I expect that many tax practitioners would consider
state taxes to be a bane in their professional practice. I – unsolicited and
without trying – have known more than a few.
Let’s limit our discussion to state income tax.
Mind you, we are not discussing the right of a state
to tax. I practice within a Tristate area (Indiana, Kentucky and Ohio) and all
three states impose business and personal income taxes. Yes, it can get messy.
Take bonus depreciation, for example. This is a federal tax provision allowing the
accelerated deduction of equipment and similar asset purchases. Some states
will follow along with the federal treatment, others will ignore it completely,
and yet others will have some odd hybrid. Take a relatively simple business
return with activities across multiple states, and depreciation alone can raise
the difficulty level of the return.
Mind you, some states are user-friendly with their tax
laws (at least, as much as possible), but some states do not even pretend to be.
I am going to crimp from a notorious California tax
case, changing the underlying taxpayer just a smidge to someone you will
recognize.
Let’s take a partially retired Cincinnati tax CPA. He
has several California clients, both business and personal. He consults, prepares
returns and assists with tax agency correspondence and issues. He of course invoices for his work, and some
of those California clients issue him a Form 1099 to memorialize the payment.
Critically, he never sets foot in California, and he has not for decades.
Does our Cincinnati tax CPA need to file a California income
tax return?
Let’s walk through this.
The California Franchise Tax Board (FTB) annually
matches 1099s to filed returns to identify individuals who may not have filed
required California returns. The FTB saw those California-origin 1099s and
contacted our valiant protagonist, who explained that he did not live in
California, had not been in California in years, and – given its current deterioration
– had no intention to ever visit California for any reason.
The FTB rejected his explanation, explaining that he
had performed services for California businesses and thus had California-source
income. The FTB sent a Proposed Assessment for tax, penalty and interest.
Our scrappy hero protested the assessment.
The Office of Tax Appeals (a/k/a Vought) decided as
follows:
California imposes a tax on the taxable income of
every nonresident, broadly defined as “gross income and deductions derived from
sources within this state.”
There is no dispute that appellant, as owner of a sole
proprietorship … conducted his … business as a sole proprietor.”
Regulation 17951-4 does not define the term ‘unitary business,’
but the definition can be inferred from Regulation 17951-4(b) … applying to a
nonresident’s business, trade or profession … conducted partly within and
partly without the state, where the part conducted within the state and the
part conducted without the state are not so separate and distinct from and
unconnected to each other to be separate businesses, trades or professions.”
Here, appellant … conducted a one-service business ….
Therefore, we find that appellant was conducting a unitary business.”
What is the point of all this gum flapping?
California wants to apportion the California invoices
to California. They do not even care if you were ever there.
Under the statutory grant of authority of R&TC
section 25136(b), the FTB promulgated Regulation 25136-2, which provides detailed
market-based sales factor sourcing provisions that implement and interpret
R&TC section 25136.”
Pray tell, oh Oracle. How shall R&TC section 25136
be interpreted?
Regulation 25136-2(c) states that sales from services
are assigned to [California] to the extent the customer of the taxpayer
receives the benefit of the service in [California].”
Here is the wrap:
I do not mean to distract the lofty legal minds at the
big-building-with-marble columns, but don’t you have to start with
more-than-one if you are uniting down to one? Is there a trick-of-the-language thing
happening here? Asking for a friend.
The case we are discussing (with some literary
license) is Appeal of Bindley (CA OTA, May 30, 2019, No. 18032402).
What got me thinking about Bindley is the
(very) recent case of Xavier Garcia-Rojas v FTB, A172054, CA Ct of
Appeal, First Appellate District, Division Three, 5/1/26.
Garcia-Rojas was a radiologist from Texas. He read images
from around the nation, some of which came from California. The FTB wanted its
pound of flesh, relying on Appeal of Bindley above.
This is, BTW, how bad tax law metastasizes. The first
court misses the pitch altogether, and the next court just piggybacks.
The Court fortunately recognized the issue:
Here is the decision:
Bindley held that a “self-employed screenplay writer” in
Arizona was a unitary business, and thus could be taxed under regulation
17951-4(c). (Bindley, at pp. 1, 4–5.) But in doing so, it focused on the tests
to determine whether two different businesses are unitary. (Bindley, at pp.
4–5.) It ignored that there must be separate business activities to unite.
(Ibid.; Bunzl Distribution USA, Inc. v. Franchise Tax Bd., supra, 27
Cal.App.5th at p. 991.) The Board also relies on regulation 25120, subdivision
(b), but that regulation states it applies only if there are “two or more
businesses of a single taxpayer.” Thus, the Board
failed to show that Garcia-Rojas is a unitary business as a matter of law.
It took it a while but they eventually got it right. This
did not help Bindley, however, who was robbed on an issue a second-year
accounting student could spot.
This seems to be an awful lot of work just to determine
if our winsome-CPA-hero-of-the-story needs to file a nonresident California tax
return. It is also why many CPAs consider state tax to be the bane of their practice.
