Help with doing business in California
General information and application
If you have less than the threshold amounts of:
You can still be doing business if you actively engage in a transaction in California for the purpose of:
- Financial gain
Less than the CA property, payroll or sales for doing business
Scenario: Partnership A, an out-of-state partnership, has employees who work out of their homes in California. The employees sell and provide warranty work to California customers. Partnership A's property, payroll, and sales in California fall below the threshold amounts. Is Partnership A doing business in California?
Answer: Yes. Partnership A is doing business in California even if the property, payroll, and sales in California fall below the threshold amounts. Partnership A is doing business in California through its employees because those employees are actively engaging in transactions for profit on behalf of Partnership A.
25% threshold computation
Scenario: Corporation B, an out-of-state corporation, has $100,000 in total property, $200,000 in total payroll, $1,000,000 in total sales, of which $400,000 was sales to California customers. Corporation B has no property or payroll in California. Is Corporation B doing business in California?
Answer: Yes. Although Corporation B's California sales is less than the $500,000 threshold, Corporation B's California sales is 40% of its total sales which exceeds 25% of the corporation's total sales ($400,000 ÷ 1,000,000 = 40%.)
Public Law 86-272
Protected by Public Law
Scenario: Corporation C, an out-of-state corporation, is a seller of tangible goods over the internet and qualifies for protection under PL 86-272. For taxable year 2018, Corporation C has $1,000,000 of sales but no property or payroll in California. Is Corporation C doing business in California?
Answer: Yes. Corporation C is doing business in California because it has sales of $1,000,000 in California. Therefore, Corporation C must file a California return to pay the minimum tax. However, since Corporation C is protected under PL 86-272, it will not be subject to California franchise tax.
Partnerships, Limited Liability Companies (treated as partnerships) and S corporations
Partnerships and LLCs are considered doing business in California if they have a general partner or member doing business on their behalf in California. Likewise, general partners and members are considered doing business in California if the partnership or LLC, respectively, is doing business in California.
For taxable years beginning on or after 1/1/2013, all apportioning trades or businesses, except those that derive more than 50% of their gross receipts from qualified business activities, shall apportion their business income to California using a single-sales factor.
Nevertheless, partnerships, LLCs treated as partnerships, and S corporations are required to provide to their partners, members, and shareholders their pro rata share of the California and total property, payroll, and sales on the CA Schedule K-1 so their partners, members, or shareholders may determine if they are doing business in CA.
Flow through property, payroll and sales
Scenario: Corporation E, an out-of-state corporation, has no property or payroll but has $450,000 of sales to customers located in California. Corporation E also has a 30 percent limited partnership interest in Limited Partnership X which is doing business in California. For tax year 2011, Limited Partnership X has $30,000, $50,000 and $200,000 in property, payroll, and sales in California, respectively. Is Corporation E doing business in California?
Answer: Yes. Corporation E has the following distributive shares of property, payroll, and sales from Limited Partnership X:
Flow through Partnership property = $9,000 ($30,000 x 30%)
Flow through Partnership payroll = $15,000 ($50,000 x 30%)
Flow through Partnership sales = $60,000 ($200,000 x 30%)
Corporation E is doing business in California because it has a total of $510,000 sales in California ($450,000 of its own sales + $60,000 of Limited Partnership X’s sales.)
Scenario: Corporation F is a 50% general partner in a California partnership. The partnership has $800,000 of sales, $10,000 of property and $10,000 of payroll in California. Is Corporation F doing business in California?
Answer: Yes. Corporation F, through its distributive share from the California Partnership, has $400,000 of sales, $5,000 of property and $5,000 of payroll in California which are below the threshold amounts. However, because Corporation F is a general partner, it is doing business in California on behalf of the California Partnership that is doing business in California.
Multiple pass-through entities
Scenario: Corporation G, an out-of-state corporation, owns multiple interests in several pass-through entities in California. How should it compute the amounts of property, payroll, and sales in California?
Answer: Corporation G computes its property, payroll, and sales in California by aggregating the property, payroll, and sales from all sources, including all distributive shares of property, payroll, and sales from each pass-through entity. If the combined property, payroll, or sales exceed the threshold amounts, Corporation G is doing business in California.
Investment Partnerships and Qualifying Investment Securities
Corporations that are permitted, pursuant to subsection (a)(1) of RTC 23040.1 to exclude from California source income their distributive share of interest, dividends, and gains from the sale of qualified investment securities from a qualified investment partnership shall also exclude those amounts from the doing business test set forth in RTC 23101(b). Furthermore, the exemption from doing business applicable to alien corporations that meet the requirements of RTC 23040.1(c) remains in effect.
Understand and select the appropriate accounting method for your business
An accounting method is a set of rules used to determine when and how income and expenses are reported. While there are several methods of accounting, the two most common are the cash and accrual basis. You should choose an accounting method for your business that will most accurately match your income and associated expenses. This is referred to as the "matching principle".
Following are some of the generally used accounting methods:
- Cash method
- Accrual method
- Special methods such as percentage-of-completion or completed contract method which are generally only used for long-term construction projects like real estate developments
- Combination method using elements of two or more of the above
If we examine your tax return, we may ask you to show:
- The method of accounting used to report your income and expenses
- That it accurately reflects your income, and
- That it's used consistently
Understand what constitutes taxable and nontaxable income and deductible business expenses
You will generally compute taxable income by starting with gross income, excluding nontaxable income and exemptions, and subtracting allowable deductions. The accounting method that you select will determine the items of income and deductions that you will include in any taxable year.
To take advantage of what the tax laws allow you to deduct, it is important that you understand what are deductible business expenses. Deductible expenses are ordinary and necessary expenses incurred in the operation of your trade or business.
On the other hand, you should also know the type of expenses that are not deductible for tax purposes such as fines, state taxes, etc. For audit purposes, it is important that you provide supporting documentation for the expenses you are reporting on your return and demonstrate how these expenses are "ordinary and necessary" for your business.
Visit Business Expenses (FTB 984) for more information.