Cal. Code Regs. Tit. 18, §§ 17951-4

Current through Register 2024 Notice Reg. No. 38, September 20, 2024

Section 17951-4 - *** Income from a Business, Trade or Profession

(a) If a nonresident's business, trade or profession is carried on entirely without the state, no portion of the net income therefrom is derived from sources within this state. If, on the other hand, the nonresident's business, trade or profession is conducted wholly within the state, the entire net income therefrom is derived from sources within this state.

(b) If a nonresident's business, trade or profession is conducted partly within and partly without the state, and the part within the state is so separate and distinct from and unconnected with the part without the state such that the respective business activities are not part of a unitary business, trade or profession, only the net income from the business, trade or profession within the state is derived from sources within this state. Thus, if a nonresident owns a hotel in California and an unrelated manufacturing business elsewhere, and is not significantly involved in the management of the hotel, only the net income from the hotel in California is derived from sources within this state.

(c) If a nonresident's business, trade or profession is a sole proprietorship which carries on a unitary business, trade, or profession within and without the state, the amount of net income derived from sources within this state shall be determined in the manner described below.

(1) The total business income of the unitary business shall be determined by subtracting from the gross income of the unitary business those deductions allowed by the law (See Articles 6 and 9 of Chapter 3 (Section 17201, Revenue and Taxation Code, and following)) which are attributable to that unitary business. If expenses relate to both business income and other income, the expenses shall be assigned to the respective income amounts as provided in Title 18, Cal. Code Regs., § 25120(d).

(2) The amount of such business income derived from sources within this state shall be determined in accordance with the provisions of the apportionment rules of the Uniform Division of Income for Tax Purposes Act, Sections 25120 to 25139, inclusive, Revenue and Taxation Code, and the regulations thereunder, except as otherwise provided in subsection (g), below, relating to professional service organizations.

(3) The source of net income which is not business income shall be determined in accordance with the sourcing rules of Sections 17951 through 17955, Revenue and Taxation Code, and the regulations thereunder, and not by reference to the nonbusiness allocation rules of the Uniform Division of Income for Tax Purposes Act, Sections 25120 to 25139, inclusive, Revenue and Taxation Code, and the regulations thereunder.

(d) If a nonresident is a partner in a partnership which carries on a unitary business, trade or profession within and without this state, the source of the partner's distributive share of partnership income derived from sources within this state shall be determined in the manner described below.

(1) Except as provided, the total business income of the partnership shall be apportioned at the partnership level in accordance with the apportionment rules of the Uniform Division of Income for Tax Purposes Act, Sections 25120 to 25139, Revenue and Taxation Code, and the regulations thereunder.

(2) If the partnership and the business activity of the partner are part of one unitary business, then the rules of Title 18, Cal. Code Regs., § 25137-1(f) apply and the apportionment of the partnership business income is done at the partner level for the unitary partner or partners. Each partner's distributive share of the partnership business income apportioned to this state is income derived from sources within this state.

(3) The source of guaranteed payments received by a nonresident partner from a partnership shall be determined as if the guaranteed payments were a distributive share of partnership business income.

(4) The source of a partner's distributive share of items which do not constitute business income shall be determined in accordance with the sourcing rules of Sections 17951 through 17955, Revenue and Taxation Code, and the regulations thereunder, as if the income producing activity were undertaken by the partner in its individual capacity.

(5) Except as provided in subsection (d)(6), the business activity of a partnership will not ordinarily be considered part of a unitary business with another business activity of one or more of its partners. However, if necessary to properly reflect the income or loss of the partnership or its partners, the Franchise Tax Board shall have the discretion to treat the business activity of a partnership and a business activity of one or more of its partners as part of a single unitary business, but only after conducting a comparable uncontrolled price examination in the manner provided by Section 23801(d)(1), Revenue and Taxation Code. For this purpose, the term "business activity" includes the partner's interest in the business activity of a sole proprietorship, another partnership, a limited liability company and an S corporation. If the Franchise Tax Board determines that unitary combination is appropriate under this subsection, the business income of the unitary activity shall be apportioned in accordance with the rules prescribed under subsection (d)(6)(A), without regard to the 20 percent limitation described therein.

(6) Exception for 20 percent or more interests. Subsection (d)(5) shall not apply to partners who own, directly or indirectly, a 20 percent or more capital or profits interest in a partnership. For purposes of this section, the ownership of a capital or profits interest in a partnership shall be determined under the rules of subsection (d)(6)(B).

(A) If a partner owns a 20 percent or more interest, as described in subsection (d)(6), and the business activity of the partnership is unitary with another business activity of the partner as that phrase is described in subsection (d)(5), the income of the unitary activity shall be combined at the partner level and apportioned to this state under the provisions of the Uniform Division of Income for Tax Purposes Act, Sections 25120- 25139 inclusive, Revenue and Taxation Code, and the regulations thereunder. In determining the amount of business income apportioned to this state, the partner shall combine the business income from unitary sole proprietorships and its distributive or pro rata shares of business income from 20 percent or more interests in unitary partnerships and S corporations. For purposes of the preceding sentence, the combined business income of a unitary partnership or S corporation shall be limited to the distributive or pro rata share of business income of the partner or shareholder from interests actually (not constructively) owned. The combined unitary business income shall be apportioned to this state under the provisions of the Uniform Division of Income for Tax Purposes Act, Sections 25120-25139, Revenue and Taxation Code, and the regulations thereunder, at the partner level. For that purpose, the partner shall aggregate its payroll, property and sales from unitary sole proprietorships and its proportionate share of payroll, property, and sales, whichever is applicable, from unitary partnerships and S corporations in which the partner or shareholder owns a 20 percent or more interest to arrive at a single apportionment percentage. That percentage is applied to the combined unitary business income computed under this subsection to determine the partner's business income from sources within this state.

(B) For purposes of this subsection (d)(6), the actual or constructive ownership of a capital or profits interest in a partnership shall be determined in accordance with the following rules:

1. An interest in partnership capital or profits which is owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries.

2. An individual shall be considered as owning the interest in partnership capital or profits owned, directly or indirectly, by or for his or her family.

3. The family of an individual shall include only his or her brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants, and

4. An interest in partnership capital or profits constructively owned by a person by reason of the application of subsection (d)(6)(B)1. shall, for the purpose of applying subsections (d)(6)(B)1. or (d)(6)(B)2., be treated as actually owned by such person, but an interest in partnership capital or profits constructively owned by an individual by reason of the application of subsection (d)(6)(B)2. shall not be treated as owned by him for the purpose of again applying either of such subsections in order to make another the constructive owner of such interest in partnership capital or profits.

EXAMPLE: Individual X is engaged in a sole proprietorship with business income of $100,000. In addition, X directly owns a 15% capital interest in Partnership P. X's sister Y also owns a 10% capital interest in P. X's distributive share of business income from P is $30,000, and his sister's distributive share of business income from P is $20,000. P and X's sole proprietorship are engaged in a unitary business. Under subsection (d)(6)(B), X is treated as constructively owning Y's interest in the partnership. Thus X's aggregate owned or constructively owned interest in P is 25%. Accordingly, X is subject to the apportionment provisions of subsection (d)(6)(A). However, under subsection (d)(6)(A), X will combine and apportion only the sum of his $100,000 proprietorship income and his actual distributive share of business income of $30,000 from P. The 20 percent test used to determine the applicability of subsection (d)(6) does not affect the amount of partnership income taken into account in computing income actually derived from sources within this state.

(e) If a nonresident is the sole member of a limited liability company whose separate existence is disregarded for tax purposes under Section 23038, Revenue and Taxation Code, and which carries on a unitary business, trade or profession within and without this state, the source of the member's limited liability company income derived from sources within this state shall be determined in accordance with the sole proprietorship provisions of subsections (c) and (g). If a nonresident is a member of a limited liability company which is classified as a partnership for tax purposes under Section 23038, Revenue and Taxation Code, and which carries on a unitary business, trade or profession within and without this state, the source of the member's distributive share of limited liability company income derived from sources within this state shall be determined in accordance with the partnership provisions of subsections (d) and (g). The provisions of (c), (d) or (g), as the case may be, shall not be construed to apply to the determination of "total income from all sources reportable to this state" for purposes of determining the annual fee imposed on a limited liability company under Section 17942, Revenue and Taxation Code.

(f) If a nonresident is a shareholder of an S corporation (as described in Section 17087.5, Revenue and Taxation Code) which carries on a unitary business, trade or profession within and without this state, the amount of the nonresident's pro rata share of S corporation income derived from sources within this state shall be determined in the same manner as if the S corporation were a partnership. Except for subsection (d)(6)(B), the provisions of subsections (d)(1) and (d)(3) through (6) are specifically incorporated by reference. In lieu of subsection (d)(6)(B), for purposes of determining whether a nonresident shareholder has a 20 percent or more interest in an S corporation, the rules for constructive ownership of stock provided in Section 267(c) of the Internal Revenue Code shall apply. The provisions of subsection (g), relating to the computation of the payroll factor for professional service organizations, shall not apply in the case of S corporations. The source of an S corporation's items of nonbusiness income for purposes of the tax imposed on the S corporation under Part 11, Division 2, Chapter 4.5 of the Revenue and Taxation Code, shall have no relevance in determining the source of items of nonbusiness income for purposes of taxing a nonresident shareholder.

(g) For taxable years beginning on or after January 1, 2013, all business income is subject to the single sales factor apportionment formula pursuant to Section 25128.7, Revenue and Taxation Code, unless subdivision (b) of Section 25128, Revenue and Taxation Code, applies. If a sole proprietorship or partnership described in subsections (c) or (d) is engaged in the practice of a profession within the meaning of subsection (h), below, the payroll factor, where applicable, of the applicable apportionment formula shall include 60% of the net income of a sole proprietorship or 60% of the distributive share of partnership income of each partner rendering professional personal services to the partnership. For purposes of the payroll factor the net income of a sole proprietorship and a partner's distributive share of partnership income shall consist only of income properly classifiable as business income. The amount so determined is deemed to be compensation paid to an employee for purposes of the payroll factor only. If a partner does not render professional services to the partnership, no part of such partner's distributive share of partnership income shall be taken into account in the payroll factor. The amount deemed to be compensation paid to an employee shall be included in the denominator of the payroll factor and in the California numerator of the payroll factor if the principal location of such partner is in this state.

Guaranteed payments to a partner who renders professional services to a partnership engaged in the practice of a profession (within the meaning of subsection (h) below) shall be treated as part of the partner's distributive share of partnership income and has a source in this state in the same manner as a distributive share properly classified as business income and shall be apportioned under subsection (d), as modified under subsection (g). In computing the payroll factor of a partner who renders professional services to such a partnership and receives a guaranteed payment, 60 percent of the sum of the partner's distributive share of partnership income properly classified as business income, and the partner's guaranteed payment, shall be deemed to be compensation paid to an employee. The amount deemed to be compensation shall be included in the denominator of the payroll factor and in the California numerator of the payroll factor if the principal location of such partner is in this state.

EXAMPLE: The A-B-C company is a partnership performing accounting services within and without this state. There are three partners, A, B, and C. Partners A and B render professional services to the partnership. Partner C is not active in the partnership business. Partner A is a resident of this state, and Partners B and C are nonresidents. For purposes of this example, each partner's principal location is in his or her respective state of residence. The partners' distributive shares of profit or loss are: A, 50%; B, 30%; and C, 20%. In addition, Partner B receives a guaranteed payment of $10,000. Partnership profits after the deduction for the guaranteed payment are $60,000 for the year. Of that amount, $50,000 is business income and $10,000 is nonbusiness income from a California real estate rental. All of the nonbusiness income is sourced to this state for purposes of this example. The partnership's income apportionment percentage for this state is determined as follows:

		Everywhere	This State	%
Property		$200,000	$70,000	35
Sales		150,000	64,500	43
Sales		150,000	64,500	43
Payroll:
	Employees	56,000	21,000
	Partners:
	A--$50,000 x 50% x 60%	15,000	15,000
	B--[($50,000 x 30%) + $10,000] X 60%	$15,000	-0-
	Total Payroll	$86,000	$36,000	41.86
				162.86
Apportionment percentage (162.86 / 4)				40.72%

The partnership's business income from sources within this state is:

Business income ($50,000 x 40.72%)

$20,360

Partner A

As a resident, Partner A is taxed on that partner's entire distributive share of ABC's income, irrespective of the source of the income:

A's share of partnership business income ($50,000) x 50%		$25,000
A's share of partnership nonbusiness rental income ($10,000 x 50%)	-	$ 5,000
A's income taxed by this state		$30,000

As nonresidents, Partners B and C are taxed on their distributive share of partnership income from sources within this state, determined as follows:

Partner B

Partner B's share of Partnership business income from sources within this state ($20,360 x 30%)	$6,108
Partner B's guaranteed payment $10,000 x 40.72%	$4,072
Partner B's share of nonbusiness rental income ($10,000 x 30%)	$3,000
Partner B's Income from sources within this state	$13,180

Partner C

Partner C's share of Partnership business income from sources within this state ($20,360 x 20%)	$4,072
Partner C's share of nonbusiness rental income ($10,000 x 20%)	$2,000
Partner C's Income from sources in this state	$6,072

(h) The practice of law, accounting, medicine or the performance of personal services in scientific and engineering discipline and the practice of any other profession in which capital is not a material income producing factor and in which more than 80% of business gross income for the taxable year is derived from personal services actually rendered by the individual or partners shall be deemed a profession for purposes of subsection (g), above.

(i) Rules and Definitions. To give effect to the foregoing, the following rules and definitions will be applied:

(1) Other Professions Defined. For purposes of this regulation, the term "other profession" includes any occupation or vocation in which a professed knowledge of some department of science or learning, gained by a prolonged course of specialized instruction and study, is used by its practical application to the affairs of others, either advising, guiding or teaching them, and in serving their interests or welfare in the practice of an art or science founded on it. The word "profession" implies attainments in professional knowledge as distinguished from mere skill and the application of knowledge to uses for others as a vocation. The performing of services dealing with the conduct of business itself, including the promotion of sales or services of such business and consulting services, does not constitute the practice of a profession even though the services involve the application of a specialized knowledge.

(2) Capital as a Material Income Producing Factor. Whether capital is a material income producing factor in the production of the income of a profession (other than law, medicine, dentistry or architecture) is to be determined by the use to which the capital is put. Ordinarily, the use of capital in a professional activity or occupation will not be considered as a material income producing factor if it is used only to defray current operating expenses such as paying salaries of assistants, rent, traveling and other incidental expenses or for investment in furniture, machines, tools and equipment essential to the carrying on of the professional activity. Capital is a material income producing factor if a substantial portion of the gross income from the occupation is attributable to the employment of capital in the business. This is ordinarily the case where substantial inventory or substantial investment in plant, machinery or other equipment is required.

(3) Gross Income Derived From Personal Services of an Individual or Partner. For purposes of determining whether more than 80% of the unincorporated business gross income is derived from personal services actually rendered by an individual or partner, gross income from the professional practice will be deemed derived from the personal services rendered by an individual or partner if such income is personal service income as distinguished from income attributable to the sale of property or to the use of capital and such income represents fees or charges for professional services personally rendered by the individual or partner or professional fees or charges for services which are attributable to the professional activities of the individual or partner. In cases where an individual or partner employs assistants to perform part of the professional work, fees or charges relating to the services of he assistants will be attributed to the individual or partner provided the individual or partner (A) gives personal attention to the work of the business, (B) consults with clients or patients, (C) devises the work program, outlines work methods and guides and directs the work procedure of the employees in the activity, and (D) supervises the formulation of advice, conclusions and reports to clients or patients as the person responsible for the services performed by the business or establishment; or provided that some combination of the foregoing and/or other activities shows that the services of the employees are merely incidental to the practice of the profession by the individual or partner. Where the profession is carried on by a sole proprietorship or partnership, income or fees relating to work performed by employees will be attributable to an individual or partner only if, in addition to the conditions enumerated above with respect to individuals or partners, it is shown that the clients or patients are advised by an individual or partner and look to an individual or partner as being responsible for the services performed.

For example, where an accounting partnership employs assistants to do much of the detail work of making surveys, studies, audits, or other work ordinarily and customarily performed as an incident to the practice of the profession involved, income from professional charges based on services of the assistants will be deemed to be income derived from the services of the partners if a partner accepts the engagement or employment, supervises and directs the work, confers with clients, and prepares and edits or completes and approves the reports. Where the nature and character of the service rendered by the assistants is such that the services are rendered without any substantial control by a partner, such services will not be considered attributable to the partner for the purposes of this subsection.

(j) This regulation shall apply to taxable years beginning on or after January 1, 1976, except that the amendments to subsections (c)(3), (d)(4), (e) and (f), to the extent that these subsections adopt the sourcing rules of Sections 17951 through 17955, Revenue and Taxation Code, and the regulations thereunder, and not the nonbusiness allocation rules of the Uniform Division of Income for Tax Purposes Act, Sections 25120 to 25139, inclusive, Revenue and Taxation Code, and the regulations thereunder, shall apply to the computation of taxes for taxable years of sole proprietors, partners, members and shareholders beginning on or after January 1, 2001, and the amendments to subsections (d)(5), (d)(6), (e) and (f), to the extent that the business activity of a partnership, limited liability company or S corporation will not ordinarily be considered part of a unitary business activity with another business activity unless the partner, member or shareholder owns directly or indirectly a 20 percent or more capital or profits interest in a partnership, limited liability company or S corporation, or the Franchise Tax Board determines that such combination is appropriate after conducting a comparable uncontrolled price examination, shall apply to the computation of taxes for taxable years of sole proprietors, partners, members and shareholders beginning on or after January 1, 2001. In the case of the computation of additions to tax under Section 18682, Revenue and Taxation Code, for failure to pay estimated tax, and the assessment of withholding liability and penalties under Sections 18815, 18684.2, 18685, and 19409, Revenue and Taxation Code, the amendments to subsections (c)(3), (d)(4), (d)(5), (d)(6), (e) and (f) which apply to taxable years beginning on or after January 1, 2001, shall also apply for taxable years of sole proprietors, partners, members and shareholders beginning on or after January 1, 2001. The remaining amendments to subsection (d) are applicable only as of the effective date of the amendments to this subsection of the regulation.

__________

^*** This regulation is substantially the same as Title 18, Cal. Adm. Code, Chapter 3, Subchapter 2, Section 17211-14(c).

Cal. Code Regs. Tit. 18, §§ 17951-4

1. Repealer and new section filed 7-9-76; effective thirtieth day thereafter (Register 76, No. 28).
2. Renumbering and amendment of sections 17951-17954(d) to section 17951-4 filed 1-15-82; effective thirtieth day thereafter (Register 82, No. 3).
3. Amendment of subsections (c), (d) and (i) and NOTE filed 3-18-94; operative 4-18-94 (Register 94, No. 11).
4. Amendment filed 12-24-2001; operative 1-23-2002 (Register 2001, No. 52).
5. Change without regulatory effect amending subsections (d)(5)(A) and (g) filed 12-9-2013 pursuant to section 100, title 1, California Code of Regulations (Register 2013, No. 50).
6. Amendment of subsection (d)(1), new subsection (d)(2), subsection renumbering and amendment of newly designated subsections (d)(5)-(d)(6)(B) and (d)(6)(B)4. and subsections (f) and (j) filed 11-20-2018; operative 1-1-2019 (Register 2018, No. 47).

Note: Authority cited: Sections 17954 and 19503, Revenue and Taxation Code. Reference: Sections 17041, 17854, 17951 and 25128, Revenue and Taxation Code.

1. Repealer and new section filed 7-9-76; effective thirtieth day thereafter (Register 76, No. 28).
2. Renumbering and amendment of sections 17951-17954(d) to section 17951-4 filed 1-15-82; effective thirtieth day thereafter (Register 82, No. 3).
3. Amendment of subsections (c), (d) and (i) and Note filed 3-18-94; operative 4-18-94 (Register 94, No. 11).
4. Amendment filed 12-24-2001; operative 1-23-2002 (Register 2001, No. 52).
5. Change without regulatory effect amending subsections (d)(5)(A) and (g) filed 12-9-2013 pursuant to section 100, title 1, California Code of Regulations (Register 2013, No. 50).
6. Amendment of subsection (d)(1), new subsection (d)(2), subsection renumbering and amendment of newly designated subsections (d)(5)-(d)(6)(B) and (d)(6)(B)4. and subsections (f) and (j) filed 11-20-2018; operative 1/1/2019 (Register 2018, No. 47).