California rules for out of state self-employed remote worker with CA clients

[Abby Normal]

Had a friend ask me about this. She has a small consulting biz in MD and just picked up a CA client. I told her I didn't know enough to give a reliable answer.

Would someone be kind enough to share the basics? Does she need to register in CA, simply because she has a customer?

I know CA is both weird and aggressive. If this were any other state, I'd know what to do.

Thanks!

[BulldogTom]

CA taxes revenue to the end customer location.   So if your friend is providing a service to a customer in CA, that revenue is sourced to CA.  There is no de minimis exception that I am aware of.

From the FTB website -

"We consider you to be “doing business” if you meet any of the following:
     Engage in any transaction for the purpose of financial gain within California"

Then you have to look at what type of entity they are.   Corps, S Corps, Partnerships and LLC all have a $800 minimum tax that needs to be paid yearly.   In order to pay the tax, you need a state tax ID number.   To get a state tax ID number, you need to register with the SOS.  The SOS has an annual filing fee of $25 (last time I checked).

If your client is a Sole Proprietor, they can just file a 540NR showing the CA profits from their business.

Hope this customer of your friend is generating enough revenue to cover the cost of doing business in CA.

Tom
Longview, TX

 

[Lee B]

I have a S Corporation client who is a Coffee Roaster/Wholesaler.

They have customers in California to whom they ship Roasted Coffee every week.

In the past that has not created a  California Nexus.

What changed and when was the effective date.

I would appreciate a link to the applicable part of the FTB website.

Also, have you noticed any commentary and analysis?

Thanks in advance,

Lee

[Lee B]

I found the applicable information in FTB Pub 1050:   https://www.ftb.ca.gov/forms/misc/1050.pdf

Based on my reading I believe my client's shipping of Roasted Coffee to customers in CA still meets the definition of "protected activity"

under Public Law (PL) 86-272, 15 U.S.C. §§381-384, which Congress adopted in 1959.

"PL 86-272 prohibits a state from imposing a net income tax on the income of a person derived within the state from interstate commerce if the only business activities within the state conducted by or on behalf of the person consist of the solicitation of orders for sales of tangible personal property."

Abby, this Pub has a lengthy list of protected and unprotected online activities.

[BulldogTom]

CA is starting to look at challenging PL 86-272.   But that was not the point of the original post.   This was services provided to an end customer in CA.  

There is a whole discussion of "doing business in CA" on the FTB website that gets into your situation @cbslee  www.ftb.ca.gov   Search "doing business in CA".

Tom
Longview, TX

[Lee B]

Tom, your original post triggered me to find out if anything had changed since the last time I looked into this issue.  :)

[Lee B]

Abby, your friend's consulting does not appear to be a "protected activity'.

My preliminary reading is that she would have to register.

[Lion EA]

Is that also the case for us (CT or where ever) tax preparers with remote CA clients?

[BulldogTom]

9 hours ago, Lion EA said:

Is that also the case for us (CT or where ever) tax preparers with remote CA clients?

Yes.  Your information is at the bottom of the tax return, so they know who prepared the return.

Tom
Longview, TX

 

[Lee B]

Yes, I still receive mail and email from the FTB even though it's been 3 or 4 years since I last filed a CA Tax Return.

[Lion EA]

Bummer. Do I have to pay, like NY? Of course, with the highest state tax rates in the nation, I'll be paying! Anyone want a couple of CA clients that I inherited?

[mircpa]

I believe nexus determines taxability of services.

@Abby NormalDoes your friend hired an employee to provide services to client in CA. If the answer is yes then business should file 100S, Sch R & individual owner 540NR (if it's an a S corporation)

[BulldogTom]

This is from Spidell Tax seminar I took last week.   It is pretty clear.

 

     A Tennessee sole proprietor who provided consulting services to a California insurance agency
had California-source income that was taxable by California, even though the sole proprietor
performed all his services in Tennessee and was never physically present in California. (Appeal of
Bass, 2022-OTA-145) All of the trainings and consulting services conducted by the sole proprietor
for his California customer and its employees were conducted from Tennessee via Skype or personal
phone calls, or physically in Tennessee.
      Under the OTA’s precedential decision in Appeal of Bindley, 2019-OTA-179P, physical presence
is not required to tax the income received by a nonresident sole proprietor if their customer receives
the benefit of the services in California. In addition, California’s nonresident sourcing regulation (18
Cal. Code Regs. §17951-4) incorporates California’s corporate apportionment rules (R&TC §25120 et
seq.), including the market-based sourcing rules (R&TC §21536; 18 Cal. Code Regs. §25136-2) if a
nonresident sole proprietor conducts a unitary business both inside and outside California.
     Under the reasoning adopted by the OTA in Bindley, a sole proprietor conducts a unitary
business if they are in a single line of business, in this case “consulting.” Furthermore, because the
taxpayer operated in Tennessee but had customers in California, he was conducting business both
inside and outside California and therefore was subject to California’s corporate apportionment
rules. 

 

Tom
Longview, TX

[Lee B]

1 hour ago, mircpa said:

I believe nexus determines taxability of services.

@Abby NormalDoes your friend hired an employee to provide services to client in CA. If the answer is yes then business should file 100S, Sch R & individual owner 540NR (if it's an a S corporation)

California is pushing the nexus boundaries to the breaking point. It's way beyond whether you have a resident employee.

Just read FTB Pub 1050, it's a real eyeopener!

[Gail in Virginia]

I have now learned that I will never prepare a CA tax return for anybody, unless they are willing to pay me an extra $1,000 or more  just to cover the extra taxes and fees I may have to pay.  Wow.

[Medlin Software, Dennis]

Ny is looking at this too, likely other states. Trickle down of the Wayfair ruling.

For me, I don’t to remote logins to customer computers for help )trigger). I don’t do automatic updates (trigger). I do have links to my email on my website (trigger), so once any other state adopts similar to CA, I may have to remove the links and make people type. I did not see anything where the software having a link is an issue, but probably since it would be triggered in another state.

Like Wayfair, it appears some states will set thresholds, and some will set theirs to zero. 

[Abby Normal]

Wow! Thanks, everyone! You're the best! I forwarded this thread to my friend. Cheers!

[Medlin Software, Dennis]

It is not going to be pretty... The Wayfair sales tax results have varied rules by state. Many adopted the recommend thresholds, a few have no threshold.  For sales tax, enforcement is an issue as it would likely be complaint driven, followed by investigation.  In other words, I doubt State X is going to try to find out how many items/dollars a small company has sold, to see if they went over their threshold.  The cost would likely outweigh the income, making it not profitable.  The purpose was to go after the big online retailers, and scoop up some of the medium folks.

This implementation based on Wayfair may end up with similar results.  But, for the purposes of this group, with ethics and with easy proof of your location, compliance will not be something to risk.  The new issue with this interpretation by CA, is setting the bar very low.  Having a clickable link to email or chat is a huge stretch, but likely enforceable unless challenged. States could develop or subscribe to some sort of web scraper to EASILY get enforcement leads. I could see an entire new industry, such as re-positioned debt collectors, selling leads for a small take of the result.  We may have to go back to sharing plain text non clickable email address on our web site (and the resulting spam via web scrapers) versus munged clickable links and chat windows.  Or, we will have to send countless emails (which can be sales oriented) so our customers have an easy way to reply.  Gray area right off the bat is a clickable link in the software itself.

Interestingly, and again, not a lawyer, but if the state determines the company has nexus via a clickable email link, then they may be able to claim proper jurisdiction in in the state, making one have to defend outside of their physical location.  It may be the tipping point to get undefended compliance, fear, for instance, of CA winning by default because someone in the East could not come to (or hire representation in) CA to defend.

Just a non lawyer opining, but I suspect it would take another SCOTUS ruling to even challenge what CA has determined (and which will inevitably followed by others).

[Lion EA]

My understanding, in very simple so not all-inclusive terms, is that if I prepare a tax return for a person/entity in CA, then I have delivered that product/service into CA and, therefore, have CA-sourced income. I think that means that even though I prepare in CT, e-file from here, and upload the client copy to my portal, that if the person who benefits is a CA resident, I have CA-sourced income.

Many states look at where the work is performed. CA looks at where the work is delivered or the location of who/what benefits from my work.

I would like to be wrong. I've had two clients move to CA and inherited a couple more from a retired preparer.

I'm raising my rates more than usual this year. I don't know if I want to keep my CA clients' rates low or raise them a whole lot more to, as Gail said, cover my additional registration, documentation, and CA taxes.

[Medlin Software, Dennis]

For me only, YMMV.  Since I am in CA, I don't have to do anything yet, but with NY already having something similar in the works, I have to plan.  My "problem" is a customer contacting me via a clickable email link, web email form, or web chat, triggers nexus under these new Wayfair caused rulings.

I asked my web hosting service about using IP to geolocate by state. There are ways to do so, so I could serve a state specific site, or not have clickable contact info.  (As an aside, if my web host service is not paying CA taxes already, answering my message, which was sent via web based email form, triggered CA nexus!)

Given IP info is not 100% accurate as to geolocation, I am going to make best effort as follows.

Remove clickable email links, the type which ask the user's system to open their email program with my address prefilled.  This includes in documentation, which resides on the users computer.

For web based email forms and web based chat, require the person select their state, and offer a check box to verify they are not in the states I elect to avoid nexus.  I can already get their IP address as a backup to the zip code.

Definitely not offer any sort of remote access help to anyone in the special states.  (Rare that I offer anyway.)

---

I think what I am pondering is a reasonable and defensible effort to stop nexus claims, at least until there is some test cases to see what "flies".  I suspect states which go after nexus will operate complaint based, or via some sort of testing that someone in the state can use the site in a way to cause nexus.  By asking for zip code, and an affirmative selection, I shift the onus back on the viewer to be honest.

I suspect once someone gets dinged by CA, the web chat providers and web hosts will come up with something, as those that do not will lose business.  I equate this "issue", in my circumstances, to the EU rules about cookie and privacy pop up we all see, except on sites, like mine, which block access from EU.

---

For others here, if you have a web site, or in any other way get messages other than via someone manually typing in your email address, watch for nexus in CA, and be ready for other states to follow.

[Lion EA]

I already e-file returns for CA resident clients, so I already have CA-sourced income. Someone who emails me from CA but doesn't hire me, won't add to my CA-sourced income.

[Medlin Software, Dennis]

41 minutes ago, Lion EA said:

I already e-file returns for CA resident clients, so I already have CA-sourced income. Someone who emails me from CA but doesn't hire me, won't add to my CA-sourced income.

Emailing directly, user opens their email software or clicks a link which opens their email software, does not trigger nexus (IMO).  Nor does sending a fax, or phoning.

The triggers are VERY specific, both in the MTC suggested text, and in CA, and in NY's proposal.  MTC suggested is "interacting with a web site or app to communicate".  CA and NY (proposed) mention only via website.

Even without income caused nexus, accepting communication via a non exempted method can trigger nexus, as it can be argued you were trying to have income.  No income does not always mean no reporting, min tax, registration, etc.

For me, no more online instant chat unless a chat service comes up with valid means to exclude based on location (which they back up with $), and no more website fill in and send messages (since it is easy to click and use their own email, although I lose the ability to require certain details).  At least (for me) once NY or any state other than CA goes live with the new policy.

[mcbreck]

The Supreme Court will need to rule on this. Imagine if 50 states had this type of ruling.

Locally we have a city earnings tax. If you live outside the city but work in the city, you owe the tax. Prior to covid if you worked remotely or at an off-site (outside the city) you were exempt for those hours. During Covid the city ruled you were subject to the tax whether you stepped into the city limits ever during the year. The Supreme Court will be ruling on that also but it's going to take years.

[Lion EA]

LLC is a state-by-state entity and not a federal entity. I'm a CT SMLLC. Will I fall under the rules for a CA LLC with the minimum tax of $800 and whatever the CA state LLC filing form is?

Not only might I revert to a sole proprietor, I might send my CA clients elsewhere. I'll still get those CT residents who work for a large bank or Fortune 500 firm in NY and spend a couple weeks at their CA headquarters so have Form W-2 with CA, NY and CT, unexpectedly. NY and CA seems to be a common duo for nonresident returns due to work locations or part-year returns due to a move. I don't think I can get rid of all CA-sourced income under current CA law; too many surprises at tax time about training in CA, for example.

[Medlin Software, Dennis]

22 minutes ago, mcbreck said:

The Supreme Court will need to rule on this. Imagine if 50 states had this type of ruling.

They did, Wayfair (which was a change to, IIRC, "Quill").  This "new item is states adding the interpretation of Wayfair to PL 86-272.  The PL was before email, so there is wide room for interpretation.  It is a federal law, with a non government entity (MTC) giving boilerplate suggestion.  Sound familiar? It is what we have with Wayfair and sales tax, some states are common, the suggested formula and triggers, and others elected something else.  It is an interesting thing our Union allows.  Even within Wayfair and sales tax, states have different/sovereign rules on what is taxable such as in my case, how is canned software treated as a whole, and does delivery (hard media or electronic) alter the status.

Same with employment law, states can nexus on first second worked in state (and what defines in state), some give 30 days, and so on.

So, to me, it seems like the only "case" would be some update to PL 86-272, which has not happened in nearing 40 years.

For me, the avoidance of unwanted nexus has a clear/easy/viable path.  For most others here, it likely means no outside of domicile returns, unless you can get a higher return than in state returns.  Tom might be one to opine, assuming he kept more than a few CA clients, and wants to keep them.

Again, for me, I do have to watch what I do when we travel, as I do not want to trigger nexus just by checking an email (hello again NY as the worst case example).