Never a dull moment with California tax rules. Only a little more than a year ago California adopted a rule allowing multi-state businesses to choose between a single sales and a three-factor apportionment method to determine their state tax liability. It actually made California a bit more business friendly for once, but not for long. Statewide Proposition 39 simplified the choice for businesses by making the single sales factor method mandatory effective January 1, 2013.
Background
Once a multi-state business establishes that it has presence in California making it subject to income tax in the state, the next step is to determine its state liability by apportioning its net income to the state using one of the allowed apportionment methods.
In years prior to 2011, a multi-state business was required to use a three-part apportionment that would take into account the business’s payroll, property and sales in the state.
For sale of intangible products , to determine sourcing of sales, businesses were to use the “cost of performance” method of which the essence was that if all or a greater portion of services were performed in the state, those sales would be sourced to California and vice versa.
For 2011 and 2012 years, multi-state businesses were provided an option to choose between a three-part and a single sales apportionment method. The caveat was that businesses needed to use the “market” method to determine source of sales. This means that as long as your customers are in California, sales are to be sourced to the state regardless of where performance of services took place.
The option to choose between the apportionment methods benefited a lot of local businesses. Those with payroll and property in California, but with sales of services/intangibles all over the country, would use the single sales factor and lower their state tax bill. Meanwhile, local businesses selling primarily to California customers could lower their tax bill by using the three-factor apportionment method.
It was too good to be true and thus, it did not last long in financially strained California.
Now what?
It may be an added cost of selling in California that needs to be planned for accordingly. Please consider adjusting your state estimated taxes for 2013 if this change directly affects you.