California: Arizona Resident Owes California Income Tax for Services Performed in Arizona

The California Office of Tax Appeals (OTA) recently sustained a personal income tax assessment on a nonresident individual who had performed screenplay writing services for two movie producers, both California LLCs, in the 2015 taxable year. The taxpayer at issue, an Arizona resident self-employed as a screenwriter, received Forms 1099-MISC from the California LLCs in 2015. The taxpayer did not file a 2015 California return. After an inquiry from the Franchise Tax Board (FTB), the taxpayer responded he had no California-source income, as he had performed all of his services in Arizona.  The FTB rejected this explanation, asserting that because the taxpayer performed services for California LLCs, the income generated from those services was sourced to California.

Under California law, income tax is imposed on nonresidents to the extent the income is derived from in-state sources. To determine whether apportionment rules apply to a nonresident’s income, pursuant to Cal. Code Regs., title 18, §17951-4, the nonresident must be: (1) carrying on a business within and without California; (2) conducting business as a sole proprietorship; and (3) carrying on a unitary business. The ALJs for the OTA determined that all three of the conditions were met, and the state’s apportionment rules applied.

The ALJs then turned to California’s market-based sourcing rules under R&TC §26136 and the underlying regulation. Cal. Code Regs. §25136-2. For purposes of the sales factor, receipts from sales of services are assigned to California to the extent the taxpayer’s customer receives the benefit of the service in California. The regulation provides cascading rules to make such a determination. The ALJs, after noting that the taxpayer’s contracts did not address where the benefit of the screenwriting services was received, determined that the benefit of the services could be reasonably approximated to have been received in California because the LLCs were registered and located in California. The ALJs concluded that the taxpayer’s physical presence did not determine whether he had California source income. Rather, this was determined based on where the benefits of his services were received.  Please contact Gina Rodriquez at 916-551-3132 with questions on this OTA opinion.