CALIFORNIA TAXATION: TOUGHER FOR SOME, A BREAK FOR OTHERS
California Taxation: Tougher for Some, A Break for Others
By Jason Morris
Manager, Tax Services, RBZ, LLP
(Note-RBZ LLP and LLG are both members of JHI, a growing global network of highly-regarded independent accountancy, business advisor and financial consulting firms in over 55 countries providing accounting, audit, tax and business consulting services in a wide range of industries for clients doing business across international borders).
At some point in a business’ life it will most likely have to deal with the issue of multistate taxation.
While state tax systems in place generally ensure a business or an individual does not have to pay state tax more than one time on the same taxable income, each state’s income tax system can be completely different. And to make things more complicated, with the fiscal difficulties many states are currently experiencing, state tax systems have also been changing significantly.
California is, of course, no exception. The state has recently enacted several tax law changes that become effective in 2011 that may have significant effects on businesses based in and outside of California.
Among some of the changes that may affect you include new “economic nexus” standards, the single sales factor apportionment election, and stricter use tax rules for out-of-state retailers as highlighted below.
In order for any state to be allowed to impose tax on a business, that business must have “nexus” in that state. California equates nexus as actively engaging in any transaction for profit. For taxable years beginning on or after January 1, 2011, the definition of doing business has been expanded to include new “economic nexus” standards which consist of the following:
- Sales to California customers of the lesser of $500,000 or 25% of the taxpayer’s total sales;
- Physical property of the taxpayer located in California that exceeds the lesser of $50,000 or 25% of the taxpayer’s total property;
- Compensation paid for work performed in California exceeds the lesser of $50,000 or 25% of the total compensation paid by the taxpayer.
Federal Public Law 86-272 (P.L. 86-272) provides a state may not impose a tax on income earned by an out-of-state business if that business’ activities within the state are limited to typical salesman type solicitation of sales activities. So despite these new economic nexus rules, P.L. 86-272 protects taxpayers from the imposition of California income tax unless the business has activities in California that go beyond solicitation of sales.
Nevertheless, if a taxpayer is considered doing business in California according to the new economic nexus standards, the taxpayer still has a tax return filing requirement and will be subject to the $800 minimum tax since this minimum tax is not computed on net income and therefore is not subject to the protections of P.L. 86-272.
Stepping aside from the income tax arena, in June 2011, California broadened its authority to assert sales tax collection on out-of-state retailers. Out-of-state retailers are now required to collect and remit sales tax if they have affiliates in California who refer at least $10,000 in merchandise to California consumers a year through links or ads on their websites, and if they sell at least $500,000 a year in merchandise to California consumers. Amazon is expected to challenge the new law as being unconstitutional so likely more to come on this issue.
The other change to note is that California has started enforcing collection of sales tax if out-of-state retailers have a corporate group member in the state that contributes to the group’s core business. For example, if a Nevada corporate retailer establishes a wholly-owned subsidiary in California to merely solicit sales, the Nevada corporation is now required to collect use tax on its sales to end users in California.
Single Sales Factor
To limit states for taxing business income twice, most states use an “apportionment” system to apportion the business’ taxable income to a state based upon the business’ relative business activity in the state to the total of all of its business activities. This has historically been done in California by taking an average of the business’ relative sales, payroll and property in California to its overall sales, payroll and property, with the sales factor being included twice in the apportionment formula.
Beginning in tax year 2011, most businesses can apportion income to California using only the business’ relative sales to California. For California-based businesses doing business in other states, this should lower the amount of California tax to be paid.
Jason Morris is a Tax Manager at RBZ, LLP, a Los Angeles-based public accounting firm. RBZ provides audit, tax and business advisory services to the entertainment, family wealth, international tax, law firms, middle market, nonprofit and real estate industries.