California requiring businesses to WITHHOLD CA taxes on payments to non-CA individuals and businesses

The California Franchise Tax Board is taking a super aggressive stance and going overboard to collect California taxes on those that have exited the state.

Any individual, LLC, Partnership, S Corporation, or C Corporation providing a service that holds a "benefit to a California business" is now going to see a California tax withholding from their invoice payments.

The FTB notice sent to businesses

The FTB notices are going out to registered California businesses with new California withholding requirements. The withholding requirement will be for payments to ANY individual or business if they provide a service to a California business from another state.

And if California businesses don't comply, the fines are HUGE!

An example notice can be found here.

Examples of California source income

Let's say you are a web developer located in Tennessee and you design a website for a California business, doing all your work in Tennessee remotely. You never step foot in California. When you send your invoice now to that California business, you will have California taxes withheld from your payment!

Bookkeepers, engineers, copywriters, accountants, social media managers, and marketers that have moved out of California and perform a service for a California individual or business, your fees are subject to this tax and withholding!  These same withholdings apply even if you have never lived in California but have clients that do.

Rent payouts? Those are on the list.

Distributions for California company shareholders non-residents... are on the list too!

What to expect to be withheld

For anyone paid over $1500 in a year for a service that "California Source Income" or benefits a business within California, 7% of all payments are required to be withheld and submitted to the California Franchise Tax Board.

The only way that businesses can get that money back is to file a California tax return.

Exceptions

Non-profits, government and businesses that have locations already in California and registered with the state of California are exempt too. 

Also if a business has applied for a waiver, they are also exempt from this withholding.

This does not apply to payments for goods or products.

Who is really affected?

There is no doubt that this is another effort by California to recoup the tax income that went away with the mass exodus of residents who moved to other states but are still providing services to their California customers and clients.

1099 contractors have always been required to pay income taxes on sourced income to California.  But now California is taking a step further to not depend on the tax filer to submit, but to require the business to collect and pay just like payroll taxes. 

What about NEXUS?

Great question! In a legal sense, a business is only required to submit and pay taxes of a state that it holds nexus in.  These new market-based sourcing RULES of California are overstepping the nexus boundaries and apply to any business even if they don't meet the California nexus rules published on the Franchise Tax Board website.

Are these new California tax filings of businesses that have taxes withheld but do not meet the nexus minimums now required to be registered in California and pay the $800 minimum fee? 

Example:

A non-California S Corporation provides a service to a California business for $1500. That California business will only pay the invoice (minus the 7%) amount and will submit that 7% amount to the California Franchise Board.

To claim that amount, the non-California S Corporation must file a tax return in California. Since they don't have nexus and don't qualify for the "doing business in California" definition (it changes if they do), they don't have to pay the $800 minimum fee to register as a company doing business in California BUT they DO have to pay 1.5% of that net income to California.

Regardless if the 7% tax is withheld or not, they must define what portion of their net income was derived from or benefited California sources and report that to California for tax reporting.

Taxation without representation

Will someone step up and take California to court over this?  If there is no nexus held in California, how can California apply these taxes? What happened in history when a mass exodus of residents left a country that continued to tax them?

Expect to see more about this in the courts!

Will businesses STOP offering services to those in California? 

We may start seeing a trend where business owners chose to not offer services to clients and customers in California. 

That said, given the large population and need of services by California individuals and companies, we don't expend there to be a huge swing in this trend. 

Most won't be aware unless they have a tax preparer who is up-to-date and providing great tax advice in advance... until they receive a notice with the FTB's calculation of that tax that they owe and have to fight or become subject to a residency audit.