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General Information on New Rules for Doing Business in California

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New Law

For taxable years beginning on or after 1/1/2011, a taxpayer is doing business in California if it actively engages in any transaction for the purpose of financial or pecuniary gain or profit in California or if any of the following conditions are satisfied:

  • The taxpayer is organized or commercially domiciled in California.
  • Sales, as defined in subdivision (e) or (f) of R&TC 25120, of the taxpayer in California, including sales by the taxpayer’s agents and independent contractors, exceed the lesser of $500,000 [1] or 25 percent of the taxpayer's total sales. For purposes of R&TC Section 23101, sales in this state shall be determined using the rules for assigning sales under R&TC 25135, R&TC 25136(b) and the regulations thereunder, as modified by regulations under Section 25137.
  • Real and tangible personal property of the taxpayer in California exceed the lesser of $50,000[1] or 25 percent of the taxpayer's total real and tangible personal property.
  • The amount paid in California by the taxpayer for compensation, as defined in subdivision (c) of R&TC 25120, exceeds the lesser of $50,000[1] or 25 percent of the total compensation paid by the taxpayer.
  • For the conditions above, the sales, property, and payroll of the taxpayer include the taxpayer's pro rata or distributive share of pass-through entities. "Pass-through entities" means a partnership, an LLC treated as a partnership, or an "S" corporation.

[1]Indexed. For taxable years beginning on or after 1/1/2012, the amounts are $509,500, $50,950 and $50,950, respectively. For taxable years beginning on or after 1/1/2013, the amounts are $518,162, $51,816 and $51,816, respectively.

Who does the new law affect?

The new law affects out-of-state corporations, LLCs, and pass-through entities (partnerships, S corporations, LLCs treated as partnership) and their partners/shareholders/members that have property, payroll or sales in this state. Currently, they may not be considered to be doing business in this state, but may be considered doing business starting in tax year 2011 if they meet any of the thresholds listed above.

What are the filing requirements in California for a taxpayer that is considered doing business in California for the first time?

An out-of-state taxpayer that is considered to be doing business in California will need to file the appropriate tax return and pay the appropriate tax and fees.

General Information & Application

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 this state 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%.)

Public Law ("PL") 86-272 and Nexus Issues

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[1].

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 RTC 25136(b) for purposes of applying the doing business test of RTC 23101(b) regardless of whether those sales are sourced under RTC 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).

Partnerships, LLCs (Treated As Partnerships) and S-Corporations

In determining their property, payroll and sales in this state, the taxpayer must also include their pro rata share of amounts from partnerships, LLCs (treated as partnership) and S corporations.  Partnerships and LLCs are considered doing business in this state if they have a general partner or member doing business on their behalf in this state. Likewise, general partners and members are considered doing business in this state if the partnership or LLC, respectively, is doing business in this state.

Corporation E, an out-of-state corporation, has no property or payroll but has $450,000 of sales to customers located in this state. Corporation E also has a 30 percent limited partnership interest in Limited Partnership X which is doing business in this state. For tax year 2011, 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 this state?

Yes. Corporation E is considered to have the following distributive shares of property, payroll and sales from 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 this state because it has a total of $510,000 sales in this state ($450,000 of its own sales + $60,000 of 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 this state on behalf of the California Partnership that is doing business in this state.

Corporation G, an out-of-state corporation, owns multiple interests in several pass-through entities in this state. How should it compute the amounts of property, payroll and sales in this state?

Corporation G computes its property, payroll and sales in this state 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 this state.

Investment Partnerships and Qualifying Investment Securities

In applying the factor presence “doing business” test set forth in R&TC 23101(b), corporations that are entitled to exclude from their income distributive share amounts of gain or loss from the sale or exchange of qualifying investment securities pursuant to subsection (a) (1) of R&TC 23040.1 shall not take into account their pro rata shares of the sales, property and payroll attributable to such sales or exchanges in determining whether they are doing business under 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.

[1]See R&TC Section 23151 for exceptions.

Send your questions or comments to the Implementation Team:
2011corplawchanges@ftb.ca.gov