News From the Salt Minds-March 10, 2014-The Impact of California Prop 39

State and Local Tax (SALT) | Chris Vignone | Mar 10, 2014

Summary.

As accountants begin to prepare corporate income tax extensions this month, many are realizing that clients with revenue from services or intangibles may be subject to California franchise (income) tax starting in 2013. This is a result of Prop 39, which was passed back in November 2012 by California voters. Prop 39 requires out-of-state companies to calculate their California income tax liability based solely on their percentages of sales in California. Companies with little or no concern for California taxation in the past could be facing a veritable sea change in their overall state tax footprint.

Background.

On March 27, 2012 California released the officially adopted regulations on market sourcing for sales of other than tangible personal property. The regulations provided guidance on (1) the sales factor assignment for sales of other than tangible personal property under California’s market sourcing statute applicable to those electing to use (see below) the single sales factor appointment and (2) the definition of “doing business” under California’s economic nexus standards.

The option to choose a single sales (versus the standard three-factor, double weighted sales) factor would result in the sourcing of service and intangibles income to California when a company has a market in the state. The regulations have sourcing rules for various types of services and intangibles income, with the intention of sourcing service and intangible revenue to California when the customer is in California or intangibles are used in California. The key change in the definition of “doing business” in California was the application of an economic nexus principal, which includes a nexus threshold where sales sourced to California exceed the lesser of $518,162 or 25% of the taxpayers’ total sales. California also clarified its position that only companies that sell intangible personal property are protected under P.L. 86-272, and that P.L. 86-272 does not apply to the sale or services or intangibles.

Effective January 1, 2013 California now requires all business income of an apportioning trade or business to be apportioned using single sales factor apportionment for tax years 2011 and 2012).

In addition, companies are now required to assign sales, other than sales of tangible personal property, using the market assignment approach. The combination of changes in the law may require companies with revenue from services performed in California.

Prager’s Take.

We strongly advise that any company with sales of services or intangibles to customers in California review their position for 2013 closely. Each company will have its own unique facts and circumstances that will need to be considered in light of the new laws in determining if a California return is due, or if California returns have been filed in the past, whether a substantial increase in California apportionment has resulted. Please contact Chris Vignone and John Engelbrecht with any questions.

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