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California source income?

Technical topics regarding tax preparation.
#1
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Is a California form 592-B determinative that the reported income is California source income?

I'm looking over the 2013 and 2014 returns for a prospective client. She is a long-time Arizona resident. In 2013, she went to California and worked on a W-2 for a California company for a couple of months. At the end of that 'trial' period, she returned to Arizona and has worked for that same company as an independent contractor, doing her work remotely from Arizona. For both years, she filed all income on her federal return. She filed as a resident of Arizona and reported all income there. She filed as a nonresident of California and reported only the W-2 income for 2013. She receives both a 1099-Misc and a CA 592-B. The 592-B shows significant withholding of CA (only) tax, with the Independent Contractor box checked in Part II.

It appears to me that this income is California sourced income and she should be paying CA tax on it minus a credit for taxes paid to Arizona on the same income.

Can a California pro tell me if I'm on the right track?
 

#2
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Compensation income is sourced to California if the services were performed in California. See section 3420 of FTB’s Residency and Sourcing Technical Manual. That would source the W-2 income to California, but not the 1099-MISC income.
 

#3
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Thank you Dave. Your posts are always great because you provide refs or links.
 

#4
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DesertRat wrote:Is a California form 592-B determinative that the reported income is California source income?

No. It is simply a record of withholding, which may apply to a California resident as well as a non-resident with California-source income. Perhaps the bookkeeper assumes the worker is a California resident, or forgot to update the personnel file.

The Instructions for Recipient (presumably attached to Form 592-B) say, "The amount shown as Total income subject to withholding may be an estimate or may only reflect how withholding was calculated. Be sure to report your actual taxable California source income. If you are an independent contractor or receive rents or royalties, see your contract and/or Form 1099 to determine your California source income." [emphasis added]
 

#5
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While I hesitate to disagree with DaveFogel, if his information is accurate then we have been preparing taxes wrong for a few years now for one particular client. In my research of CA source income, we determined that for independent contractors CA sources the income based on where the benefit of services is received, with no regard to where the services are performed. So when our IL corporation pays a NC independent contractor for work that benefits a CA client, that income is sourced to CA and we withhold CA income tax. I noticed that the linked manual is from 2009 and CA modified their sourcing rules in 2011.

https://www.ftb.ca.gov/businesses/New_Rules_for_Doing_Business_in_California.shtml

There are of course income thresholds and perhaps they apply to my client but not yours.
 

#6
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Nightsnorkeler, you might be correct, but more information is needed. Effective January 1, 2011, California adopted market based sourcing rules by regulation. Under 18 CCR §25136-2(c)(2), where a corporation or other business is the taxpayer’s customer, the location of where the benefit of the service is received determines its source. If, under the contract for services, the benefit of the services is received in California, then the source of the compensation for services will be California. 18 CCR §25136-2(b)(1) states that the “Benefit of a service is received” means the location where the taxpayer’s customer has either directly or indirectly received value from delivery of that service. 18 CCR §25136-2(b)(6) states that “Service” means “a commodity consisting of activities engaged in by a person for another person for consideration.” But it goes on to state that the term “service” does not include activities performed by a person who is not in a regular trade or business offering its services to the public.

[Edited to fix the links, which weren't working]
Last edited by DaveFogel on 3-Nov-2015 11:12am, edited 1 time in total.
 

#7
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Nightsnorkeler wrote:when our IL corporation pays a NC independent contractor for work that benefits a CA client, that income is sourced to CA and we withhold CA income tax

Wow, that's heavy. I knew California was agressive about out-of-state companies paying sales tax, but income tax from the workers too? Somebody's going to take that to the Supreme Court as a violation of interstate commerce.

Meanwhile I do appreciate the guy in NC contributing to my sunny lifestyle. Not only does he give us benefits, but he pays us for the privilege!
 

#8
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"In my research of CA source income, we determined that for independent contractors CA sources the income based on where the benefit of services is received, with no regard to where the services are performed."

I always thought along with post #2 that to be CA source income the services have to be performed in CA(physically present days in CA). I have always did this for W-2 and 1099-MISC clients who work outside CA for a CA client. After 1/1/2013, CA went to a single sales factor to apportion income from multi state businesses. The sales includes personal services to the extent the personal services are performed within CA. FTB legal Ruling 2005-1 defines personal services for sales factor purposes. Now if the out of state contractor is shipping in tangible property to the CA customer, then the sales are CA sourced.
 

#9
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WEISSEA wrote:to be CA source income the services have to be performed in CA(physically present days in CA)

What posts #5 and #6 have shown us is that this traditional position may expose clients (and practitioners too) to penalties for intentional disregard of the rules. Apparently California nexus can attach to intangible services as well as physical location.

Well (speaking as a California resident) I say it's about time them non-resident freeloaders pay their fair share for taking advantage of the vibrant California marketplace maintained at such a high regulatory cost.
 

#10
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4Seasons wrote: I say it's about time them non-resident freeloaders pay their fair share for taking advantage of the vibrant California marketplace maintained at such a high regulatory cost.

Yes, and it’s about time the California freeloaders start paying their fair share in the other 20 or 30 other states (or whatever it is now) that have similar market-based rules…
 

#11
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DaveFogel wrote:Nightsnorkeler, you might be correct, but more information is needed. Effective January 1, 2011, California adopted market based sourcing rules by regulation.


I don't know if this is the same thing, but in a CE seminar [Vicki Mulak] I took a year ago, this item was mentioned:

"Single Sales Factor
With the passage of Proposition 39 in November 2012's general election, all businesses are required to apportion income using the single sales factor (SSF) apportionment method (began 2013). The new rules apply for every size of business including a sole proprietor or independent contractor. SSF assigns services sales and sales of intangibles to California using market-based or market assignment sourcing rules."
 

#12
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This is not the same thing. Proposition 39 dealt with SALES.
See R&TC § 25128.7—Apportionment of Business Income on the FTB’s website.

As I said in #6 above, 18 CCR §25136-2(b)(6) states that term “service” does not include activities performed by a person who is not in a regular trade or business offering its services to the public.

So, I think that this is the key to the answer of whether OP’s client, who worked for the California company as an independent contractor, doing her work remotely from Arizona, was engaged in a regular trade or business offering her services to the public. If not, then I think that she has a defensible position in not treating the 1099-MISC income as California-sourced.
 

#13
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"Apparently California nexus can attach to intangible services as well as physical location. "

Yep, must have been asleep in class. From Spidell, (post 1-1-13) for Non resident service business. Because of Prop 39, even small multistate business's including Schedule C must use the single sales factor. Using the single sales factor requires service business to compute CA taxable income based on where the client is located. Example, Joe performs tax services in both CA & NV, but is located in NV. Joe performs tax services for a CA client. Those fees are allocated to CA even if Joe performs all the services for this client in NV.
 

#14
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According to this page on the FTB’s website, a nonresident individual (1) who has income from a business, trade, or profession, and (2) who must apportion its business income to California under 18 CCR §17951-4, must use the single-sales factor for taxable years beginning on or after 1/1/2013 unless 50% of the gross receipts were derived from a qualified business activity (QBA), i.e., an agricultural, extractive, savings and loan, or banking or financial business.

So, WEISSEA, I suggest that you read 18 CCR §17951-4, especially subsections (a) and (g). Please let us know if you still believe that the 1099-MISC income is subject to California tax, because I don't think it is.
 

#15
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DesertRat wrote:It appears to me that this income is California sourced income

On further reflection, it appears that way to me. Post #14 links to California statutes that make a point about conducting or carrying on a business "within and without the state." It also links a government website that explains "within" refers to the receipt of benefit, not the work as such. This seems to be related to the way sales tax is assessed according to delivery address rather than where the transaction took place.

The website gives an example of Jill, who performs work for a California company. In original post, the independent contractor likewise performs work for a California company. The company apparently understands this to be subject to California withholding, and there is nothing whatsoever in original post to suggest they are making a mistake.
 

#16
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4Seasons, the example with Jill is where Jill's sole proprietorship conducts business in several states, which seems quite different from OP's client, who only conducted her business in one state (Arizona). Seems like this would be an important distinction. Here's the example from the FTB website:

Jill, a nonresident of California, owns a web design business that she holds as a sole proprietorship. She works from her home out of state but has customers in various states including California. For the 2013 taxable year, Jill's sales receipts from California customers are $300,000 out of the total sales receipts everywhere of $1,000,000. Does Jill have a filing requirement in California?

Yes, nonresident individuals are taxed on all California source income. Jill's sole proprietorship is carrying on a business in and out of California and will be required to apportion its income to California using UDITPA rules. Under market assignment, sales of services are assigned to California if the purchaser of the service received the benefit of the service in California. Accordingly, $300,000 will be assigned to the California sales factor numerator for Jill's sole proprietorship and Jill would apportion 30% ($300,000 CA sales/$1,000,000 total sales) of its business income from her sole proprietorship to California.
 

#17
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DaveFogel wrote:the example with Jill is where Jill's sole proprietorship conducts business in several states, which seems quite different from OP's client, who only conducted her business in one state (Arizona)

Apparently, according to the information forms issued, her California customer does not agree. She conducted business in California if she sold some service or product to a customer within the state. From there it is a question of the threshholds.
 

#18
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4Seasons wrote:Apparently, according to the information forms issued, her California customer does not agree. She conducted business in California if she sold some service or product to a customer within the state. From there it is a question of the threshholds.

In essence, you're saying that the fact that the California company issued her a Form 592-B is dispositive of the issue of whether the 1099-MISC income was California sourced. It most certainly is not. Obviously, the California company wouldn't know whether her situation was similar to Jill's in the example above, or whether her only self-employment income was from the California company and that she wasn't offering her services to the public. This fact is critical to determining whether the income is California sourced, at least according to 18 CCR §25136-2(b)(6).
 

#19
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DaveFogel wrote:you're saying that the fact that the California company issued her a Form 592-B is dispositive of the issue of whether the 1099-MISC income was California sourced

No, that is the opposite of what I said (in post #4). However, though not "dispositive" it is suggestive because the payor presumably knows whether the services were provided in California.

But I admit I am responding here to posts I don't actually understand. Post #16 seems to be saying that if California customers provided 100% of the worker's income it would not be sourced to California, but if they provided some lesser percentage it would be. I don't see that in the cited authority.
 

#20
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4Seasons wrote:Post #16 seems to be saying that if California customers provided 100% of the worker's income it would not be sourced to California

That isn't what I'm saying. What I’m saying is that if OP’s client didn’t offer her services to the public, then the 1099-MISC income can’t be sourced to California if she performed the services in Arizona.

I pointed out in #6 and #12 that although 18 CCR §25136-2(c)(2) provides that if a corporation or other business is the taxpayer’s customer, the location of where the benefit of the “service” is received determines its source, that same regulation states that the term “service” does not include activities performed by a person who is not in a regular trade or business offering its services to the public.

DesertRat needs to come back into this discussion and tell us whether his client was in a regular trade or business offering her services to the public, because that will help resolve this issue.
 

#21
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All of the responses here have been greatly appreciated.
One aspect of her employment was not correct in the OP. I stated that she 'worked for' the CA company. She actually is contracted to a large recruiting firm (headquartered in MA) and supplies IT services for that CA company. Her services have not, so far, been supplied to the general public. If intent is material, she would like to continue her relationship with the recruiting firm, with whatever company they place her.
 

#22
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DesertRat wrote:She actually is contracted to a large recruiting firm (headquartered in MA) and supplies IT services for that CA company

Who paid her, subject to California withholding? I would guess a national recruiting company is likely to be correct about individual state laws. Now that we know it was for IT services in California it looks even more like the example of Jill. She was physically in her office in Arizona, but the client didn't care about that because she was linked to the company's computer in California. I'm not sure why "the general public" is an issue in this scenario, but I wouldn't say having a single client means an independent contractor is not providing services to the public.

An interesting point in original post is that Arizona does not allow residents a credit for income tax paid to California.
Last edited by 4Seasons on 5-Nov-2015 8:43am, edited 1 time in total.
 

#23
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DesertRat wrote: I stated that she 'worked for' the CA company. She actually is contracted to a large recruiting firm (headquartered in MA) and supplies IT services for that CA company.

Check me on it, but I think CA’s market-based sourcing rule might even extend to the customer’s customer…a bit of a stretch if you ask me. Anyway, I think Dave Fogel’s comments about “service” and offering said services to the public are on point. These market-based rules involve more questions than answers. Consider your guy, whose work might be part of a bigger project that might end up being used by some big corporation that operates in all 50 states and maybe in some foreign countries. Your guy’s IT work will be deployed across those places. Is the benefit really received by the customer (or the customer’s customer) in California alone? Not really, truth be told. (Although I’ll readily admit I don’t know the actual nature of your guy’s work, but often, with these IT big project guys, the way I describe it is the way it works).

In your case, though, even if we have CA source income under the CA statute, won’t we be dealing with the reverse credit situation in the case of AZ/CA, with CA giving a credit on the non-resident CA return? If that is the case, I suppose the guy might end up paying some CA tax on the Schedule C income attributed to CA because of the CA/AZ tax rate differential and because of CA’s market-based sourcing rules. This, of course, is a real crock.

And don’t forget that MA is a market-based state as well. If MA doesn’t have a look through rule to the customer’s customer, but CA does, maybe we have MA, CA and AZ income all at the same time.
 

#24
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She is paid by the 'recruiter'. Yes, CA allows a credit for tax paid to AZ and, yes, there is a differential.
{I'm leaving for eye surgery in about 20 minutes and probably won't be back at a computer for a couple of days. Thanks again for the great discussion}
 

#25
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Ok, we’ll see you later…
 

#26
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Jeff-Ohio wrote:Check me on it, but I think CA’s market-based sourcing rule might even extend to the customer’s customer…a bit of a stretch if you ask me.


"The FTB ruled that, when a taxpayer receives income from subcontracting services that its customers would otherwise be required to perform themselves for ultimate end-user customers, the benefit is received by the taxpayer’s direct customer and not the ultimate customer. "

https://www.grantthornton.com/~/media/c ... 09-14.ashx
 


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