There are a number of notable legislative changes and proposals in California for 2010 and 2011, some inspired by the state's continuing fiscal problems.
Legislative Changes for 2010
New Estimated Tax Schedule. California's budget issues have sparked yet another change in the estimated tax payment schedule for individual and corporate taxpayers. Historically, taxpayers were required to pay estimated tax in equal quarterly installments. In an effort to accelerate revenue, California revised this payment schedule for taxable years commencing on or after January 1, 2009, to 30% for the first two quarters and 20% for the last two quarters. The payment schedule has been revised once again for taxable years beginning on or after January 1, 2010, to 30%, 40%, 0%, and 30% for the first through fourth quarters.
Relief for Suspended Net Operating Losses. For taxpayers whose net business income was $500,000 or more, California disallowed a net operating loss ("NOL") deduction in 2008 and 2009. The use of NOLs was restored in 2010. Recently enacted legislation would extend the carryover period for the suspended NOLs for an additional two years to allow affected taxpayers to have the same number of years to utilize the deduction that they would have had if the change had not been enacted. Moreover, NOLs that are incurred in years beginning on or after January 1, 2010, can be carried back two years (on a reduced basis for NOLs incurred in 2011 and 2012) and carried forward for 20 years (up from 10 years).
Corporate Understatement Penalty. For taxable years beginning on or after January 1, 2003, for which the statute of limitations on assessment has not expired, California will impose a 20% penalty on banks, corporations, and any other entity subject to tax under Part 11 of the California Revenue and Taxation Code with an understatement of tax in excess of $1 million in a taxable year. The penalty is assessed in addition to the interest and penalties that are normally assessed on underpayments. However, the penalty will not be imposed if the understatement is attributable to (i) the taxpayer's reasonable reliance on a Franchise Tax Board Chief Counsel Ruling, or (ii) a change in law occurring after the earlier of either the date the taxpayer files the return or the extended due date of the return for the taxable year in which the change is operative.
Intra-Group Credit Transfers. For taxable years beginning on or after January 1, 2008, taxpayers may assign certain credits to unitary affiliates. Assigned credits may be used for taxable years beginning on or after January 1, 2010. The credits that may be assigned are those earned by, or that can be carried forward to a taxable year beginning on or after, July 1, 2008. Research and development credits, new jobs credits, and any other credits are all eligible for transfer under this rule.
Backup Withholding. California law now conforms in part to the federal backup withholding rules. For payments made on or after January 1, 2010, backup withholding at the rate of 7% is required for "reportable payments" (as defined in §3406 of the Internal Revenue Code), including payments of rents, prizes and winnings, compensation for services (including bonuses), and other fixed or determinable annual or periodic gains, profits, and income. Backup withholding is not required for payments of interest and dividends, or for any release of loan funds made by a financial institution in the normal course of business.
Legislative Changes Effective 2011
New Apportionment Methodology. For taxable years beginning on or after January 1, 2011, certain taxpayers engaged in a multistate unitary business can elect to apportion their business income using only the sales factor. Historically, taxpayers determined their California business income using a formula that took into account their property, payroll, and sales in California (with double weight applied to the sales factor) relative to their worldwide property, payroll, and sales. All taxpayers are eligible for single-factor apportionment other than those engaged primarily in agriculture, extraction, or the savings and loan, banking, or financial businesses. The election is made annually and, once made, is irrevocable for that year.
New "Doing Business" Standard. California will soon join the group of states which take the position that physical presence is not required for income tax nexus and which have asserted tax against taxpayers on an economic or factor nexus theory. For taxable years beginning January 1, 2011, taxpayers will be deemed to be doing business in California for income tax purposes if (i) California sales (including sales by an agent or independent contractor) exceed the lesser of $500,000 or 25% of total sales, (ii) real property and tangible personal property within California exceed the lesser of $50,000 or 25% of the taxpayer's total real property and tangible personal property, or (iii) amounts paid for compensation in California exceed $50,000 or 25% of the total compensation paid by the taxpayer. The threshold amounts will be adjusted annually for inflation.
New Definition of "Gross Receipts." California has adopted a new definition of "gross receipts" for sales-factor purposes for tax years beginning on or after January 1, 2011. "Gross receipts" will be defined as the gross amounts realized on the sale or exchange of property, the performance of services, or the use of property or capital in a transaction that produces business income, in which the income, gain, or loss is recognized (or would be recognized if the transaction were in the U.S.) under the Internal Revenue Code. As the focus is on gross amounts, there is no reduction to the amount realized for the cost of goods sold or adjusted basis. There are a number of exclusions from this definition, including redemptions of loans, bonds, CDs and other marketable assets, and amounts from hedging transactions and intangible assets held in connection with a company's treasury function.
New Sourcing Rule. California historically has sourced sales other than sales of tangible personal property according to the location of a taxpayer's costs of performance. For tax years beginning January 1, 2011, California will source sales of services and intangibles differently. Sales of services will be sourced in California to the extent the purchaser received the benefit of the services in the state, and sales of intangible property will be sourced in California to the extent the property is used in the state. Moreover, receipts from the sale, lease, rental, or licensing (as appropriate) of real property or tangible personal property will be sourced in-state if the property is located in California.
Sales Throwback Rule. States that require combined reporting generally follow either the so called Joyce or Finnigan approach to calculating the combined sales-factor numerator. Over the years, California has bounced back and forth between the two methods, and for taxable years beginning on or after January 1, 2011, it will readopt the Finnigan approach. Finnigan provides that all sales of a combined group are included in the sales-factor numerator if any member of the group is subject to California tax. Likewise, sales that are delivered outside California are excluded from the sales-factor numerator if any member of the group is subject to tax in the state to which the goods are sold.
Proposed "Tax Haven" Legislation
AB1178. This proposal would require multinational corporations filing a water's edge election to include in their California combined reports the income and apportionment factors of any affiliated corporation that does business in, or derives income from or attributable to, a tax haven. This rule would modify the existing practice of permitting eligible electing taxpayers to determine their California income by excluding generally their foreign affiliates. AB1178 was passed by the California State Assembly and is currently pending in the California State Senate. If adopted, AB1178 will be effective for taxable years commencing on or after July 1, 2011, and before July 1, 2014, and will sunset on June 1, 2015.