In the Matter of , OTA Case No. 18032402 (May 30, 2019), a sole proprietor performed all of his services outside of California, but some of his customers were in California. Is that enough for the poor guy to attract California tax liability? The California taxing authorities said he was operating a "unitary" business. Therefore, his tiny business was subject to California's apportionment rules. The FTB would not budge, so Mr. Bindley went over their head to the state’s Office of Tax Appeals (OTA), but it agreed with the FTB. This case has precedential effect, so it is clear that the Golden State can go after other non-Californians too, and it’s happening. Exactly what was poor Mr. Bindley’s tax offense in California? He is a self-employed screenplay writer living in Arizona. He performed services for a few companies headquartered and registered in California. The California Franchise Tax Board matched income records showing that he collected $40,000 of income from California companies. Not surprisingly, Bindley did not file a California tax return.
That meant California’s statute of limitations would never start to run. That itself is a useful lesson. The statute of limitations is a reason that many non-residents of California file a return to report a small amount of California source income. In Bindley’s case, the state noted that whether a nonresident is subject to California's rules for apportioning income depends on : (1) whether the taxpayer is carrying on a trade or business within California, outside of California, or a combination thereof; (2) the type of entity conducting the business; and (3) whether the business is unitary. California ruled that Bindley’s screenwriting business was carried on inside and outside of California. He worked as a proprietor, and basically did the same kind of work for non-California and for California companies. That’s a useful lesson too. What exactly is unitary anyway?
California’s tough tax regulations only describe what is not a unitary business. California says that a business is not unitary where the part within the state is so separate and distinct from (and unconnected to) the part outside the state that the businesses are not a unitary business. Here, the Golden State said that this screenwriter ran a unitary operation. After all, the part conducted inside California and the part conducted outside the state were not separate and distinct so as to be separate businesses. If your business is unitary, the income derived from services is sourced to the place where the benefit of the service is received. To determine the place where the benefit of the service is received, California law provides rules looking first to the contract. If the contract does not specify the location where the benefit is received, then California or the taxpayer can try to approximate the location where the benefit is received. For the companies located in California that paid the screenwriter, California said it was reasonable to conclude that the companies received the benefit of the services in California.
Does this screenwriter’s unfortunate tax flap mean other little businesses that happen to sell into in California could face tax troubles? Yes, it does. California can now push even on sole proprietors who might have California customers. They might have to file California returns and pay California taxes. This is so even if all the services are performed outside of California, and even if the sole proprietor has no connection to California. Poor Mr. Bindley isn’t the only one either. California OTA just decided another case, Appeal of Bass,2022-OTA-145, involving a Tennessee sole proprietor who provided consulting services to a California insurance agency by Skype and phone. He never set foot in California, but the state ruled that he had to pay California taxes no matter what. Mr. Bass argued that his case was different from the Bindley case because Bindley had produced a tangible product, a screenplay for a California customer. Bass was just consulting, not selling anything but his time.
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