Articles Posted in Doing Business in Calilfornia

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doing business in CaliforniaOur office has experienced a significant increase in the number of taxpayers reporting they have received 4600 Notices “Request for Tax Return” sent by the Franchise Tax Board (California’s tax enforcement agency). The likely explanation is discussed below.

What’s Happening?

This July, our office saw a spike of 100% from the prior year in contacts from taxpayers seeking guidance after receiving a 4600 Notice from the FTB. There is a particular increase in nonresidents who have businesses out of state with no direct contacts with California. The notice relates to whether they are “doing business in California” as a result of sales to California customers. The upsurge could simply be more potential clients are choosing to contact our firm, but the more likely explanation is an actual increase in the volume of 4600 Notices sent, especially those relating to doing business in California.

What Is a 4600 Notice?

The FTB sends a 4600 Notice when it has reason to believe the recipient, usually a nonresident, was required to file a California tax return in a prior year, but didn’t. The notice is sent automatically when the FTB receives information to indicate that the non-reporting taxpayer earned or was distributed California-source income or may reside in California. The notice requires recipients to either prepare and file a California tax return or explain why they aren’t required to. If the FTB accepts the explanation, the matter ends there. If the FTB doesn’t, then a full audit follows.    Continue reading →

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Promissory note sourcingNonresident individuals and out-of-state companies often make loans to California-based borrowers. It’s not unusual for those promissory notes to be secured with California real estate. The scenarios take many forms. A person may inherit the note from a parent, or they may feel obliged to make a loan to a child purchasing their first home. Or the note may be on the books of an out-of-state company as a result of the sale of assets or a subsidiary to a California buyer. Clients in these circumstances often ask me whether the interest from the note is California-source income. The short answer is, generally no. The long answer is, it depends.

Why It Matters

It obviously makes a financial difference if loan interest is California-source income. Nonresidents are taxed by California on income sourced to this state. If the interest on such loans are California-source income, the nonresident must file a nonresident return and pay California income taxes. An analogous situation applies to out-of-state companies that hold such notes. If the interest is revenue sourced to California, the lender is “doing business in California” and owes California taxes on that revenue. But even if the amount of tax is minor, there may be a larger downside. For nonresidents, a California income tax reporting requirement means that the Franchise Tax Board, California’s tax enforcement agency, will know everything about the taxpayer’s global income. That’s because the nonresident must attach a federal return, Form 1040, to the nonresident state return, Form 540NR. It’s not the end of the world, and it by no means guarantees a residency audit, but if the person’s global income is particularly high, and if there are indications of other significant contacts with California, then it could increase the chances of the FTB initiating a residency audit, something that promises unique unpleasantries for nonresidents. See, California Residency Audits: Three Year-End Tasks to Reduce the Risk for Nonresidents.

For business entities, having California-source income raises similar complications. An out-of-state company doing business in California has to register as a foreign entity and file all appropriate entity tax returns, regardless of how de minimis its California taxable income is. And, if the entity is a pass-through, the reportable California-source income may also require the principals to file nonresident returns. A double whammy. Continue reading →

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Doing Business in CaliforniaThe Franchise Tax Board, California’s taxing authority, has consistently taken an aggressive stance in claiming out-of-state businesses have income tax reporting requirements for “doing business in California.”  The FTB reached a limit in Swart Enterprises, Inc. v. Franchise Tax Board, Cal. Ct. App. (5th App. Dist.), 7 Cal. App. 5th 497 (2017).  In that case, a California appeals court ruled against the FTB’s claim that a foreign corporation with a passive .02% ownership in a California LLC was doing business in California.  As a result, the FTB was forced to modify its ruling on doing business in California by members of multi-member limited liability companies.

FTB Walks Back Prior Ruling

Specifically, the FTB has modified California FTB Legal Ruling No. 2014-01, 07/22/2014, which sets forth the FTB’s analysis on a number of “doing business” scenarios involving members of multiple-member LLCs that are classified as partnerships for tax purposes.  The ruling had asserted that the distinction between “manager-managed” and “member-managed” LLCs, made no difference in determining whether a member of the LLC was doing business in California.  The reasoning in Swart Enterprises made that assertion untenable.  As a result, the FTB has removed the language and replaced it with the innocuous phrase: “a narrow exception may apply in limited circumstances.”  Continue reading →