CALIFORNIA FILING AND TAX RESPONSIBILITIES

California has the largest economy in the United States and a reputation for being at the forefront of technological innovation. It is no surprise that California is an attractive market for businesses. Before entering the California market it is important to review California’s complicated rules dictating when companies must register, file tax returns, and pay tax.

The California Revenue & Tax Code uses a number of similar criteria to determine when tax returns are required and from whom. These requirements benefit from some further explanation. As such, the first part of this Memorandum defines some of the common terms that arise. The second part of the Memorandum then explains when businesses are required to file tax returns and pay California taxes.

DEFINING THE IMPORTANT TERMS

Business organizations incorporated or organized in California need to file tax returns. In addition, organizations will need to file a California tax return if they are: (1) doing business in California; (2) qualified to do business in California; or (3) receiving income derived from or attributable to sources within California. This section defines those important terms.

A. Doing Business in California

“Doing business” is defined as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.”[1] Doing business does not necessarily mean conducting regular business.[2] The important criterion is whether the goal or aim of a transaction is a gain or profit[3] and it is irrelevant whether or not that goal is achieved.[4]

A taxpayer is deemed to be doing business in California if any of the following conditions are met: (1) the taxpayer is organized or commercially domiciled in California; (2) the taxpayer’s sales in California exceed the lessor of $500,000 or 25% of the taxpayer’s total sales; (3) the taxpayer’s real and tangible personal property in California exceeds the lessor of $50,000 or 25% of the taxpayer’s real and tangible personal property; or (4) the taxpayer pays compensation in California in excess of $50,000 or 25% of the taxpayer’s total compensation paid.[5]

B. Qualified to do Business in California

References to business organizations being “qualified to do business in California” are references to the California Certificate of Qualification that must be obtained before a non-Californian organization conducts any intrastate business in California.[6] Without this certificate, a foreign corporation cannot use a California State court to sue on an issue of intrastate business.[7] Failure to register before transacting intrastate business results in penalties of $20 per day that intrastate business was conducted.[8] In addition, a misdemeanor penalty of between $500 and $1,000 could apply.[9]

Intrastate business is defined as an organization “entering into repeated and successive transactions of its business in [California].”[10] An organization is not considered to be conducting intrastate business just because its subsidiary is conducting intrastate business or because it is a member/shareholder/partner in an organization conducting intrastate business.[11] Carrying out the following activities in California does not constitute intrastate business: (1) maintaining or defending any legal action; (2) holding meetings concerning the internal affairs of the company; (3) maintaining bank accounts; (4) effecting sales through independent contractors; (5) soliciting orders where those orders require acceptance outside California; or (6) conducting an isolated transaction completed within a period of 180 days.[12]

C. Income Derived From or Attributable to Sources Within California

The rules used to determine whether income is derived from or attributable to California vary depending on the nature of the income. Business income that is part of one distinct business (a unitary business) is apportioned to California based on a statutory formula.[13] This formula is: unitary business income * ((payroll factor + property factor + sales factor + sales factor)/4).[14] The payroll, property, and sales factors are the percentages of payroll/property/sales in California compared to the totals for the unitary business as a whole.

Nonbusiness income is allocated as follows: (1) rents from property are allocated to California to the extent the property is located or used in California;[15] (2) capital gains and losses are allocated to California based on the location of the property;[16] (3) interest and dividends are allocable to California if the taxpayer’s commercial domicile is in California;[17] (4) patent and copyright royalties are allocable to California to the extent that the patent or copyright is utilized by the payor in California.[18]

Employment income is generally sourced in California if it relates to a period of continuous employment in the state.[19] Commissions will also be California sourced if the commission relates to transactions within the state.[20]

II. FILING RESPONSIBILITIES AND TAX LIABILITIES IN CALIFORNIA

The obligation to file and pay tax in California is dependent on status. While there is a significant amount of overlap in the rules, there are unique criteria for: individuals; general partnerships; limited partnerships and limited liability companies treated as partnerships; and corporations.

A. Individuals

1. Filing Obligations

An individual must file a tax return if the individual was a resident of California during the entire tax year. In addition, individuals not resident in California for the entire tax year must file a return if there was income during a period of residency or income derived from sources within California.[21] There is an exception for individuals with adjusted gross income of less than $8,000, or $16,000 if married, or if gross income is under $10,000, or $20,000 if married.[22]

A resident is an individual who is in California for other than a temporary or transient purpose, or is domiciled in the state of California.[23]

2. Potential Tax Liabilities

Individuals who are California residents for the entire tax year will pay California income tax on their entire taxable income.[24] Individuals only resident for part or none of the tax year, will pay California income tax on income generated while resident or income derived from sources within California.

B. General Partnerships

1. Filing Obligations

A general partnership, i.e. one that is not a Limited Partnership, must file Franchise Tax Board (FTB) Form 565 if the partnership is doing business in California or has income derived from sources within California.[25]]

2. Potential Tax Liabilities

No tax is levied on general partnerships. The income of the partnership will be taxed on the individual partners.

C. Limited Partnerships and Limited Liability Companies

1. Filing Obligations

Limited Partnerships (LPs) and Limited Liability Companies (LLCs) operating as partnerships must file a tax return in California if the LP or LLC is: (1) organized in California; (2) doing business in California; (3) qualified to do business in California; or (4) receiving income derived from sources within California.[26]

An LP that meets one or more of the above conditions must file a Form 565. An LLC that meets one of requirements (1) to (3) must file a Form 568. An LLC that only meets requirement (4) must file Form 565.[27]

2. Potential Tax Liabilities

LPs and LLCs must pay an $800 franchise tax if they are organized in California, qualified to do business in California, or doing business in California.[28]

An LLC that is required to pay the $800 franchise tax and has income over $250,000, must also pay a gross receipts tax that ranges from $900 to $11,790.[29] The amount payable is determined with reference to “income from all sources derived from or attributable to” California.

D. Corporations

1. Filing Obligations

A corporation must file a tax return in California if the corporation is: (1) organized in California; (2) doing business in California; (3) qualified to do business in California; or (4) receiving income derived from sources within California.[30]

A corporation that meets one or more of the above conditions must file a Form 100. If the corporation wants to make a “water’s edge” election, it must file Form 100W.

2. Potential Tax Liabilities

Corporations must pay a franchise tax of 8.84% of the net income of the corporation if the corporation is registered in California, qualified to do business in California, or doing business in California. Net income is the income derived from or attributable to sources within California.[31]

Corporations that do not do business in California must pay an income tax of 8.84% of net income derived from sources within California.[32] A corporation that also pays franchise tax in the same period can take a credit for the franchise tax against the income tax.[33]

Please see www.RroyseLaw.com or contact Royse Law Firm, PC at rroyse@rroyselaw.com for additional information.

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[1] Cal. Rev. & Tax Code (RTC) § 23101.
[2] Golden State Theatre & Realty Corp. v. Johnson, 21 Cal. 2d 493, 496 (1943).
[3] Hise v. McColgan, 24 Cal. 2d 147, 150-151 (1944).
[4] People v. Alexander Goldstein Co., 66 Cal App 2d 771, 774 (1944).
[5] RTC § 23101.
[6] Cal. Corp. Code (CCC) §2105(a).
[7] CCC § 2203(c).
[8] CCC § 2203(a).
[9] CCC § 2258.
[10] CCC § 191(a).
[11] CCC § 191(b).
[12] CCC § 191(c).
[13] 18 CCR § 17951-4.
[14] RTC § 25128(a).
[15] RTC § 25124.
[[16] RTC § 25125.
[17] RTC § 25126.
[18] RTC § 25127.
[19] 18 CCR § 17951-5(a)(4).
[20] 18 CCR § 17951-5(a)(1).
[21] RTC § 17041(i) (imposing tax on certain income of nonresidents and part-residents); RTC § 18501(a) (stating that requirement to file a return is based on application of tax).
[22] RTC § 18501(a).
[23] RTC § 17014(a).
[24] RTC § 17041(a),(b),&(i).
[25] FTB Form 565 Instructions at 6.
[26] Cal. Rev. & Tax Code § 18633.5(a); FTB Form 565 Instructions at 6.
[27] FTB Form 565 Instructions at 6.
[28] RTC § 17935(a) & (b) (regarding limited partnerships); RTC § 17941(a) & (b) (regarding limited liability companies); RTC § 23153(d)(1).
[29] RTC § 17942(a).
[30] RTC §§ 18601, 23151, & 23501; FTB Form 100 Booklet at 6.
[31] RTC § 25101.
[32] RTC § 23501.
[33] RTC § 23503.