An out-of-state taxpayer that has less than the threshold amounts of property, payroll, and sales in California may still be considered doing business in California if the taxpayer actively engages in any transaction for the purpose of financial or pecuniary gain or profit in California.
Partnership A, an out-of-state partnership, has employees who work out of their homes in California. The employees sell and provide warranty work to California customers. Partnership A's property, payroll, and sales in California fall below the threshold amounts. Is Partnership A considered to be doing business in California?
Yes. Partnership A is considered doing business in California even if the property, payroll, and sales in California fall below the threshold amounts. Partnership A is considered doing business in California through its employees because those employees are actively engaging in transactions for profit on behalf of Partnership A.
Corporation B, an out-of-state corporation, has $100,000 in total property, $200,000 in total payroll, $1,000,000 in total sales, of which $400,000 was sales to California customers. Corporation B has no property or payroll in California. Is Corporation B doing business in California?
Yes. Although Corporation B's California sales is less than the $500,000 threshold, Corporation B's California sales is 40 percent of its total sales which exceeds 25 percent of the corporation's total sales ($400,000 ÷ 1,000,000 = 40%.)
PL 86-272 still applies to sellers of tangible personal property. As a result, if a taxpayer's activities in California stay within the protections of PL 86-272, a taxpayer also remains protected from the imposition of those taxes that are computed based on net income, namely, the California franchise and income tax. Nevertheless, if a taxpayer is considered doing business in California either under R&TC Section 23101(a) or (b), it still has a filing requirement and will be subject to the minimum tax, because that tax is not computed based on net income and therefore is not subject to the protections of PL 86-272.
Corporation C, an out-of-state corporation, is a seller of tangible goods over the internet and qualifies for protection under PL 86-272. For taxable year 2011, Corporation C has $1,000,000 of sales but no property or payroll in California. Is Corporation C considered doing business in California?
Yes. Corporation C is considered doing business in California because it has sales of $1,000,000 in California. Therefore, Corporation C must file a California return to pay the minimum tax. However, since Corporation C is protected under PL 86-272, it will not be subject to California franchise tax.
Corporation D, an out-of-state corporation with no property or payroll in California, is a service provider that has sales of $2,000,000 to purchasers who receive the benefit of Corporation D’s services in California. Those services are from income-producing activity that is performed outside of California and Corporation D uses the four-factor formula (property, payroll, and double-weighted sales) to apportion its income to California. As a result, none of Corporation D's income is apportioned to California. Is Corporation D considered doing business in California?
Yes. Sales of services and intangibles are sourced under R&TC 25136(b) for purposes of applying the doing business test of R&TC 23101(b) regardless of whether those sales are sourced under R&TC 25136(a) for income apportionment purposes (that is, regardless of whether taxpayer elects single sales factor apportionment). Accordingly, Corporation D is considered doing business in California because it has sales of services here of $2,000,000. Although Corporation D has no California source income, it is still liable for the minimum tax because it is doing business here. PL 86-272 does not protect the taxpayer, because it does not apply to service providers, nor does it protect against the minimum tax (because that tax is not income-based).
In determining their property, payroll, and sales in California, the taxpayer must also include their pro rata share of property, payroll, and sales from partnerships, LLCs treated as partnerships, and S corporations. Partnerships and LLCs are considered doing business in California if they have a general partner or member doing business on their behalf in California. Likewise, general partners and members are considered doing business in California if the partnership or LLC, respectively, is doing business in California. For taxable years beginning on or after 1/1/2013, all apportioning trades or businesses, except those that derive more than 50% of their gross receipts from qualified business activities, shall apportion their business income to California using a single-sales factor. Nevertheless, partnerships, LLCs treated as partnerships, and S corporations are required to provide to their partners, members, and shareholders their pro rata share of the California and total property, payroll, and sales on the CA Schedule K-1 so their partners, members, or shareholders may determine if they are doing business in CA.
Corporation E, an out-of-state corporation, has no property or payroll but has $450,000 of sales to customers located in California. Corporation E also has a 30 percent limited partnership interest in Limited Partnership X which is doing business in California. For tax year 2011, Limited Partnership X has $30,000, $50,000 and $200,000 in property, payroll, and sales in California, respectively. Is Corporation E considered doing business in California?
Yes. Corporation E is considered to have the following distributive shares of property, payroll, and sales from Limited Partnership X:
Flow through Partnership property = $9,000 ($30,000 x 30%)
Flow through Partnership payroll = $15,000 ($50,000 x 30%)
Flow through Partnership sales = $60,000 ($200,000 x 30%)
Corporation E is doing business in California because it has a total of $510,000 sales in California ($450,000 of its own sales + $60,000 of Limited Partnership X’s sales.)
Corporation F is a 50 percent general partner in a California partnership. The partnership has $800,000 of sales, $10,000 of property and $10,000 of payroll in California. Is Corporation F considered doing business in California?
Yes. Corporation F, through its distributive share from the California Partnership, has $400,000 of sales, $5,000 of property and $5,000 of payroll in California which are below the threshold amounts. However, because Corporation F is a general partner, it is considered doing business in California on behalf of the California Partnership that is doing business in California.
Corporation G, an out-of-state corporation, owns multiple interests in several pass-through entities in California. How should it compute the amounts of property, payroll, and sales in California?
Corporation G computes its property, payroll, and sales in California by aggregating the property, payroll, and sales from all sources, including all distributive shares of property, payroll, and sales from each pass-through entity. If the combined property, payroll, or sales exceed the threshold amounts, Corporation G is considered doing business in California.
Corporations that are permitted, pursuant to subsection (a)(1) of R&TC 23040.1 to exclude from California source income their distributive share of interest, dividends, and gains from the sale of qualified investment securities from a qualified investment partnership shall also exclude those amounts from the doing business test set forth in R&TC 23101(b). Furthermore, the exemption from doing business applicable to alien corporations that meet the requirements of R&TC 23040.1(c) remains in effect.
Editor’s Note: This post was originally published in 2012 and has been updated for accuracy and comprehensiveness.
If you’re an American living abroad who came from California, you may not know that your former state might still consider you a resident. If that’s the case, you may need to file a state tax return along with your Federal expatriate tax return. It’s very important you pay close attention to how your former state home regards you in order to know whether you should file State Tax Returns. Otherwise, you may have back taxes waiting for you.
How to Determine Whether You Need to File CA State and Federal Expat Tax Returns
The first thing you will need to determine is whether the State of California continues to consider you a resident. The state looks at various factors to make that determination (listed below), some of which may surprise you. Then, you will need to check your income-producing assets to see if any of these assets are located in California. Even as a non-resident of California, you may have to file a California return to report your California-sourced income (for example, rental income). This will be in addition to your Federal expat tax returns.
California explains residency as “…the place where you have the closest connections.” If you want to make sure the State of California no longer considers you a resident, you should be careful to read their list of residency factors:
- Amount of time you spend in California versus amount of time you spend outside California
- Location of your spouse/RDP and children
- Location of your principal residence
- State that issued your driver’s license
- State where your vehicles are registered
- State in which you maintain your professional licenses
- State in which you are registered to vote
- Location of the banks where you maintain accounts
- The origination point of your financial transactions
- Location of your medical professionals and other healthcare providers (doctors, dentists etc.), accountants, and attorneys
- Location of your social ties, such as your place of worship, professional associations, or social and country clubs of which you are a member
- Location of your real estate property and investments
- Permanence of your work assignments in California
Remember, the burden of proof is on you. Your tax records should include proof that you severed enough of your strongest California ties on this list (or other factors that apply to your unique situation) to prove you are a non-resident of California.
If you have not severed all your California ties, be prepared to defend your position. They may want to use any of your California connections to require you to file a return as a California resident, subjecting you to California tax on your worldwide income. In California, as in most states, residents are taxed on worldwide income no matter where it was earned or where the property is located. This is an important thing to remember when filing your expatriate tax return.
If you left California temporarily with an intention to return, California would probably determine that your stay outside of the state was not permanent or indefinite. In that case, you would continue to be considered a California resident and would have to file a California tax return in addition to your Federal expat tax returns, including all your income. If you were a California resident for part of the year, you have to file a California tax return for that year.
If you are a non-resident of California and have California-sourced income, you may have to file a California tax return. But take note – the following kinds of California income are not subject to California tax for non-residents:
- Investment income such as interest, dividends, and capital gains from stocks or bonds. Generally, these are considered to have their source where you are a resident. (However, if investment accounts are used in a trade or business located in California, or pledged as security for a loan and the loan proceeds are used in California, then you must file a California income tax return and report the income from these accounts.)
- A California retirement plan distribution to a non-resident is not subject to California tax. Since 1995, non-residents are not taxed by California on California-sourced pensions, lump sums from qualified plans, and IRAs.
If all of your California income falls into one or both of these kinds of income, as a non-resident, you do not have to file a California tax return.
If you are a California non-resident and receive any other kind of income from property located in California, such as rental property, income from a California partnership or LLC, gain from the sale of land in California, etc., you should file a California tax return. Again, this is in addition to your US Federal Tax Return. Note however, that you may be entitled to deductions or exemptions to offset the California income. However, even if you expect not to owe taxes, you should still comply with the filing requirements and file the California tax return.
The “Safe Harbor” Rule
For those leaving California under employment-related contracts, it may be possible to break tax residency even if you are still considered domiciled in California (that is, your permanent home is in California). To do this, you would need to be outside of California under an employment-related contract for an uninterrupted period of at least 546 days (18 months). It is possible to visit the state during this time; however, no more than 45 days per calendar year can be spent in California without triggering your tax residency. Once more than 45 days are spent in California, you would be required to file resident returns again, reporting your worldwide income.
Need Help With Your State and Federal Expatriate Tax Return?
Our team of expat-expert CPAs and IRS Enrolled Agents are here to help! If you have any questions about your State or Federal Tax Return, or if you would like to learn more about our expat tax services, contact us today.