California's Apportionment Rule

Tax Professionals' Resource
October 18, 2012 — 1,196 views  
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California's Apportionment Rule

Sales apportionment is an important topic when it comes to paying taxes. In California, the recent change in legislation has modified the sales apportionment process. This change has the potential benefit of saving taxpayers a significant amount of money when it comes to their company's state tax liability. 

The taxpayers affected by this new rule would normally have to pay taxes based on a formula for multi-state tax situations. The three factor apportionment rule used sales, payroll and property to determine the tax that a company pays. With the new apportionment rule, taxpayers can choose to use a single sales factor method that lets a taxpayer use just the sales from the business. 

This method, however, uses a different way of looking at sales within California. For those who sell intangibles, such as services, to their customers will have to base their tax rate on market-based sourcing. These types of businesses include accounting architecture and law firms. Those who continue to sell tangible personal property will continue to use the original cost of performance method. 

Which companies will benefit the most? The companies more likely to see a significant tax benefit due to this change in the rule are companies that operate in California and serving customers in other states. With market-based sourcing, sale of services are are attributed to California, provided the customer receives the benefit from the service within the state. Any sale of intangible property or gross receipts can be attributed to California as well when the property is used in California. 

No matter what type of business a person owns, it is important to look at both methods to understand which one would reduce tax liabilities. With the new apportionment rule in California, California business owners have the choice to pick which tax formula works best for them, but they do not have to commit to it for more than one year. If the business changes significantly over a year, and the tax formula used no longer provides the most benefit, the company can begin using the other method. 

Companies that deal with international customers as well as out of state customers could see even more benefits. Typically, those who do not pay taxes on tangible items had the taxes on the company assessed at a California rate. With a single sales factor, tax-free jurisdictions could be set up for these customers, allowing more business success.

 

Tax Professionals' Resource