California Franchise Tax Board Puts Burden on Buyer to Withhold Seller’s Tax Liability
The Change to the California Tax Law Affecting Real Estate:
A change in the tax law, Revenue and Taxation Code §18662 and following, as of January 1, 2003, now requires the Buyer of California real estate to withhold 3.3% of the gross sales price from the proceeds due to the Seller, and remit that amount to the Franchise Tax Board (“FTB”). The Buyer, “or other transferee”, is responsible for withholding the money, completing FTB Form 597, providing two (2) copies of Form 597 to the Seller, and providing the withholding payment to the FTB by the due date together with one copy of Form 597. A Buyer who fails to comply can be held “liable for . . . the amount of taxes due from the person to whom the payments are made [the Seller’s tax obligation] to an extent not in excess of the amounts required to be withheld [up to 3.3% of the gross sales price]” together with a penalty of up to ten percent (10%) of the amount required to be withheld, and interest from the due date of the withholding payment.
The Problem: While the escrow officer is required to notify Buyers in writing of the withholding obligation, it has come to our attention that some title and escrow companies are not complying with these new requirements. An escrow officer who fails to notify the Buyer in writing of the withholding requirements faces a possible penalty of up to ten percent (10%) of the amount required to be withheld. But if the notice is provided to the Buyer, it is the Buyer’s responsibility to comply.
Why Was The Tax Law Changed:
Withholding taxes due on real estate sales is not new, it has simply been expanded to cover more transactions. The withholding requires the taxpayer to prepay taxes that would otherwise be due at regular tax time. It is similar to the wage withholding that employees have deducted from their paychecks, and in many cases will save the Seller from having to make an estimated tax payment on their capital gain. The purpose is to provide the State of California with an accelerated tax revenue estimated to be $225 million. The tax is now an upfront income tax being collected at the close of escrow from individual real estate investors.
Who Is Included In These Requirements:
Before the withholding law was changed at the first of the year only out-of-state sellers were covered. The changes bring in all individuals, whether resident or not, who do not qualify for an exemption. The requirements continue to apply to non-resident entities. An individual means people, as distinguished from entities. “Individual” includes married couples, trustees of revocable trusts, and virtually anyone with a pulse and an opposable thumb. Non-individuals are entities, like corporations, partnerships, and irrevocable trusts.
Who Is Exempted From These Requirements:
The following are eligible for an exemption;
Exemptions are available for Individuals in these situations:
- The property is the Seller’s principal residence (IRC § 121)
- The sales price is under $100,000 (If you know of houses here under $100,000 please contact this author immediately, as I am in a buying mood)
- Sale will be a tax loss to Seller for California tax purposes
- Like-kind exchanges, except for any boot (IRC § 1031)
- Involuntary conversions (IRC § 1033)
- Certain foreclosuresExemptions are available for Entities (non-individual sellers) in these situations:
- Corporations with a permanent place of business in California (Amazon.com does not qualify)
- Partnerships or Limited Liability Corporations (LLC’s)
- Tax exempt entities, insurance companies, IRA’s, or qualified pension plans
- Irrevocable trusts with a California trustee
- Estates with a California decedent
- Banks or banks acting as trustees of trusts
Sellers who qualify for one of the above exemptions must sign the appropriate written certification under penalty of perjury to be exempt (Form 593-C, I, L, or W). The signed form becomes part of the escrow documentation.
Buyer’s Reporting Requirements:
Remember, unless the escrow officer or company does this for the Buyer it is the Buyer “or other transferee” who is responsible for withholding the money, completing FTB Form 597, providing two (2) copies of Form 597 to the Seller, and providing the withholding payment to the FTB by the due date together with one copy of Form 597.
We recommend that Buyers or their Real Estate Professionals modify the Buyer’s escrow instructions to shift the duties of Revenue and Taxation Code §18662 et seq. to the escrow officer or company. Delegating the responsibility to the escrow officer is actually contemplated by the Franchise Tax Board, and is mentioned in multiple places in those areas of their website that discuss this law. We suggest that Buyers or their agents simply modify the escrow instructions presented to them by their title or escrow company by adding a sentence to the effect of, “Escrow officer and company shall be responsible for compliance with all tax withholding and reporting requirements, including the requirements of Revenue and Taxation Code §18662 et seq.”
For more detailed information on the changes in this area of the tax law we suggest that the reader explore the California Franchise Tax Board’s website at www.ftb.ca.gov. Another cynical but accurate article appears at the Foreclosure Forum’s website, under January 2003 articles, at www.foreclosureforum.com/articles.
This article written and © Peter N. Brewer, Esq.
Brewer Offord & Pedersen LLP (www.BrewerFirm.com) serves the legal needs of homeowners, real estate and mortgage brokers, agents, brokerages, title companies, developers, investors, other real estate professionals and their clients. Mr. Brewer and his firm also represent clients in debt collection, breach of contract matters, and other litigation and transactional work. The firm’s client range from homeowners, brokers and lenders based in Santa Clara County, San Mateo County, San Francisco County, as well as throughout other counties in California.