the Sierra Mountains at Lake Tahoe in California. The purpose was to get my legs and lungs in shape for a trip to the European Alps.
I spent the last week of January in the Savoy Region of France skiing Courchevel, Meribel, Le Menuires, St. Martin and Val de Isier. Snow was everywhere, the food and wine was outstanding and the French people were accommodating.
In February I skied the Rocky Mountains in Colorado at Steamboat Springs and Beaver Creek.
In between all my travels, I managed to move my office upstairs from my previous location in the same building. The address is the same except the new suite number is 225.
While I may have been quiet, Michigan State and Local Tax issues have been popping up in the legislature and the courts. The year 2013 appears to become a significant year in Michigan taxes.
I have arranged with the MACPA to present four Sales and Use Tax seminars as well as four State and Local Tax Updates. register at the MACPA Website.