Authored Articles & Publications Jul 14, 2015

Best in Law: The Far Reach of California’s Taxes

BB&K Attorney Jeremiah Lee Writes in The Press-Enterprise About the Real Costs of Doing Business in California

By Jeremiah J. Lee

Although some businesses have left California for states with seemingly more friendly regulations and taxes, many remain in California because their customers are in California.

When a company operates in California, even if not headquartered in California, it generally has to play by

California’s rules, including paying franchise taxes “for the privilege of doing business in this state.”

What if a company’s customers are not in California and it does not have active business operations in California? Would such an out-of-state company still have to pay franchise taxes in California? For example, if a Colorado company owns vacant property in California, but does not otherwise have any business operations here, does it have to pay franchise taxes as if it were a California company? The answer, surprising to some, likely is yes.

When a company operates in California or is formed or registered in California, it must pay franchise taxes based on its net income. The minimum amount of the franchise tax is $800 even if the annual net income is zero. Unbeknownst to many businesses located outside of California, the minimum franchise tax has significant reach.

The California Revenue and Tax Code requires a corporation or limited liability company which is “doing business” in California to file a tax return and pay franchise taxes. “Doing business” is defined to include some expected operating metrics such as 25 percent of a company’s sales are in California, $50,000 or more is paid in compensation to workers in California or a company is organized in California.

However, the code also contains an often overlooked definition of “doing business” that includes real property and tangible personal property located in California exceeding the lesser of $50,000 or 25 percent of the company’s total real property and tangible personal property. Based on real property prices in California, it would not take owning very much land, even vacant land, in California to exceed $50,000.

The confusion and frustration most commonly expressed by an out-of-state company discovering it may owe the minimum franchise tax stems from the different standards California uses for determining whether or not a business is operating in our state. A company is required to register with the California Secretary of State in order to “transact intrastate business” if it enters into repeated and successive business transactions in this state, other than interstate or foreign commerce.

However, the Franchise Tax Board uses the broader definition discussed above and requires a company to file a tax return if it is “doing business” in the state. Many companies consider the more narrow definition in determining whether its business is engaged in California – whether it has repeated business transactions in the state. Even if a company has no repeated transactions and only passively holds vacant land in California, the company may still be considered to be doing business in California under the tax code if the property’s value exceeds the threshold under the law (the lesser of $50,000 or 25 percent of the company’s total real property and tangible personal property). The unaware company could be required to pay franchise taxes in California and, even if such a company does not have any net income for a given year, the minimum franchise tax of $800 would be due.

Leaving California or holding California property through an out-of-state entity in an effort to escape this state’s taxes may be a good plan in theory; however, the long reach of the state’s tax code may still be able to touch out-of-state owners of property located in California.

* This article first appeared in The Press-Enterprise on July 2, 2015. Republished with permission.

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