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Steve Sims, Taxpayers' Rights Advocate.

What State Is that Income Sourced to Again?

As the Advocate, taxpayers often bring me issues that cannot be resolved through normal channels. Sometimes these issues occur because people and businesses are continually adapting to a constant environment while our laws can be slow to follow. An issue that seems to be gaining steam recently is how states are sourcing income and taxing residents and nonresidents. As the Advocate, my concern is that this can create double taxed income for California residents where current law provides no relief.

You may be thinking what about the Other State Tax Credit (OSTC)? It does not always cover every situation. In some instances, a taxpayer will be taxed by both California and a different state on the same income. To prevent the income from being taxed twice, either California or the other state will generally allow an OSTC to offset the taxes paid to the other state. However, if the taxpayer is a resident of California, the income must be sourced in the other state to be allowed the credit.

The problem I am finding is that some states are taking more aggressive positions in determining what is or is not income sourced in their state. Most of the time it involves sourcing income where services provided is not clearly defined. For example, a case that recently came to my office involved a California resident who was at home during the off–season but still receiving a paycheck from his out-of-state employer. Even though services were not provided anywhere and he was physically located in California, the employer sourced those wages paid to the other state because he was considered “on-call.” He filed a California resident return, reported all his income, and claimed the OSTC for the taxes paid to the other state. He was surprised when we denied the OSTC and sent him a bill because the credit was based on California sourced income. His only option was to go back to the other state and try to seek relief from double taxed income there because California did not allow any other remedy.

As many states, including California, struggle with how to close massive budget gaps, I suspect that this trend toward broader enforcement of source of income will continue. If you have clients who receive income within and outside of California, the following is a California income source table. It may not happen until some of these current cases are litigated that we will see clearer rules for all states on sourcing income in some of the gray areas.

 

TYPES OF INCOME SOURCE
Wages, salaries, tips, and other compensation from personal services. Where the services were performed.
Interest and dividend income. State of residence.
Business income. Where the business activity is being conducted.
Rental Income. Where the rental property is located.
Sale of tangible property such as a boat, car, personal residence, rental property, business property, or land. Where the property is located.
Sales of intangible property such as stocks or bonds. State of residence.

Steve Sims, EA
Taxpayers’ Rights Advocate

Follow me on Twitter at twitter.com/FTBAdvocate.

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