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I recently received a request from the California Franchise Tax Board saying that they believe I need to file a tax return. I am a sole proprietor programmer, with a client in California who paid me and submitted a 1099-misc. My contract with the client states that all work will be performed in another state (location is listed in contract). I did not visit California or perform any work there.

Whether I need to file (and possibly owe taxes) seems to hinge on whether this 1099-misc income is "California source" income. Despite the fact that the work was performed in another state, is it California source income?

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    CA FTB's site is pretty clear that CA source income must be "carried on in California," so maybe respond asserting that none of the 1099 income is CA source, and if they keep insisting, file a return saying $0 CA-source income = $0 tax due? – Kevin May 8 '18 at 19:56
  • Thanks for pointing that out. I intend to at least have that discussion with them, but I would love more clarity on what defines "business [...] carried on in California." Does it require a worker's physical presence? I hope so, but would appreciate any information from folks more knowledgeable than myself. – grateful-planes May 8 '18 at 20:08
  • California loves to send out those tax notices to anyone that got a 1099-misc from someone in California. My wife used to get them, we pointed out the situation, they dropped it until next year. – Loren Pechtel Jul 28 '18 at 14:11
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You have to file and pay taxes in California for your income received from California based clients, even though no services were performed inside of California. See California's OTA ruling on Bindley [i]. Bindley is important because it comes one year after a similar case, appeal of Larsen, where the OTA reached the opposite conclusion. Bindley took precedential status, Larsen did not. Therefore, Bindley is the rule going forward.

Scott
Why Blu, Tax & Accounting Firm

Sources
[i] In the Matter of the Appeal of Blair S. Bindley, OTA Case No. 18032402 (May 30, 2019).
[ii] See 18 Cal. Code Regs. § 17951-4.
[iii] 18 Cal. Code Regs. § 17951-4(b).
[iv] 18 Cal. Code Regs. § 17951-4(b).
[v] Appeal of Bindley, OTA No. 18032402, at 6 (May 30, 2019).
[vi] Cal. Rev. & Tax. Code § 25136.
[vii] See 18 Cal. Code Regs. § 25136-2(c).

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By definition of the word source, in this context, you may be double-taxed:

Nonresidents R&TC Section 17951 provides that gross income of nonresidents includes only income from California sources. The word "source" pertains to the place of origin. R&TC Section 17041(b) and (d) provide that nonresidents are taxed only on taxable income derived from sources within California.

Example 2

John, a nonresident of California, has the following income:

Wages earned in California $45,000
Wages earned in Japan $30,000
Interest from Nevada bank account $10,000

Total $85,000

Determination


Because John is a nonresident, only his California source wages of $45,000 are taxable by California.

Deriving income is the main consideration:

A business entity that is not doing business in this State, but derives income from sources within this State or from activities carried on in this State, may also be subject to tax so long as constitutional nexus has been satisfied and Public Law 86-272 does not apply. A business entity that falls under this provision will be taxed under Chapter 3 of the Corporation Tax Law

Contractor payments are treated as follows:

If the services are performed by an independent contractor rather than by an employee of the taxpayer, the receipts must be attributed to the state of the taxpayer's commercial domicile

You may be eligible for a tax credit depending on the location of your tax home:

California nonresident individuals, estates, or trusts that are residents of one of the following states or U.S. possessions and paid a net income tax to that state or U.S. possession on income that is also taxed by California may claim the other state tax credit:

Arizona (AZ), Guam (GU), Oregon (OR), and Virginia (VA).

California nonresidents who are residents of any state or U.S. possession not listed may not claim this credit. This credit is not allowed on a California group nonresident tax return.

The nexus test is the basis for this:

The sale, lease or license of services, intangibles, and digital products for primary use by a purchaser known to the seller to be in this State. If the seller knows that a service, intangible, or digital product will be used in multiple States because of separate charges levied for, or measured by, the use at different locations, because of other contractual provisions measuring use, or because of other information provided to the seller, the seller shall apportion the receipts according to usage in each State.

The "convenience of the employer" test is the theory behind this in other states (the California law uses the word source rather than employer and resident/non-resident instead of any relationship to the source):

State income tax rules can sometimes affect the efficacy of telecommuting. Depending on the states involved, employees telecommuting across state lines may have their income taxed twice, once by their employer's state and again, by the state where they reside. While states differ in their tax treatment of such income, most apply a "physical presence" test. This test apportions income based on the number of days a taxpayer physically works in each state. New York, however, applies a "convenience of the employer test," which provides that 100% of income earned by a nonresident working for a New York employer is taxable by New York State, unless the work performed outside of New York on which the income is earned is performed outside New York for the employer's convenience, rather than for the employee's.

References

  • but the question is about somebody who is self employed. – mhoran_psprep Jul 27 '18 at 10:20
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    Is there a particular reason you used "spoiler" tags for the new quotes? – TripeHound Jul 31 '18 at 11:41
  • @TripeHound The spoiler tags were added to address mhoran_psprep. – Paul Sweatte Jul 31 '18 at 14:09

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