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Have you ever put up outdoor holiday lights during the holiday season? Ever
had them NOT get tangled? I swear little gremlins must live in my attic
where I store my lights because every season my lights are a tangled mess
that I could not make worse if I tried. And after I get them untangled, I
always find that one of the 4,580 tiny light bulbs is burned out and none of
the other 4,579 lights will work until I find and replace that one tiny
Property taxes are a lot like those strands of holiday lights. It only takes
one small mistake to set off a string of events that will consume more time
and money than you care to imagine.
I know the range of sentiments out there… “property taxes are
insignificant”, “I focus on the top line growth, not tax issues”, “My
accountant handles all the taxes”. If you can relate to these thoughts
please read on. The stories that follow are for you, they are true, and they
happen all the time.
Property taxes related to a portfolio of leased assets present challenges
that few industries face. For example: consolidated tax bills for multiple
lessees, appropriate tax allocation for lessee reimbursement, assets being
moved without notice from one taxing jurisdiction to another, assets rolling
off lease in the middle of a tax year, and the list goes on.
Lessors are saddled with mountains of paperwork and varying compliance
requirements from approximately 80,000 taxing jurisdictions. Many of these
jurisdictions have their own forms, deadlines, and methodologies for
determining taxes. As these states, counties and cities face hard economic
times with sales tax revenues falling to record low levels, they must look
to other sources of revenue to maintain their already anemic budgets. The
current trend is to bolster the property tax revenue. However you choose to
handle property taxes, you must acknowledge and accept the LAW of Property
Tax Administration: The cost of performing the property tax function
“marginally” WILL cost you thousands of dollars annually….PERIOD!!
To minimize your taxes and insure your lessee reimburses you for their
appropriate share of property taxes, you must commit the proper resources.
Long gone are the days that lessors could “have the accountants handle
property taxes”. Property tax administration requires specialized knowledge
of each taxing jurisdiction where your lessees are located. Today, assessing
jurisdictions are ever vigilant in their discovery of taxable assets, and
tax collection efforts continue to be relentless.
Tangled Mess #1: Assets Incorrectly Classified
A lessor leases rail car loading equipment that is coded in their general
ledger as rail cars. Employee #1 fails to review the asset listing detail
and assumes the description is accurate (Mistake # 1). Since employee # 1
knows rail cars are not taxable for property tax purposes in this particular
state, the rail cars are not reported (Mistake # 2). After Employee # 1
leaves the company for greener pastures, Employee # 2 takes over the
property tax administrative function the following year. Employee # 2 knows
to look beyond the General Ledger code when reporting assets and finds that
the true asset description of these assets is rail car loading equipment,
not rail cars. Since these assets are taxable, Employee # 2 reports the
assets. Upon receiving the asset listing from Employee # 2, the taxing
jurisdiction notes that the assets have been in service for 3 years but have
never been reported so the assets are assessed for three prior years and the
tax bill total is $400,000. When the mistake was discovered, and the tax
bill was due and payable, the lease had expired and the lessor was liable
for the previous years property taxes. The lessor should have the ability to
collect the tax portion from the lessee, however penalties and interest are
the responsibility of the lessor. Prior to collecting any money from the
lessee, the lessor had to write a check for $465,000 to the taxing authority
for taxes, penalties, and interest.
Tangled Mess # 2: Assets not Properly Reported
A lessor has many expensive assets being leased. The assets are considered
“rolling stock” and as such, are typically reported by the lessee (for
property tax purposes) to achieve an interstate allocation of taxes among
the various states the assets have traveled. It is important to note that
the lessee in this story represents a significant portion of the lessor’s
leasing portfolio business.
The lessor assumed that the lessee reported the assets to the taxing
jurisdictions for property tax purposes (Mistake # 1), and therefore the
lessor did not report the assets. Further, the lessor did not obtain
verification from the lessee that the assets had in fact been properly
reported (Mistake # 2). The fact is, the lessee did not report the assets to
the taxing authorities.
When taxing authorities discovered that the assets were not being reported,
a back-assessment was sent to the lessor (the owner of record). The lessor
had two options; (1) Pay the resulting $300,000 tax bill plus $35,000 in
penalties and interest or (2) Approach the lessee and request payment from
them (remember the lessee represents a significant portion of the lessors
portfolio). This oversight created a no-win situation for the lessor that
could have been avoided.
Tangled Mess # 3: Double Assessments
A lessor had vehicles titled under several DBA names to identify various
leasing portfolios. For several years Employee #1 reported the assets to
taxing authorities under the different DBA names. After Employee #1 decides
to take a job with another company, Employee # 2 is hired to administer
property taxes. In order to simplify the property tax reporting function
Employee #2 decides to report the vehicles under the parent company name
(Mistake #1). The taxing authorities promptly assessed taxes on these “new”
Since the vehicles reported in previous years under the DBA names were not
reported in the current year, the taxing authority rolled over the prior
year assessment and sent out current year tax bills to the various DBA’s.
This created a double assessment of taxes for the same assets (one
assessment to the parent company and another to the DBA). Now the story gets
even better (or worse if you are the lessor)…Employee # 2 was not fully
versed on the property tax laws in the state where this debacle occurred and
failed to protest the double assessments within a two year period (Mistake #
2). Since too much time had passed, appeal remedies had expired and the
lessor was required to pay $80,000 in extra taxes while spending countless
hours trying to correct the situation.
Tangled Mess # 4: Assets Relocated by Lessees
A lessor has a portfolio of commercial vehicles. Generally, for property tax
purposes, vehicles are taxable in the jurisdiction where the vehicle is
registered. When vehicles are moved from one location to another, double
assessments can easily occur. In this situation the lessee failed to notify
the lessor that the vehicles had been moved, and the lessor failed to ask
(Mistake # 1). Essentially, bad information created a double tax assessment
whereby two or more different taxing authorities tax one asset. When the
double assessments were discovered, the lessor had to file formal protests
in 5 different states, contact each tax jurisdiction and each lessee to
determine the actual location of each asset, and attend appeal hearings in 5
different states. The man-hours and travel costs alone were calculated to
total $75,000 not counting the liability in taxes that remains in dispute.
Tangled Mess # 5: Asset Cost Incorrectly Reported
A lessor routinely included commissions, travel expense, training, and
additional soft costs into the “Cost” of all leased assets. While this cost
amount was meaningful for certain purposes, this erroneous cost was utilized
as the basis for reporting assets for property tax purposes. The result was
that the lessor reported costs 250% higher than the actual taxable cost and
by doing so, incurred a tax liability 250% too high!
After the “glitch” was discovered, the lessor spent countless hours
attempting to recover the overpayments in taxes from taxing authorities. The
following year when the assets were correctly filed, and lessees received
tax bills for much less than in previous years, some lessees raised
questions. Ultimately the lessor had to calculate the amount of over-charges
that were billed to lessees and refund monies to almost 3,000 lessees. This
project encompassed almost two years and countless man-hours to correct, not
to mention the negative goodwill generated with the lessees.
These stories are all true, and they happen every day. How do YOU avoid
these situations? There are a number of ways to avoid the quagmire of faulty
property tax administration.
Property taxes represent significant liabilities that
require in-depth knowledge and expertise to manage appropriately. The risk
of financial loss and tarnished customer relationships is too high to
minimize the importance of this component of your business.
The stories above are not extreme and oddball occurrences. They are
scenarios that are happening every day. Taxing jurisdictions make big
mistakes every year, and if you are not knowledgeable of the various taxing
authorities rules of engagement, and if you are not monitoring the process,
you can safely assume you and your lessee are overpaying property taxes.
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