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Out of State Ownership Can be a Tax Trap
As I flip through the pages of recreational vehicle magazines, I am often reminded of what my mentor told me when I first began to study sales and use tax law. “If it walks like a duck and quacks like a duck, it is probably a nuclear missile aimed at your bank account.”
It doesn’t seem to matter whether your passion is vehicles, boats or airplanes, somebody from one of the five states in the U.S. that have no sales tax will set up his covered wagon along side the road and begin selling you on the idea of avoiding sales and use tax. There is nothing in the law that prevents you from establishing a corporation in one of these states. However, owning a corporation in a state that has no sales tax doesn’t preclude your corporation from owing sales tax in another state.
If your accountant advises you to use a corporation in a state other than the one you live in for IRS purposes, he probably knows what he is talking about. If your attorney advises you to use a corporate structure to minimize personal risk, you can be reasonably certain that he knows his area of expertise. However, if anyone leads you to believe that owning your personal property in an out of state corporation legally avoids your sales tax obligation in the state where you store and use the property, you are being led down a path of financial destruction.
There are many people who believe that by registering their motor home in the name of a Montana or Delaware corporation they have legally avoided sales and use tax. The truth is they believe it because they haven’t been caught yet. Their ignorance of the law will not be a valid defense when their case has to be argued. The fact that they have been told by 50 people in their RV club how “Rufus and Tilly” didn’t pay sales tax doesn’t change the brutal truth for them. Every person who has used an out of state corporation or address to register their property is juggling a hand grenade with the pin pulled. In fact, the longer they juggle it, the more dangerous it becomes.
The following hypothetical story is intended to explain the pitfalls.
In January of 1998, Chuck and Mary Robinson of Lodi, California were planning to retire. They planned to drive around the United States in their new recreational vehicle as long as the weather was good. For years Mary had flipped through the pages of magazines and fantasized about Chuck in his old ball cap driving the back roads of the United States, while she prepared breakfast in the modern kitchen in their motor home. Meanwhile, Chuck was fantasizing about the feel of the open road, the freedom from restaurant food, and taking a shower in his own bathroom along the way.
Life had been good to the Robinsons and they could afford one of the top of the line coaches that used to be reserved for traveling rock stars. They read all the ads, test drove a few of the previous year’s models and finally arrived at picking out the options, paint schemes, and checking off the accessory list. Chuck wanted a state of the art satellite system so he could track his investments, and Mary wanted to be able to keep up with her favorite sitcoms while they traveled.
When the couple realized that the sales tax on their $350,000.00 motor home was over $25,000.00, they began to pay attention to the ads about buying their new motor home in Montana. They knew there was no sales tax in Montana, and the savings would pay for a lot of accessories.
By March they were ready to commit to the vehicle of their choice and the new out of state corporation had been set up. They flew to the Montana dealer’s location, picked up their vehicle, and spent three weeks winding their way back to Lodi. Two quick trips to Nevada and Oregon in April and May encouraged the Robinsons to take an early retirement and spend the summer of 1998 in the southwest.
In September of 1999 they went to the DMV to re-register their motor home to their California address. Soon after a letter from the Consumer Use Tax Section arrived in their mailbox, requesting the details of their purchase. The nuclear missile had arrived and the missile was armed.
The Robinson’s accountant filed the tax return for the vehicle claiming that the corporation was an out of state resident and the purchase took place in Montana.
The Board of Equalization’s response was that it didn’t matter who owned the vehicle. They forwarded a letter with Regulation 1620 (b)(3), which states in pertinent part:
“Property purchased outside of California which is brought into California is regarded as having been purchased for use in this state if the first functional use of the property is in California. When the property is first functionally used outside of California, the property will nevertheless be presumed to have been purchased for use in this state if it is brought into California within 90 days after its purchase, unless the property is used or stored outside the state of California one-half or more of the time during the six-month period immediately following its entry into this state.”
The countdown to explosion had begun.
The accountant filed a statement that said the vehicle was purchased for out of state use. He included gas receipts from the trip between Montana and California (three weeks), the two short trips to Nevada and Oregon (two weeks) and a few receipts from the trips to Arizona and New Mexico in June, July and August of 1998. He also included receipts to show that over the two years, more than 8,000 miles were driven outside California.
The Board responded that even though the property was purchased outside the state, it entered California within 90 days. Therefore, it was presumed the vehicle was purchased for use inside California. The Board issued a Notice of Determination on April 15, 2000 for the $25,000.00 in tax, a $2,500.00 failure to file penalty (10% of the tax) and $3,000.00 in interest. Included in the Notice was a warning that the interest accrued an additional $250.00 each month that the tax remained unpaid.
The Robinsons brought their attorney into the case along with their accountant to file a Petition to have their case reheard. Six months later an appeals conference was held and the taxpayer’s representatives used the previously submitted documents to support that the vehicle was purchased for out of state use. They claimed that the majority of the use of the vehicle since the date of purchase had been in traveling outside California. The Board staff responded that since the vehicle entered the state 21 days after the purchase, the only time that would be evaluated was the six month period following the date of first entry into California.
The representatives responded that in Regulation 1620 it states, “unless the property is used or stored outside the state of California one-half or more of the time during the six-month period immediately following its entry into this state.” They asserted that trips to Oregon and Nevada in the first few weeks, as well as the trips to New Mexico and Arizona throughout June, July and August of 1998, constituted 4700 miles. They further claimed that over 3500 of the miles occurred outside California. It was their assertion that because the regulation states that the property must be used “or” stored more than one-half the time, the Robinson’s vehicle was exempt.
The staff responded that for the last several years the Board had been interpreting that the property must be used “and” stored for more than one-half the time. Therefore, the miles analysis meant nothing.
The representatives responded that when you take into account the time the vehicle was in out of state locations, the actual total far exceeded the 50 percent requirement in the Regulation. The Board responded that fuel receipts only prove where the vehicle was located at the moment of the purchase, and less than 15 receipts were submitted. Often there were periods of time in excess of 10 days where no receipt was provided. The reps responded that they provided two monthly rental receipts from an RV park in Phoenix for the months of July and August 1998. The staff countered that even though the taxpayer had provided the receipts for those months, it did not prove the vehicle never re-entered California during that time.
The representatives then asserted that the period of time was now over two years old and it was impossible to recreate a document trail to establish that the taxpayers had supported their claim for an exemption. The staff simply reminded the reps that it is the taxpayer’s burden of proof, not the staff’s burden to prove the exemption was not supported.
On February 7, 2001 the Robinsons wrote a check to the Board for over $33,000.00, after exhausting a settlement offer with the Board and an oral hearing before the elected members of the Board of Equalization, who found the staff’s positions within the laws and regulations. After adding to the bill over $15,000.00 in legal and accounting fees that were incurred for establishing the out of state corporation, filing its returns, and for the representation before the California State Board of Equalization, the time had finally run down to zero and the missile detonated, inhaling nearly $50,000 out of the Robinson’s retirement funds.
The sad truth is that the Robinsons could have legally avoided the tax in California. They didn’t need the Montana corporation and they could have registered the vehicle to their California address. Instead of hiding in a bomb shelter and waiting for a missile to hit its target, all they had to do was wrap themselves in the armor of a specialized program that is prepared by a sales and use tax expert who understands the way the Board works.
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If you have any questions regarding this article, other sales and use tax issues, or want to know if you qualify for an exemption contact Joseph Micallef at (916) 369-1200 or visit us on the web at www.ASTC.com.
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Audit Division