Discussion:CA state income source changes ??

Suppose I am a TX LLC/S-Corp that does a lot of 540 returns and efiles. Will I be required to apportion that income to CA and file a CA LLC/S-Corp return?

Interested in hearing comments on the interpretation of that change. I guarantee that TX will consider it TX income.

If you have nexus in both states one where apportionment for services is based on "where the benefit was received" and one where the apportionment for services is based on "cost of performance" you have the potential to have the same services sourced in both states.

If you do a lot of 540's can you avoid nexus with CA?

There are a lot of uncertainties here. The U.S. Supreme Court has so far declined to rule on any case challenging the concept of economic nexus (i.e., nexus with no physical presence in the state) that has been applied by state courts. Also, where is the benefit of the service received if Gary prepares and e-files a California 540NR on behalf of his Texas resident client? Seems to me the benefit is received in Texas, not California.

For example if we have engineers, here in Michigan, that design cars that an unrelated party is building in TX, and if we had nexus in TX because we also manufacture cars there. Then the service income would be apportioned to TX for MI purposes, but for TX purposes they would be apportioned to MI.

It never occurred to me before, but you have to reside in one of these "where the benefit was received " states in order to have this nowhere apportionment occur. If you perform services in a cost of performance state that outcome could never occur.

KatieJ I appreciate you mentioning that the S Ct. has not ruled on economic nexus yet. That seems bound to happen since economic nexus affects all the large litigating multi-national companys.

Terry, your example cuts both ways. Turn the facts around, and the same service revenue would be included in the sales factor numerator in both states. MI assigns sales of services to the place where the benefit is received, while TX assigns them to the place where the service is performed. If the engineering firm in TX, with nexus in MI, designs cars for a MI customer, the receipts would be assigned to TX for TX purposes and to MI for MI purposes.

The same thing happens with respect to sales of tangible personal property in a combined report situation, when a sale is shipped from a "Joyce" state to a "Finnigan" state or vice versa. The same sale may be included in the numerators of both states, or in neither state, depending on the direction of the shipment.

For this discussion, I have no property, office or employees or any other presence in CA and never go there. (Especially now with the UCLA trounching of our beloved longhorns). The internet would be my only "presence" and I don't do $500K of business with CA residents.

A substantial number of clients are CA residents and I do their 1040 + CA resident returns. We use email, fax and phone and they never come to my TX office. I agree they could claim my 540NR returns were soucred to CA as KatieJ suggests.

I do enough 540s to know CA FTB marches to its own drummer. A literal reading of the revised rules makes it appear they want to reach out to pockets residing totally in other states or countries.

TOrahaCPA hits the nail on the head with "If you do a lot of 540's can you avoid nexus with CA?"

Based on these figures would we need to apportion any of the income to CA? To add another twist, our client called FTB and spoke to someone who told him that "analysis was different than consulting" and that because he was only doing "analysis" in CA and the "consulting" while he was back in IL that none of the income would need to be apportioned to CA. This part sounds strange to me, but then again we only do a few CA returns which are much more straightforward.

Thanks in advance for any comments.

Talking to someone at a tax authority often gets you a weird answer, which is the category into which I would put the FTB response your client got. As far as I know, services are services, whether they consist of "analysis" or "consulting." I'm not aware of any distinction between the two.

California Reg. Sec. 17951-4(d) provides that to determine the California source income of a nonresident partner in a partnership that carries on a unitary business within and without California, the apportionment rules of California's version of UDITPA (CRTC Secs. 25120-25139) are applied to the partnership's business income. That brings into play the regulations under those code sections, including Reg. Sec. 25136(d)(2)(C). Under that regulation, gross receipts from services that are performed partly within and partly without the state are generally apportioned on a time basis; that is, the part performed in one state is considered a different income-producing activity (IPA) from the part performed in another state.

It's true that the general pre-2011, standard UDITPA rule for sales of other than tangible personal property (including sales of services) generally assigns such gross receipts to the numerator of the state where the greatest proportion of the income-producing activity takes place (CRTC Sec. 25136(a)(2), as in effect before 1/1/2011). This isn't a more-than-50% rule; in fact, if 10% of the IPA were performed in each of 8 states, and 9% in a 9th state, and 11% in a 10th state, 100% of the gross receipts would be assigned to the 10th state! But the regulation (which dates back to the MTC's 1971 UDITPA regulations) carves out an exception to this general rule for sales of services, assigning them on a time basis by the somewhat disingenuous mechanism of treating the part of the service performed in each state as a separate IPA.

This is a long-winded way of saying that yes, under the pre-2011 version of CRTC Sec. 25136 and the regs thereunder, your client (and every other nonresident partner in the partnership) has California source income arising from this activity, because part of the gross receipts from each of the contracts in question is assigned to the California numerator of the sales factor. It doesn't matter whether more or less than 50% of the service was performed in California; you would multiply the gross receipt from each contract by the percentage of time spent in California and add them all up to get the total California sales factor numerator for the partnership.

Of course it will all be different in 2011!

Earlier in the week I spoke to a CA-FTB representative myself who specializes in non-resident issues, she said the same as you regarding apportionment, although in nowhere near as much detail. I'm now presented with another issue, however, and I'd love to have either confirmation of the information I was given, or hopefully tell me that they are wrong. Here's the more complete and complex scenario:

My client, the IL LLC, performs consulting services for hospitals. As I said earlier in 2010 he did work for a few CA hospitals. For example's sake we'll say that he billed a hospital $100,000, of which 30,000 was earned while working in CA and $70,000 was earned while working in IL. The hospital should have withheld $2100 from their payment ($30,000 * 7% = $2100) which would be credited to whatever tax he owed on the apportionment. They did not withhold this tax, however my client will still file a CA return and apportion the income properly and pay whatever tax is due.

Now I need to determine if my client needs to withhold and submit CA tax on the amount that they paid their subcontractors. The LLC has subcontractors who live in IL and performed work for the CA hospital both in CA & IL at the same 30/70 ratio. If the LLC paid this subcontractor 50,000 for the job, do we need to apportion the payment made to the subcontractor and withhold tax from their payment ($50,000 * 30% * 7% = $1050)? CA-FTB says yes, but it seems to me like CA is double dipping here. They would be getting $3150 of withholding on total CA income of $30,000. Please tell me that we don't need to withhold CA tax here because the subcontractor was working for the IL LLC, and even though work was performed in CA, the subcontractor was not paid by a CA company.

Thanks so much in advance for your help!

I believe your client's LLC is a withholding agent under this definition. Although it is not organized in California and does not have a place of business here, it does have due process/commerce clause nexus by virtue of the performance of personal services in California and is therefore "subject to the jurisdiction of the laws" of California.

It's not really a "double dip" for California because both entities, the contractor and the subcontractor, have California source income arising from these activities. The contractor owes California tax on its net income from the performance of services in California; the base is calculated after deducting its payment to the sub. So the same income is not taxed twice in the end. If the 7% rate results in significant over-withholding at either the contractor or the subcontractor level, the payee can file a request for reduced withholding on Form 589 (http://www.ftb.ca.gov/forms/misc/589.pdf).

Bear in mimd that in 2011, ALL of the gross receipts from these contracts will go in the California numerator because the benefit of the service is received in California. Fortunately Illinois has a similar rule (ILCS Chapter 35 §5/304(a)(3)(C-5)), so none of those receipts will be included in the Illinois numerator. If your state still followed the UDITPA Sec. 17 rule, the gross receipt from the portion of the service performed in that state would be included in the numerators in both states. Not that it matters to Illinois resident members, who will be taxed by Illinois on 100% of the flowthrough income.

I notice you refer to this entity as an LLC taxed as a partnership. If it is not a single-member LLC, note that all of the California nonresident members, not just the individual who actually performs the services, have California source income passing through from the LLC. FTB Pub. 1017 (http://ftb.ca.gov/forms/2010/10_1017.pdf) explains how the withheld tax filters down to the individual partners.

I find it interesting that the 2011 form 587 has not changed from 2010. If there won't be allocation of income in 2011 why are we still having our sub-contractors fill out an allocation worksheet?