Chief Counsel Corner February 2019 Tax News

Office of Tax Appeals Decision - Appeal of Larsen

The Appeal of Larsen, 2018-OTA-073, July 25, 2018, is a recent nonprecedential decision of the Office of Tax Appeals (OTA). Nonprecedential decisions are controlling for the case before the OTA, but only precedential decisions are binding for any subsequent cases. (California Code of Regulations (CCR), title 18, Section 30502(b).)

The case stemmed from a filing enforcement action in which the FTB received information that Mr. Larsen, a resident of Idaho, had received a Form 1099-MISC reporting non-employee compensation from a company with a California address. As explained in last month's Chief Counsel Corner, it is FTB’s position that the nature of these facts indicate Mr. Larsen had California-sourced income under the market-based sourcing rules for sole proprietorships.

Mr. Larsen disputed the tax and penalties because he had not lived or worked in California during the year at issue. He did not, however, dispute that he was paid as an independent contractor by the company in question. Further he did not provide the FTB or the OTA with any information regarding his compensation, including a description of the services provided or a copy of a contract between the company and him. As explained last month, neither the residence of the taxpayer nor the place where the services were performed are dispositive in this type of case.

Under CCR Section 17951-4(c) and (c)(2) a nonresident's California source income from a sole proprietorship which carries on a unitary business, trade, or profession within and without the state is the amount of business income apportioned to this state. For sales of other than tangible property (services and intangible property), sales are apportioned using the market-based rules (MBR). (CCR Section 25136-2.) Under MBR, sales are considered California sales if the taxpayer's customer received the benefit of service in this state or if the taxpayer's customer used the intangible in this state. Since a customer received a benefit of service in this State, a nonresident may have California source income from California and may therefore have a filing requirement. For the purposes of CCR, title 18, Section 17951-4, unitary businesses are those businesses where there is an interrelationship between in-state and out-of-state activities that are constitutionally permitted to be treated as a discrete business enterprise.

The OTA analyzed whether Mr. Larsen's business was unitary and determined that the FTB had not met its initial burden of showing that Mr. Larsen was engaged in a unitary business.

Mr. Larsen performed the services entirely from Idaho, but the Form 1099-MISC suggests that a customer from California received those services from within California. The out-of-state activity (provision of service) and the in-state activity (receipt of the benefit of that service) are interdependent of each other showing a strong indication of a unitary business.