All about business December 2019 Tax News

Public Law 86-272: How does this Federal law affect your requirement to file in California?

Over the years, California has made several law changes that affects your business clients that do business both in California and elsewhere, an apportioning trade or business.

Public Law 86-272 (15 USC Section 381) prevents States from asserting their right to impose a tax based on net income, such as the corporate income tax or franchise tax. Public Law 86-272 protection is available to out-of-state business entities that:

  • Sell tangible personal property in this state
  • Who’s in-state activities are limited to the solicitation of orders for their goods

As a result, if a taxpayer is protected by Public Law 86-272, they will not be required to pay the franchise tax or the corporate income tax, as both are measured by net income.
However, even if protected by Public Law 86-272, an out-of-state entity that is doing business (R&TC Section 23101) in California is still obligated to file a tax return and pay taxes that are not measured upon net income, unless certain exceptions apply, such as:

  • The minimum franchise tax
  • Annual limited liability company tax
  • The limited liability company fee

You are probably asking, “What does this mean, how does this work?”
First of all, protection under Public Law 86-272 does not apply to businesses that derive in-state income from the solicitation or sale of:

  • Intangible property
  • Services
  • Any combination of goods and services

Technical Advice Memorandum: 2018-03 addresses the application and interpretation of Public Law 86-272 in the context of delivering goods by company owned delivery vehicles. This memorandum concluded the delivery via a private delivery truck is protected activity under Public Law 86-272. However, any activity that goes beyond the scope of delivery, such as backhauling, is not protected activity.

For example: Corporation C, an out-of-state corporation that does not file a combined return, sells tangible goods over the internet and qualifies for protection under Public Law 86-272. For the 2019 taxable year, Corporation C has $1,000,000 of California sales but no property or payroll in California. Corporation C, though considered doing business in California because it has $1,000,000 in California sales, will not be subject to California’s franchise tax as it is protected under Public Law 86-272. This is true even if the tangible goods are delivered using Corporation C’s vehicles. However, Corporation C must still file a California return and pay the minimum franchise tax of $800. If Corporation C’s vehicles are used for any other business activity along with the delivery, such as backhaul of goods (like hauling off the customer’s old items), this activity would go beyond the solicitation of orders and would no longer be protected.

Another example: LLC Z, an out-of-state LLC that engaged in activities that are protected under Public Law 86-272 and considered to be doing business in California for the tax year 2019. LLC Z’s total income from sources derived from or attributable to the state of California was $300,000.Therefore, LLC Z must file a California tax return, pay the annual LLC tax of $800, and pay the LLC fee of $900. Public Law 86-272 does not protect qualified out-of-state business entities from the annual LLC tax or the LLC fee.

For further details regarding which activities are protected by Public Law 86-272, see FTB 1050, Application and Interpretation of Public Law 86-272. In addition, for more information on the minimum franchise tax, annual LLC tax, and LLC fee, as well as their exceptions, please reference Revenue and Tax Code Sections 23151, 17941, and 17942, respectively.

The LLC fee amount can be determined from the LLC fee table. Go to ftb.ca.gov and search FTB 3556.