Press Room: Tax Release

December 07, 2011

Elect to Reduce California Tax in 2011

In 2011, California has given your business a tax break. Are you ready to take full advantage of it?

For tax years beginning on or after January 1, 2011, most businesses may elect each year whether to use a single sales factor or a blend of property, payroll and sales factors to determine the portion of business income taxable in California.

Who may make the election?
Any apportioning trade or business that is not a bank or a farm may make the election. The state has provided guidance for combined corporate groups, corporations under water's-edge elections, partnerships with varying ownership structures and businesses in unitary relationships. These rules can be complex and it is likely not every situation may be addressed.

How should a choice be made?
The decision to use one formula over another is not as simple as reviewing historical tax returns. Factors to consider include whether the business is in an income or loss position, the potential for utilizing tax attributes, whether to make a water's-edge election and unity among business activities.

Under the single sales factor, certain rules have changed. In particular, for service and technology businesses that sell anything other than tangible personal property or real property, the sales factor is computed differently depending upon the election made. Under a single sales factor receipts are sourced to the market – where your customer receives the benefit of your services or intangible property. Under the historical formula, services and intangible receipts are sourced based upon where costs are incurred.

Where does your customer receive the benefit?
Market-based sourcing is simple in concept but not in application. California Regulation Section 28128.5 provides rules for sourcing receipts related to marketing intangibles, manufacturing intangibles, services provided to businesses and services provided to individuals. There are various alternatives for sourcing receipts based upon the books and records of the taxpayer. For example, is the benefit of advertising revenue received at the customer’s headquarters, advertising office, billing address or where the advertisements are viewed by the target market? There may be a basis for using any one of these depending upon the discernable facts.

Why is it important to get it right the first time?
While the election is year-by-year, the California Franchise Tax Board may require the method chosen to determine the location where the benefit is received be applied consistently from year to year. Taxpayers may consider a method that would assign more sales to California in a loss year but may be locked in to such method in future profitable tax years. Taxpayers should carefully consider the alternatives before making the first election on a timely-filed return.

How can WTAS help?
WTAS can assist taxpayers to navigate the new law by employing a systematic approach. WTAS reviews the structure, income streams, and books and records to identify benefits unique to each company and get these benefits reflected properly in tax returns.