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It is a fact that California is the sixth largest economy in the world. As such, companies from throughout the United States and the world are eager to market and sell goods and services in the state. In decades past, some companies might have opened a local branch in the state. Other businesses may have marketed their goods through catalogs, radio or television advertisements, and even direct mailers sent through the U.S. Postal Service. While these approaches are still viable and in use by an array of companies, today, these efforts have expanded to online marketing. Online retailers and similar companies may direct these efforts through a platform offered by companies such as Amazon, eBay, or other companies that allow people to sell products online. Other businesses may independently develop their own online properties which seek out customers and clients in California.
However, with the opportunities and benefits that California’s economy and markets offer, also come tax obligations and duties. Businesses and individuals who purposely ignore these obligations can face penalties, fines, and even criminal tax consequences. Therefore, it is essential for all taxpayers with a nexus, or connection, to California to engage in tax compliance efforts. The Tax Lawyers and CPAs of the Tax Law Offices of David W. Klasing can provide individualized California state tax guidance for your business. to schedule a confidential reduced rate consultation at our Los Angeles or Irvine law offices, please call 800-681-1295 today.
When Can California Impose Income or Corporate Tax on an Out-of-State Business?
Most businesses located and doing business in-state would not deny that California has a valid nexus to tax. However, there are also several scenarios when California can lawfully impose an income, excise, sales or franchise tax against an out-of-state company doing business in the state. Whether the imposition of the tax is appropriate and legal comes down to whether there is a nexus between the entity and the state of California. The process of determining whether nexus should with the state of California begins with an inquiry into whether an entity is doing business or deriving income within the state. When a business has taken such actions, a statutorily based nexus is established.
Following the determination that a statutory nexus has been established, the California Franchise Tax Board will also assess whether the requirements set forth by the U.S. Constitution’s Due Process Clause and the Commerce Clause are satisfied. If this nexus is also established, then the FTB will assess whether the potential tax nexus is permissible under Public Law 86-272 (15 USC §381). If the public law does apply, then taxation based on California sourced net income or sales is inappropriate and thus the standard corporate or franchise tax will not apply. However, the business may still have an obligation to pay California’s minimum franchise tax.
The types of out-of-state businesses and operations that can face California state taxes are broad and include:
- An out-of-state or any company that has established physical offices or locations in California.
- Any company that has “sales” in the state exceeding the lesser of $500,000 or 25 percent of the taxpayer’s total sales.
- The taxpayer has real or tangible property in the state that aggregates to exceed the lesser of $50,000 or 25 percent of the taxpayer’s total property.
- The compensation paid by the business in California exceeds the lesser of $50,000 or 25 percent of the total compensation paid by the business entity.
- Entities not engaged in business in California but derives income in the state provided that the requirements set forth in the previous paragraph are met.
It is important to speak with a tax lawyer when considering if your business falls under one of these or another nexus for imposing California tax obligations. A tax lawyer can help you understand and apply the U.S. Tax Code to your circumstances.
What Additional Tax Obligations Can An Out-of-State Business Have That Are Subject To California Voluntary Disclosure Program?
While the above discussion is concerned with the imposition of one type of tax: state income or corporate tax, there are several other types of taxes that can be imposed. Depending on the entities operations, sales, and other factors a company may also face California payroll tax, use tax, and sales tax obligations. Payroll tax obligations are generally only incurred if the business has employees in the state. That said, if a payroll tax obligation exists, the failure to account for, hold, and turn over the employment tax obligation in a timely manner can result in an array of negative consequences including responsible party’s personal liability for the unpaid tax. Unfortunately, there is no voluntary disclosure program for payroll tax obligations. Therefore, it is essential for taxpayers and businesses to maintain compliance with this obligation.
In addition, in-state and out-of-state companies can also incur sales and use tax obligations. Sales and use tax obligations are somewhat related. That is, typically only one of the two taxes will apply to a transaction. Sales tax applies to goods sold in California. By contrast, use tax applies to goods purchased out-of-state where sales tax was not collected and then used, stored, or consumed in-state. The California BOE has established voluntary disclosure programs for both in-state and out-of-state companies that fail to satisfy either of these obligations.
How Can a Business Secure Relief from California State Tax Mistakes?
If an out-of-state company has failed to satisfy all state tax obligations, the potential for fines, penalties, and other consequences is a real possibility. For business owners who may assume that their distance from California will prevent California from asserting Nexus, the California Franchise Tax Board and other state tax enforcement agencies will not hesitate to commence a tax enforcement action regardless of whether a company is located in California or across the country.
However, when tax mistakes have occurred, businesses and other taxpayers can avoid a worst-case tax scenario through the appropriate California Voluntary Disclosure Program. An array of taxpayers can qualify for the program including legal entities shareholders, and beneficiaries. For a qualified entity seeking entry for income or corporate tax problems, all the following criteria must be met to be eligible including:
- The entity is a corporation, S Corp, LLC, or trust.
- The entity has no previous filings with the California FTB.
- The trust does not have non-contingent California resident beneficiaries.
- The trust has never been administered in California.
- The trust has never been previously investigated or audited for tax obligation failures.
- The entity has come forward voluntarily and has not been the subject of inquiries from the FTB.
- The entity can make a complete and accurate disclosure that describes all taxable activity in California during the previous six years.
Businesses and other taxpayer entities that can establish these or alternate eligibility for the state voluntary disclosure program can avoid many of the fines and penalties that would otherwise be imposed. Similar requirements apply to voluntary disclosure relief from unfulfilled sales and use tax obligations administered and enforced by the California Board of Equalization.
What Benefits Does California Voluntary Disclosure for Income or Corporate Taxes Provide?
The exact benefits your organization or company can obtain is based on the facts and circumstances surrounding your income, corporate, franchise, sales, or use tax error. However, businesses, taxpayers, and other entities that can qualify will generally be able to avoid a worst-case scenario and can typically expect to have certain penalties that would otherwise be imposed waived. A taxpayer who enters the FTB’s voluntary disclosure program to address income, franchise, or corporate tax issues can potentially avoid any or all the following penalties under California law:
- Failure to make and file a return (Section 19131)
- Failure to pay any amount due by the date prescribed for payment (Section 19132)
- Underpayment of estimated tax (Section 19136)
- Secretary of State penalty (Section 19141)
- Failure to furnish information or maintain records (Section 19141.5)
- Underpayment of tax (Section 19142)
- Failure to file information returns (Section 19183)
- Late filing of partnership returns (Section 19172)
- Contract voidability penalty (Section 23301.5)
This potential tax penalty relief will apply for all the years covered by the disclosure agreement. The elimination of penalties that would otherwise be imposed can significantly reduce the tax burden a business or entrepreneur faces.
What Benefits Does entering into a California Voluntary Disclosure Provide concerning Sales and Use Taxes?
If one pursues a voluntary disclosure agreement with the Board of Equalization for unpaid sales or use tax obligations, the penalty relief and other benefits that may be available include:
- Waived late filing and late payment fees.
- A condensed assessment window. Absent this relief, California may be able to assess up to the last eight years of sales taxes. When a valid disclosure is made, the assessment period is limited to just three years.
- Applicants can make a disclosure on an anonymous basis and receive an opinion letter regarding whether they are likely to qualify for this relief.
In sum, the availability of a California voluntary disclosure program can protect new businesses and out-of-state businesses from potentially company-ending consequences due to a mistake. A narrowed assessment period can significantly reduce the assessed tax liability. However, taxpayers who do not act in a timely manner may find this relief option foreclosed since unilateral contact by a California tax agency or the start of an investigation will result in ineligibility.
What Types of Companies Will California Tax Agencies Pursue an Enforcement Action Against?
California’s various tax agencies will not hesitate to pursue a business in any industry if it has the requisite tax nexus to the state and a tax obligation was not satisfied. As a practical matter, California tax agencies are more likely to pursue enforcement actions against businesses with significant risk factors where there is a strong likelihood for a significant recovery. While this is especially bad news for large companies with significant revenue, small to mid-sized businesses also frequently face tax enforcement actions.
For instance, businesses that deal predominately or exclusively in cash are a frequent target of tax authorities because of the potential for abuse that cash presents. In addition, online businesses that target California can also receive priority. The reason for online companies facing this scrutiny is two-fold. First, an online business presents a greater opportunity for abuse due to its ability to reach across borders, a potentially non-fixed place of business, and due to the potential for significant revenue. Second, online businesses are extremely easy to find and often have tax issues and oversights.
Attorneys Handle California Tax Obligations for Out-of-State Businesses and Taxpayers
If you have started a business that will derive income from selling goods or services in California, careful tax guidance is essential. While results can never be guaranteed, the best-case scenario is to work with an experienced team of Tax Attorneys and CPAs who can assist your organization in achieving compliance from the outset. However, if you commenced operations before getting a handle on the tax obligations you would face in each state, you may need to utilize the California’s Voluntary Disclosure Initiatives to come back into compliance while mitigating the penalties your entity faces in the state.
The Tax Lawyers, CPAs and EAs of the Tax Law Offices of David W. Klasing offer full-service tax guidance for organizations and entities with California tax obligations. If you already have a relationship with a CPA who is in your company’s home state, we are happy to consult on the matter. We can provide California tax guidance to increase the likelihood that your California tax return or other tax filing is accepted without issue. Since our practice consists of both Tax Lawyers, CPAs and EAs we take a comprehensive approach to business and tax law issues in California, in-state tax filings, and additional aspects of multi-state taxation. In fact, David Klasing is a dually certified Tax Lawyer and CPA who can provide insight and guidance regarding both the interpretation of tax laws and the accuracy of tax filings.
To schedule a confidential reduced rate consultation, please call our Los Angeles or Irvine, California tax law offices at 800-681-1295 or schedule online today.
