State Tax Audit Assessments: Who Has Burden of Proof?
Two recent court cases in Indiana, and one in South Carolina make you pause and ask - who has the burden of proof?
The Indiana Tax Court ruled in AE Outfitters Retail Co. v. Indiana Department of State Revenue (No. 49T10610126TA66, October 2011) and in Rent-A-Center East, Inc. v. Indiana Department of State Revenue (952 N.E. 2d 387) that Indiana could not force a taxpayer to file a combined return until it has determined that other, less drastic departures from "standard" separate return and apportionment methodologies will not provide an equitable allocation and apportionment of a taxpayer's income.
In both of the Indiana cases listed above, the taxpayer filed a separate return as required by Indiana law. Upon audit, Indiana attempted to force the taxpayer to file a combined return. The taxpayers protested and ended up in Indiana's Tax Court. The Tax Court in both cases stated the burden of proof that the standard separate return and apportionment is invalid rests on the party that is deviating from the standard method. Hence, the burden of proof was ruled to be on the state of Indiana.
The state of Indiana has appealed the Rent-A-Center East, Inc. case to the Indiana Supreme Court.
In South Carolina, the Administrative Law Court recently ruled in Carmax Auto Superstores West Coast, Inc. vs. South Carolina Department of Revenue (Ct. of Appeals, Case No. 09-ALJ-17-0160-CC), that the alternative method proposed and assessed by South Carolina was reasonable. In this case, the taxpayer filed its original return using the standard apportionment formula. Upon audit, South Carolina deviated from the standard apportionment formula. The Court said the taxpayer had the burden of proof to show that South Carolina's alternative method was not reasonable or that the standard method was reasonable.
This case is currently in South Carolina's Court of Appeals. Oral arguments in the Court of Appeals focused on who had the burden of proof. Normally, when a taxpayer receives an audit assessment, the taxpayer has the burden to challenge it. However, the burden of proof can also relate to specific issues. For example, in the case of whether an affiliated group of companies is unitary, generally, the taxpayer is presumed to be unitary and the burden of proof is on the taxpayer. In regards to business vs. nonbusiness income, generally, all income is presumed to be business income. The burden rests on the taxpayer to prove that income is nonbusiness income.
Now, in regards to alternative apportionment, most state statutes say the burden of proof to prove that distortion exists rests with the party that requests to deviate from the standard apportionment formula.
What do you think? What will happen in Indiana's Supreme Court and South Carolina's Court of Appeals? How does this impact your company's or client's filing positions? When can a taxpayer request alternative apportionment or combined reporting? Is combined reporting an alternative apportionment option? Must the state consider ALL other reasonable options before forcing a taxpayer to file a combined return?
Brian Strahle is the owner of LEVERAGE SALT, LLC where he provides state and local tax technical services to accounting firms, law firms and tax research organizations across the United States. He also writes a weekly column in Tax Analysts State Tax Notes entitled, "The SALT Effect." For more info, visit his website: www.leveragestateandlocaltax.com
You can reach Brian at firstname.lastname@example.org.
Because state and local taxes are deceptively simple and endlessly complicated.