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Water's-edge and non-effectively connected income

California regulations require water's-edge taxpayers to include non-effectively connected income (NECI) on their tax returns. NECI is income derived from the United States by a foreign corporation that is not engaged in a U.S. trade or business.

FTB proposed regulation amendments to provide rules to determine the deductions that can be allowed to offset NECI, with the residual net amount of NECI included in income. After further legal review, FTB counsel concluded that NECI should be excluded from water's-edge tax returns, and reported this conclusion to FTB's three-member Board at their September meeting. The Board voted at their December meeting to approve FTB's recommendation to amend the regulation, i.e., to entirely remove NECI from water's-edge tax returns, and asked FTB to proceed with the regulation amendment.

If your water's-edge clients reported NECI, consider filing a claim for refund to protect the revenue until this matter is resolved. If your clients file amended returns to remove NECI, please instruct them to write "NECI" in red, at the top of the return. Mail to:

State of California
Franchise Tax Board
PO Box 1998
Rancho Cordova CA 95741-1998