California’s new Nexus Rule … Will it Drive Businesses Away?

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Some days, I wonder what goes through the minds of elected officials. I’ve been exploring California’s new budget legislation and in particular how they’ve revised the state’s already loose definition of “doing business.” Now I’m wondering if it’ll be worth it for companies to do business with California, period.

If you go looking through California’s legal statutes and the Franchise Tax Board’s website for their definition of nexus, it’s very vague. That’s on purpose. This way, if you call up the FTB to ask “will this constitute nexus” they can say “Why yes, it does!” (and then figure out how). That differs dramatically from many other states, who have clear-cut rules on what is and isn’t considered doing business.

Anyways, starting in 2011, here’s what will constitute “doing business” in California:

  1. You live in CA
  2. You have a business structure organized in CA
  3. Your CA sales, including sales by an independent contractor or an agent, exceed the lesser of $500k or 25% of your total sales
  4. Your CA-based real and tangible personal property exceed the lesser of $50,000 or 25% of your total real and tangible personal property
  5. The amount you pay in CA for compensation (presumably for an agent or an IC) exceeds the lesser of $50,000 or 25% of the total compensation you pay out.
  6. These amounts also include your distributions from a partnership or an S Corporation.

Much of this is pretty much standard operating procedure … although many states don’t consider hiring agents or independent contractors to establish nexus. The idea that 25% of your total sales can be enough to drag you into CA is kind of daunting though.

But wait, there’s more! Right now, when you sell services to a CA resident, but perform the work outside of the state, that’s not considered a taxable sale under CA statutes. For example, you may live and work in Indiana and have a web design business with CA customers. If you design a website for someone in CA, that’s not a taxable event in CA — it’s taxable in Indiana, where the work was done.

However, starting in 2011, sales of services will be considered sourced in CA if the purchaser of the service received the benefit of the service in CA. As far as I can tell, unlucky web designer in Indiana, you’ll get to report the income you make from CA clients in CA and pay tax on it … AND report and pay tax on that income in Indiana as well.

I’m not sure how CA will regulate non-state business owners, or even track sales of services provided to CA residents. How many out-of-state businesses will voluntarily comply with this new ruling, I don’t know either. But if it catches on, I’m willing to bet that other states will try to join the party. In any event, it just feels to me like the idea of interstate commerce is under attack, period. If cross-border state tax issues get business owners knotted up in red tape to the point where they reconsider operating, then what?

Maybe this type of legislation is what it will take for the Supreme Court to finally agree to step in and provide some guidance. I know they don’t want to. They declined to hear a couple of cases on this issue recently. If you read some of the Supreme Court landmark cases like Quill, they were pretty clear that the matter needed to be determined by Congress, not the Court. But if Congress won’t act, and state governments keep reaching further and further beyond their own borders, then what?

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