MacFarlane v. Utah State Tax Com'n

• Decision Date: 24 March 2006
• Docket Number: No. 20040956.,No. 20030949.,No. 20030887.,20040956.,20030949.,20030887.
• Citation: 2006 UT 18,134 P.3d 1116
• Parties: James and Carol MacFARLANE, Bernard and Verbena Diamond, Samuel and Sandra A. Hunter, Jane A. Marquardt, Robert L. and Annette Marquardt, Robert S. and Kim Marquardt, Barbara B. Baker, and William and Julia L. Reagan, Plaintiffs and Appellees, v. UTAH STATE TAX COMMISSION, Defendant and Appellant.
• Court: Utah Supreme Court

Page 1116

134 P.3d 1116

2006 UT 18

James and Carol MacFARLANE, Bernard and Verbena Diamond, Samuel and Sandra A. Hunter, Jane A. Marquardt, Robert L. and Annette Marquardt, Robert S. and Kim Marquardt, Barbara B. Baker, and William and Julia L. Reagan, Plaintiffs and Appellees, v. UTAH STATE TAX COMMISSION, Defendant and Appellant.

No. 20040956.

No. 20030949.

No. 20030887.

Supreme Court of Utah.

March 24, 2006.

As Amended April 8, 2006.

Mark K. Buchi, Steven P. Young, Charles R. Brown, Jennifer A. James, Roger O. Tew, Salt Lake City, for appellees.

Mark L. Shurtleff, Att'y Gen., Mark E. Wainwright, Asst. Att'y Gen., for appellant.

Carol B. Lear, Jean Welch Hill, for amicus Utah State Board of Education.

DURHAM, Chief Justice:

INTRODUCTION

¶ 1 This is a consolidated appeal of judgments of the Fourth Judicial District Court and the Utah State Tax Commission. The common issue is whether Utah Code section 59-10-106 allows the taxpayers to claim a credit against their income taxes for certain corporate franchise taxes paid to California and Texas by the small businesses of which they were shareholders. The Tax Commission argues that the franchise taxes are not included in the category of taxes for which a credit is statutorily allowed. We disagree.

BACKGROUND

¶ 2 Four sets of taxpayers are involved in this case. The first party consists of Bernard and Verbena Diamond, Samuel and Sandra A. Hunter, Jane A. Marquardt, Robert L. and Annette Marquardt, and Robert S. and Kim Marquardt (collectively, the "MTC Shareholders"), each of whom was a shareholder, or the spouse of a shareholder, in Management and Training Corporation. The second party consists of James and Carol MacFarlane, who were the sole shareholders of I.C. Security Printers, Inc. The third party, Barbara Baker, was the sole shareholder of Challenger Schools. Finally, William Reagan, who with his wife forms the last party, was the sole shareholder of Reagan National Advertising of Austin, Inc. All of these individuals (collectively, the "Taxpayers") were Utah residents and each filed, either individually or jointly with a spouse, Utah individual income tax returns. Additionally, all of the corporations in which the Taxpayers were shareholders were S corporations organized in Utah.

¶ 3 An S corporation is a small business that meets certain criteria set forth in subchapter S of chapter 1 of subtitle A of the Internal Revenue Code and thereby qualifies for special federal tax treatment. 26 U.S.C. § 1361 (2000). A business becomes an S corporation by shareholder election. Id. § 1362 (2000). Once the election has been made by a qualifying corporation, it is treated as a pass-through tax entity, meaning that all revenues, profits, expenses, and losses are passed through, pro rata, to the shareholders based upon their percentage of ownership. Id. § 1366 (2000).

¶ 4 Because of this pass-through characteristic, shareholders of such corporations are individually responsible for taxes imposed upon the corporate entity. In this case, either Texas or California, or both, levied corporate franchise taxes on the four S corporations at issue.¹ The reason these states did not impose the tax directly on the shareholders rather than the companies is that states are not obliged to recognize S corporation status. While both Utah and California recognize S corporations for state tax purposes, Texas does not. Compare Utah Code Ann. § 59-7-701 (2004) and Cal. Rev. & Tax.Code § 23800 (West 2004) with Tex. Tax Code Ann. § 171.001 (Vernon 2002 & Supp.2005). Also, at all relevant times, California allowed foreign S corporations doing business in the state to elect to be treated as regular C corporations for California tax purposes. Cal. Rev. & Tax Code § 23801(A)(4)(a)(ii) (West 2004). Because the four corporations were treated as C corporations by both Texas and California, the taxes were imposed by these states on the corporation, but the shareholders were ultimately responsible for their payment.

¶ 5 The Taxpayers sought to offset the effects of these taxes by claiming a credit against their Utah individual income taxes for a portion of the corporate franchise tax which had been paid by the S corporation to either Texas or California, or both. The Taxpayers claimed this credit pursuant to Utah Code section 59-10-106. The credits were disallowed. The Taxpayers each filed Petitions for Redetermination with the Tax Commission to review the credit denials.

¶ 6 The Tax Commission conducted four formal hearings to determine the validity of the credits claimed by the Taxpayers, one each for the MTC Shareholders, the MacFarlanes, Ms. Baker, and the Reagans. In each case, the Tax Commission denied the credits, reasoning that because the Texas and California taxes were franchise taxes they were not eligible to be credited against the Taxpayers' individual income taxes under Utah Code section 59-10-106. The Tax Commission noted that although the Texas and California taxes were measured by income,² they were imposed on the privilege of doing business within each state.³ Thus, the Tax Commission concluded that such taxes were not "on income" as required by Utah Code section 59-10-106 in order for a credit to be claimed.⁴

¶ 7 Taxpayers appealed the decisions of the Tax Commission. Ms. Baker and the Reagans appealed directly to this court under Utah Code section 78-2-2(3) (2002). The MTC Shareholders and the MacFarlanes appealed to the Fourth Judicial District Court, which granted them summary judgment. The district court found that the language and purpose of Utah Code section 59-10-106 (2004) supported a broader interpretation of the statute, particularly of the phrase "on income." That court looked not at the label of the taxes imposed i.e., as a franchise or excise tax as opposed to an income tax but instead at the functional effect of the tax on the taxpayers. The Tax Commission appealed the judgment of the district court. The parties agreed to consolidate the appeals of Taxpayers and of the Tax Commission for a determination of the common legal issue.

¶ 8 We have jurisdiction over the appeal from the district court pursuant to Utah Code sections 59-1-608 and 78-2-2(3)(j), and over the appeals from the Tax Commission pursuant to Utah Code sections 59-1-602(1) and 78-2-2(3)(e)(ii).

STANDARD OF REVIEW

¶ 9 A matter "of statutory interpretation [is] a question of law that we review on appeal for correctness." State v. Schofield, 2002 UT 132, ¶ 6, 63 P.3d 667. We also use a correction of error standard for the conclusions of law of the Tax Commission, Utah Code Ann. § 59-1-610(1)(b), and review the conclusions of law of the district court for correctness on summary judgment. Dick Simon Trucking, Inc. v. Utah State Tax Comm'n, 2004 UT 11, ¶ 3, 84 P.3d 1197.

ANALYSIS

¶ 10 The sole issue before this court is whether shareholders of an S corporation can claim a tax credit under Utah Code section 59-10-106 (2004) for taxes paid to other states by the S corporation when those taxes are measured by income. The Tax Commission argues that shareholders cannot claim such credits because the term "on income" as used in the statute does not include taxes labeled as franchise or excise taxes. Such an interpretation, the Tax Commission believes, is in accordance with the principle of statutory construction that tax credit statutes are to be strictly construed against the taxpayer.

¶ 11 While we recognize the general proposition that tax credit statutes are to be strictly construed against the taxpayer, we do not find it conclusive in this case. Instead, we find that the plain language of section 59-10-106 is clear in extending credits not only for taxes labeled as income taxes, but also for franchise or excise taxes measured by income. This plain language reading is wholly consistent with the statute's purpose of avoiding double taxation.

I. THE PLAIN LANGUAGE OF SECTION 59-10-106 IS SUFFICIENTLY BROAD TO INCLUDE FRANCHISE TAXES MEASURED BY INCOME

¶ 12 In undertaking statutory construction, "[w]e look first to the plain language of a statute to determine its meaning. Only when there is ambiguity do we look further." J. Pochynok Co., Inc. v. Smedsrud, 2005 UT 39, ¶ 15, 116 P.3d 353. Moreover, "[w]hen examining the plain language, we must assume that each term included in the [statute] was used advisedly." Carrier v. Salt Lake County, 2004 UT 98, ¶ 30, 104 P.3d 1208 (citation omitted).

¶ 13 Utah Code section 59-10-106 (2004) states:

A resident individual shall be allowed a credit against the tax otherwise due under this chapter equal to the amount of the tax imposed on him for the taxable year by another state of the United States, the District of Columbia, or a possession of the United States, on income derived from sources therein which is also subject to tax under this chapter.

The controversy in this case surrounds the definition of the term "on income." The Tax Commission argues that there is a distinction in tax law between excise franchise taxes and taxes "on income," even though both types of taxes may be measured by income. For example, Hellerstein divides taxes measured by income into two categories: "(1) excise taxes on ... the privilege of doing, or the license to do, business in the state; and (2) taxes on net income derived from or attributable to the state." Jerome R. Hellerstein & Walter Hellerstein, State Taxation, ¶ 7.01 (3d ed.2000). Because excise and franchise taxes are distinct from taxes on income, the Tax Commission asserts that credits are not available for the former under section 59-10-106.

¶ 14 We do not find this distinction relevant to the case before us. The Tax Commission has failed to show that this distinction is recognized in any area apart from state taxation of income from federal obligations. In that area of the law such a distinction is sometimes warranted and useful to avoid rendering state legislation void.⁵ But there is no reason why such a...