In 2012, California adopted the “single sales factor” to determine how much of a taxpayer’s business income should be subject to California tax. This is determined by multiplying the taxpayer’s total business income by the sales factor, the numerator of which is the total sales of the taxpayer in California during the taxable year, and the denominator of which is the total sales of the taxpayer everywhere during the taxable year.
For example, assume that: (1) Corporation X, a C corporation, has gross sales of $1,000,000; (2) 50% of the gross sales were in California; and (3) Corporation X’s total taxable income is $100,000. International Corporation X would report 50% of the taxable income ($50,000.00) as California-source income, and would pay a corporate tax of 8.84% of California-source taxable income, or $4,420 in California income tax.
What kind of sales are considered “sourced” to California under the revised law? Here are the general rules:
• Sales of tangible personal property (i.e., electronic equipment) are sourced to California if the purchaser is located in California.
• Sales of services are sourced to California if the customer receives the benefit of the service in California.
• Sales of intangible property (i.e., computer software) are sourced to California to the extent the property is used in California.
It is important to remember that California will collect tax on California-source income even if the corporation is formed in another state (i.e., Delaware or Georgia). This is true even if the corporation does not have a permanent office or employees in California: for example, a company formed under Delaware law with offices in New Jersey and Georgia must pay tax on its California-source income even if it has no office or employees in California.
The only significant restriction is the U.S. Constitution’s Commerce Clause. Under the Commerce Clause, California may not tax the income of an out-of-state business unless California has a “substantial nexus” with the business activity to be taxed. However, the current trend is to find a “substantial nexus” through virtually any ongoing commercial activity: for example, if Corporation X devotes any significant effort toward developing a market in California it will probably have a “substantial nexus” (and therefore be subject to California tax) even without a permanent office or employees in California.
This is just a basic overview and is not legal advice specific to your situation. If you would like to speak with Jonathan about your tax or business situation, please email him at firstname.lastname@example.org or call him at 925-217-3255.