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February 2011: California's 2011 Corporate Income Tax Law Changes

February 2011: California's 2011 Corporate Income Tax Law Changes

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Published by: SingerLewak on Apr 15, 2011
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FEBRUARY 2011
California’s 2011 Corporate IncomeTax Law Changes
Given the state’s fnancial straits o the past several years, Caliornia has seen several changes in its tax laws as policymakers ridethe tides o a severely strained budget. With the beginning o the new year, many o the tax law changes implemented since 2009are now in ull eect, and represent signifcant changes in the way domestic and out-o-state companies do business. The newlegislation, eective January 1, 2011:
•
Readopts the Finnigan approach to assigning receipts rom combined groups to Caliornia
•
Changed the nexus standards or companies doing business in the state
•
Will allow corporate taxpayers to elect to use a single sales actor apportionment ormula
•
And transition to a market-based approach or sourcing receipts rom sales o other than tangible personalproperty
Finnigan Takes the Field 
For taxable years beginning on or ater January 1, 2011, the state has enacted legislation adopting the Finnigan rule, which pro-vides that the sales actor numerator o a combined group include all corporations in the unitary group that have Caliornia sales,regardless o whether the corporation has nexus or is protected under Public Law (P.L.) 86-272.The state has teetered back and orth between Joyce (adopted or tax years prior to January 1, 2011) and Finnigan since the rulewas frst adopted in the mid-1960’s. Under Joyce, the sales actor numerator o the combined group consists o sales by thosecorporations that have nexus in Caliornia and are required to fle a Caliornia corporate income tax return.Finnigan’s signifcance lies in the new law’s impact on out o state businesses. Taxpayers engaged in the sale o tangible personalproperty to Caliornia customers and are protected under P.L. 86-272 will see an increase in their Caliornia corporate income taxliability due to the inclusion o sales o tangible personal property in the numerator o the sales actor notwithstanding the P.L. 86-272 protection. The constitutionality o this method o sourcing receipts rom sales o tangible personal property has been gener-ally upheld, as the inclusion o the sales do not amount to a tax on entities without nexus, but instead is considered a method o calculating the tax imposed on a combined unitary group.
“Doing Business” Defned – New Nexus Standards or Presence
For taxable years beginning on or ater January 1, 2011, a taxpayer is deemed to be “doing business” in this state i it is organizedor commercially domiciled (i.e., the principal place rom which taxpayer’s trade or business is directed or managed) in Caliornia or ithas:
 
FEBRUARY 2011
1. Sales in the state that exceed the lesser o $500,000 or 25-percent o the taxpayer’s total sales (includingsales by an agent or independent contractor)2. Real property and tangible personal property in the state that exceed the lesser o $50,000 or 25-percent o the taxpayer’s total real property and tangible personal property3. Payroll in the state that exceeds the lesser o $50,000 or 25-percent o the total compensation paid by thetaxpayerFor tax years beginning prior to January 1, 2011, a taxpayer was considered to be doing business in the state i it was activelyengaged in any transaction or the purpose o fnancial or economic gain or proft.
 Single Sales Factor (“SSF”) Election
The February 2009 state budget agreement, passed under Governor Arnold Schwarzenegger, changed the apportionment ormulaused to determine Caliornia taxable income or businesses with multi-state operations. Beginning January 1, 2011, businessessubject to the Caliornia Corporate Income or Franchise Tax may make an annual irrevocable election to apportion income usinga single sales actor (“SSF”) apportionment ormula. The election is irrevocable only or the tax year to which the election isapplied. As such, taxpayers have the ability to choose the apportionment option that would yield the least amount o tax on anannual basis.Under prior law, businesses with activities or income derived rom sources both within and outside o Caliornia, were required tocalculate their Caliornia income tax using the three-actor apportionment method (i.e., property, payroll, and sales) with double-weighted sales (i.e., the sales actor is used twice in the apportionment ormula). Taxpayers not making the SSF election wouldcontinue to use the three-actor, double-weighted sales apportionment ormula.The move to an elective SSF was meant as a business development incentive to attract businesses into the state. The absenceo a property and payroll actor or income tax apportionment purposes would encourage businesses to establish operations inCaliornia, given the tax costs o such a move would be nil. Moreover, given the trend by most states move to a SSF method o apportionment, Caliornia-established business would be given equal ooting when competing with out-o-state competitors whohave the ability to manipulate their sales activities and source such sales to SSF states.The election to use a SSF must be made on an original, timely-fled return, including extensions, and is an irrevocable annualelection. Presumably, many Caliornia corporations will choose to make the SSF election and beneft orm a decrease in Calior-nia income tax. However, out-o-state corporations will likely choose to continue to utilize the three-actor, double-weighted salesormula described above.Businesses that derive more than 50% o its gross business receipts rom agricultural, extractive, savings and loan, and bankingand fnancial activities, are excepted rom the SSF election, and must use an evenly-weighted three actor apportionment ormula.The Franchise Tax Board (“FTB”) is currently drating regulations that would clariy the implementation and the proper method o electing the use o a SSF apportionment method.On January 10, 2011, Governor Jerry Brown revealed his proposed state budget or the 2011-2012 fscal year, which wouldremove the election rom the statutory language, and make the SSF mandatory or all businesses.
“Market-Based” Sourcing 
For tax years beginning on or ater January 1, 2011, receipts rom sales, other than sales o tangible personal property, will besourced based on the ollowing:

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