Corporation cannot deduct California business privilege tax in year paid

BY SALLY P. SCHREIBER, J.D.

Wells Fargo, an accrual-basis taxpayer, could not deduct the California business privilege tax it paid in one year (year 1) for the privilege of doing business the next year (year 2), even though California law had, since 1972, treated the tax as being incurred in year 1, a federal district court has held (Wells Fargo & Co., No. 09-CV-2764 (D. Minn. 8/10/12)).

Until 2003, Wells Fargo had deducted the business privilege tax in year 2, but chose to change its treatment to deducting it in year 1 because the obligation to pay those taxes and the amount of those taxes became fixed by the end of year 1 (and Wells Fargo actually paid the tax in year 1 through its estimated tax payments). These facts meant that the “all-events test” by which an accrual-basis taxpayer is able to deduct a liability was met.

The district court found that the all-events test had been met; however, due to a quirk in the federal tax law, Wells Fargo nevertheless could not deduct the tax in year 1. Under Sec. 461(d), which governs the tax year in which a taxpayer can take a deduction for accrued taxes, any change to a state’s tax laws that occurs after Dec. 31, 1960, cannot affect the timing of a deduction. As a result, the court had to determine how California tax law before 1961 would have treated the accrual of the business privilege tax.

Current California law requires a corporation to pay business privilege tax calculated on the basis of its year 1 income for the privilege of conducting business in year 2, even if the taxpayer discontinues operations before the end of year 2. Before 1972, however, the amount of the corporation’s tax liability would be reduced if it discontinued operations in year 2.

Because liability for the California business franchise tax before 1972 was contingent on actually conducting business in California in year 2, the event that would create the liability was not fixed for purposes of the all-events test until year 2, according to the court, and therefore the tax was not deductible until year 2.

Because Sec. 461(d) forbids post-1960 law changes from affecting the timing of the deduction, Wells Fargo, therefore, had to continue deducting its California business privilege tax in year 2, even though current California law fixes liability in year 1.  

Sally P. Schreiber ( sschreiber@aicpa.org ) is a JofA senior editor.

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