Posts Tagged ‘Nexus’

Have I Committed Malpractice?

Friday, February 2nd, 2018

Let’s say John Smith is a consultant in Syracuse, New York. His business is conducted fully in Syracuse. He never travels outside of Syracuse. He writes reports on a niche area for businesses. Mr. Smith files and pay New York state income tax (as he’s a resident of New York) in addition to his federal income tax. Has he satisfied his income tax filing requirements? (There are no local income taxes in Syracuse.)

In my view, almost certainly. His activity is conducted solely within Syracuse, New York. He’s filed his tax returns every year. Yet in the view of the State of California he may owe tax to the Bronze Golden State. How, you might ask, might this be the case?

The State of California, in its unending wisdom, enacted legislation for “economic nexus.” If you have sales to California, a portion of your income is, in the view of California, subject to California tax. Here’s an excerpt from the FTB’s website:

Jill, a nonresident of California, owns a web design business that she holds as a sole proprietorship. She works from her home out of state but has customers in various states including California. For the 2013 taxable year, Jill’s sales receipts from California customers are $300,000 out of the total sales receipts everywhere of $1,000,000. Does Jill have a filing requirement in California?

Yes, nonresident individuals are taxed on all California source income. Jill’s sole proprietorship is carrying on a business in and out of California and will be required to apportion its income to California using UDITPA rules. Under market assignment, sales of services are assigned to California if the purchaser of the service received the benefit of the service in California. Accordingly, $300,000 will be assigned to the California sales factor numerator for Jill’s sole proprietorship and Jill would apportion 30% ($300,000 CA sales/$1,000,000 total sales) of its business income from her sole proprietorship to California. [emphasis in original]

In a tax professional’s forum I noted that while the California legislature enacted this law, there is a good chance that it’s unenforceable except for businesses with nexus to California. Consider a partnership with one of the partners a California resident and the other a New York resident. Here, there’s clearly nexus to California and California tax is owed.

However, in the example I give (above) Mr. Smith clearly has no nexus to California and while California thinks he has a filing requirement, he probably doesn’t because of court cases. I noted the following on that forum:

While I understand that’s the Franchise Tax Board’s position, the ability for a state to to force collection of taxes to a nonresident who resides in another state is governed also by Quill Corp. vs. North Dakota, the famous case on states having the ability to force collection of sales tax on nonresident companies. The background for this case is the “dormant commerce clause.” (Interestingly, the Supreme Court recently accepted another case on this same issue: South Dakota vs. Wayfair, so it’s possible Quill will be overturned.)

The principal of this is that California has the absolute right to tax individuals with nexus to the state. But does California have the right to tax me–a resident of Nevada with no nexus to California–on the (say) 10% of income I receive from California residents whose tax returns I prepare? Can California legally go after Jill who never sets foot in California? My suspicion is courts in Nevada and Jill’s home state would today look askance at such requests.

One tax professional said my response bordered on malpractice: advising clients to disobey laws. I don’t think that’s the case at all. What I am advising clients is that the California law is of dubious legality, and it is difficult for California to enforce on businesses without nexus to California (such as the hypothetical Mr. Smith). I am not ignoring what California is stating (and I’m informing clients who may be impacted by this). That said, based on current precedent federal courts would, in my opinion, rule for Mr. Smith. (Since Mr. Smith has no nexus to California, a court case would almost certainly be in federal court in New York–the only place he has nexus to.)

It’s important to realize that the law could change based on the decision in South Dakota vs. Wayfair. (South Dakota enacted a law regarding sales tax that allows for economic nexus to the state. South Dakota courts held the law was unconstitutional based on the Quill decision.) Today, though, the federal supremacy clause (the federal supremacy clause means that state constitutions and laws are subordinate to federal law) governs; current federal law holds that California cannot tax companies without nexus to the state–and today nexus means physical nexus.

The Shipment of California Jobs to Texas — What can be Done?

Monday, August 29th, 2011

Back in April, Herman Bouma, an attorney with Buchanan Ingersoll & Rooney PC in Washington, DC, penned this prediction:

May 2, 2011. This just in: Concerned about the shipment of California jobs to Texas, the California State Legislature today passed legislation imposing current, worldwide income taxation on every corporate group headed by a California corporation, thus subjecting such a group to current taxation on its income earned worldwide, including in Texas. The Governor indicated he will sign the legislation, stating, “It is high time we repeal the tax breaks and loopholes for shipping California jobs to Texas.”

May 2, 2016. This just in: Recently released statistics indicate that the number of corporate groups headed by California corporations has dropped precipitously over the last five years. The statistics also indicate that those California-headed corporate groups still remaining are having a difficult time competing with other corporate groups. Members of the California State Legislature expressed surprise at the findings.

May 2, 2017. This just in: Dazed but undaunted, the California State Legislature today passed legislation imposing current, worldwide taxation on every corporation in the world and instructing the Governor to take over the world in order to ensure compliance. The Governor indicated he will sign the legislation and expressed every confidence in the ability of the California Highway Patrol to carry out its new mission.

This is, of course, false…except that as Phil Hodgen noted, its true about trusts.

Let’s say there exists a trust. The assets are outside of California. All of the beneficiaries live outside of California and have never traveled to California in their lives. The only connection with California is that the trustee is based here.

Result 1: California says the trust must pay California income tax on its income. (Consequently, the beneficiaries end up paying the California income tax even though they don’t live here). This is seen as completely logical in Sacramento–as immutable as the Law of Gravity.

Result 2: California banks and trust companies cannot compete for this business. Instead they open trust companies in Nevada and Delaware. (Consequently, banking and trust company jobs are created in Nevada and Delaware). This produces utter bewilderment in Sacramento.

It’s also true about business entities which are registered to do business in California, especially LLCs. Assume Acme LLC is a Delaware LLC; its managing member, Joe Smith, is a California resident but none of the business of the LLC is conducted in California. All of the business is conducted in Delaware (there are no California employees, offices, or any other ties that would give nexus to California). Tough; just having the managing member be a Californian is enough to give nexus to California for the LLC.

California also passed the “economic nexus” bill last year. Under this law, if 25% of an entity’s sales are to California, there is economic nexus to California and an entity is supposed to file a California tax return even if it has no employees, plant, or materials in California. (Good luck on enforcing this, or on the constitutionality of it, but the law is on the books.)

Mr. Bouma’s prediction was meant in jest about the way California has gone. The trouble is, some of his prediction is already true.

Could You be Doing Business in California Without Knowing It?

Monday, March 28th, 2011

Let’s say your Florida-based company manufactures and sells widgets. You used to be located in California, but decided the Sunshine State was a better business location than the Bronze Golden State. You have no employees, property, or any other ties to California. You do sell to California, but those sales are all shipped from your plant in Florida. Your sales to California businesses totaled $287,012 (out of your $1 million in total sales) in 2011. As you open your mail you see a letter from California’s Franchise Tax Board (the income tax agency here in California) saying that you have economic nexus to California and you must file and pay California taxes. Could this happen?

Yes, it could. Under a law passed by California’s legislature, effective as of January 1, 2011, any business will be considered to have economic nexus to California if:

  • It is organized or domiciled in California;
  • Its sales exceed the lesser of $500,000 or 25% of total sales;
  • Its payroll exceeds the lesser of $50,000 or 25% of its total compensation; or
  • Its real and tangible personal property exceed the lesser of $50,000 or 25% of the entity’s total real and tangible personal property.

According to the law as passed the Florida company would have economic nexus with California, as more than 25% of its sales were to the state. Of course, it is highly unlikely that the FTB would be able to discover this, and very unlikely that a notice would ever find its way to that company.

There’s also the dubious legal nature of this. The US Constitution that only the federal government can regulate interstate commerce. The constitutionality of economic nexus is very debatable. Additionally, the ability of California to collect such a tax is doubtful.

(Do note that the other areas of economic nexus–employees within the state, property within the state, or being a California entity–almost certainly are legal and California has every right to tax such entities.)

Just another way that California leads the country….