2011 California Nexus Expansion
As we indicated in the December 2010 edition of the newsletter, California’s nexus requirements have changed as of January 1, 2011.
The requirements have expanded the definition of nexus to include “economic nexus,” and thereby subjecting more taxpayers to California’s minimum tax, and possibly to, income taxes or Limited Liability Company (LLC) fees. Specifically, taxpayers will be considered to be doing business in California if any of the following conditions are satisfied:
- they engage in any transaction for financial or pecuniary gain within California; or
- they are organized or commercially domiciled in California; or
- annual sales in California exceed the lesser of $500,000 or 25% of total sales; or
- the value of real and tangible personal property in California exceed the lesser of $50,000 or 25% of total property; or
- payroll in California exceeds the lesser of $50,000 or 25% of the total payroll.
When determining the amount of the taxpayer's sales, property, and payroll for purposes of doing business, the taxpayer's pro rata share of sales, property and payroll from partnerships, LLCs treated as partnerships, and S corporations are included. Partners and members are considered doing business in California if the partnership or LLC is doing business in California. Similarly, a partnership or LLC is considered doing business if the entity has general partners or members doing business in California.
California has recently outlined a number of scenarios under which a taxpayer might have nexus. For example, a corporation might find itself with nexus because it meets one of three new provisions, such as having over $500,000 in sales in California or over 25% of its sales in California. It might also have nexus if it’s pro rata share of sales, property or payroll of a partnership (in which it has a limited partnership interest) exceeds the limits set out in the new provisions. A corporation that has its own sales, property, or payroll, as well as a pro rata share of sales, property, or payroll from an interest in a partnership, would aggregate such to determine whether it has nexus. The same is true of upper-tier partnerships, which would have to aggregate all of the property, payroll, and sales of lower-tier partnerships to determine whether nexus exists.
A partnership could have nexus by virtue of the fact that it has employees working from their homes providing warranty work to California customers, even though the property, payroll and sales fall below the thresholds. Nexus is found because the employees are “actively engaging” in transactions for profit on behalf of the partnership.
These changes to the nexus requirements could result in out-of-state taxpayers being subject to California’s minimum tax, (which is imposed on the privilege of doing business), while still being protected under Public Law 86-272 and, thereby not being subject to California taxes based on income. Likewise, because different sourcing rules apply for purposes of determining the apportionment of income, taxpayers may not be subject to California’s income tax if none of its income is apportioned to California under these rules, yet would still be subject to the minimum tax.
In addition, the State’s recent switch to the “market rule” for sourcing of services, which sources receipts based on the location of the purchaser, could result in an out-of-state service provider being subject to tax in California even though it has no property or payroll in California and all of the services are performed outside of California.
Now is the time to review the potential impact that these new nexus provisions could have on your company’s California filing requirements.