Weather aside, a rapidly growing economy and profitable marketplace has named California one of the most desirable states for new and expanding businesses and individual taxpayers. One major obstacle that taxpayers face when seeking to enter into, or expand in California, is state taxes. California is a high-tax state with some of the highest sales/use, personal income and corporate tax rates in the United States. With proper planning, taxpayers may be able to relieve some of the tax burdens that may arise. In this article we will discuss a number of potential state tax opportunities in California.
- Market Sourcing
California uses a market-based sourcing approach when apportioning sales of items other than tangible personal property (e.g. services and intangibles) for any entity level income taxes. Sales from items other than tangible personal property are assigned to California’s sales factor based upon where the benefit is received by the end user (i.e. customer). This could have a significant impact on taxpayers that may currently be sourcing sales to California, for income tax purposes, under a different sourcing method, and would allow taxpayers to exclude sales where the benefit is received outside of the state. The benefit may be even greater for sellers of tangible personal property that ship products from a facility in California.
- Partial Sales and Use Tax Exemption
Taxpayers in the manufacturing and research and development (R&D) industries may qualify for a partial exemption of sales and use tax on purchases or leases of qualified manufacturing and R&D equipment. With this opportunity, qualified taxpayers are allowed a 3.9375 percent exemption on the current 7.25 percent California state sales tax rate (net rate of 3.3125 percent). Qualified taxpayers are required to provide sellers a partial exemption certificate to obtain the reduced tax rate.
- Tax Credits
California offers tax credits and incentives available for business and individuals in various industries. One such credit is the California Competes Tax Credit (CCTC), also known as the Governor’s Office of Business and Economic Development (GO-Biz) Tax Credit. This credit allows taxpayers to offset corporate income or personal income taxes in exchange for meeting certain hiring and investment goals over a five-year period. The CCTC is negotiated on a case-by-case basis by the GO-Biz.
The California Research Credit is available for taxpayers to reduce income or franchise tax. This credit is available for any taxpayer incurring qualified research expenditures while conducting qualified research projects in California. Credits are calculated as 15% of the excess of current year research expenditures over a computed base, and may be claimed on the current year return. Any remaining credits are carried forward until utilized.
Another notable credit is the New Employment Credit (NEC). Similar to the CCTC, this credit also allows an offset against corporate income or personal income taxes to qualified taxpayers that hire qualified full-time employees to work in a designated credit qualifying zone. To secure the credit, a tentative credit must be reserved and an annual certification of employment must be submitted for each qualified employee.
- Filing Group Composition
California offers a water’s edge election to allow corporate taxpayers to file income tax returns based upon US source income and other includable subpart F income, rather than worldwide income and apportionment. This election is available for both separate (i.e., foreign corporations with economic nexus) and combined (i.e., taxpayer groups with foreign activity) reporting entities. Taxpayers who would otherwise pay more taxes on a worldwide basis in California will benefit from this election. Filing on a water’s edge basis may also reduce record maintenance for some taxpayers.
In addition, unitary entities must be included in a combined group or entity filing for corporate income tax purposes. In general, the concept of unitary relationships for California purposes is based on ownership, operation, and use characteristics between entities. For non-unitary flow-through investments, income may be allocated to California and included on the California income tax return on a post-apportionment basis. For non-unitary corporate entities, these members may be excluded from the California combined filing group if the entities are deemed non-unitary.
- Entity Choice
Determining a strategic filing structure in California may be a key area of opportunity. California has specific rules pertaining to different filing structures. For example, C corporations are taxed at 8.84% while S corporations are subject to a 1.5% tax on net income. Further, all entities are subject to California’s $800 minimum tax; including disregarded Limited Liability Companies. There may be significant cost and tax savings opportunities available for businesses and individual taxpayers with complex filing structures, based upon the specific needs of the taxpayer.
Multistate taxation is an area filled with complexity and nuances. With proper planning, taxpayers can take advantage and prevent the oversight of available state tax opportunities. We recommend that taxpayers seek the advice of a tax professional to maximize realization and minimize tax burden. If you have any questions regarding the above and/or potential U.S. tax filings, our contact details are below.