Now that Proposition 39 has Been Approved, What Does this Mean for Multistate Businesses?

Our first post-election blog post is brought to us courtesy of  my friends at HMWC CPAs & Business Advisors.  The question that I asked them to address in this blog is Prop 39’s impact on mutlistate businesses. The summary is below which I commend to our readers.

The amount of money a business owes the state in corporate income taxes each year is based on the business’ taxable income. For a business that operates both in and outside of California (a multistate business), the state only taxes the amount of its income that is associated with California. While only a small portion of corporations are multistate in nature, multistate corporations pay the vast majority of the state’s corporate income taxes. This tax is the state’s third largest General Fund revenue source, raising $9.6 billion in 2010–11.

Prior to the approval of Proposition 39, state law allowed most multistate businesses to pick one of two methods to determine the amount of their income associated with California and taxable by the state:

  • “Three-Factor Method” of Determining Taxable Income.  When using this method, the more sales, property, or employees the multistate business has in California, the more of the business’ income is subject to state tax.
  • “Single Sales Factor Method” of Determining Taxable Income.  When using this method, the more sales the multistate business has in California, the more of the business’ income is taxed. (For example, if one-fourth of a company’s product was sold in California and the remainder in other states, one-fourth of the company’s total profits would be subject to California taxation.)

Any multistate business using the three factor formula could effectively reduce its California income by relocating its physical operations to another state.  By doing this, the overall California factor would be diluted with two thirds of the formula representing payroll and property showing zero.

Supporters of Proposition 39 argued that it will close a tax “loophole” that rewarded out-of-state companies for taking jobs out of California.   

Opponents argued that Proposition 39 is a tax increase. 

With the passage of Proposition 39, this debate is moot. Starting in 2013, most multistate businesses will have to determine their California taxable income using the single sales factor method. Depending on the facts and circumstances of a multistate business, this could result in higher taxes being paid to California.  However, it could also discourage current California companies from moving their operations out of California or perhaps encourage out of state business to relocate operations into California since the payroll and property factors are no longer part of the tax formula. 

Businesses that operate only in California would be unaffected by this measure.

Similar laws have been passed in New Jersey, Illinois, and Texas.

This measure also includes rules regarding how all multistate businesses calculate the portion of some sales that are allocated to California for state tax purposes. These include a set of specific rules for certain large cable companies.

In addition, this measure establishes a new state fund, the Clean Energy Job Creation Fund, to support projects intended to improve energy efficiency and expand the use of alternative energy. The measure states that the fund could be used to support: (1) energy efficiency retrofits and alternative energy projects in public schools, colleges, universities, and other public facilities; (2) financial and technical assistance for energy retrofits; and (3) job training and workforce development programs related to energy efficiency and alternative energy.

The Clean Energy Job Creation Fund would be supported by some of the new revenue raised by moving to a mandatory single sales factor. Specifically, half of the revenues raised—up to a maximum of $550 million—would be transferred annually to the Clean Energy Job Creation Fund. These transfers would occur for only five fiscal years—2013–14 through 2017–18.

Curtis Campbell is partner-in-charge of the Tax Services department at HMWC CPAs & Business Advisors.  The department’s services are extensive, including: short and long-term business and individual tax planning; planning and structuring for business/personal transactions; consulting for mergers and acquisitions; consulting for reorganizations; assistance with tax-free exchanges of property; California and multi-state tax planning; and representation before the IRS and Franchise Tax Board.

Joel Jorrisch is a senior tax manager in HMWC CPAs & Business Advisors Tax Services department with over twenty years of experience in public accounting and private real estate companies.  He provides tax preparation, planning and projection services for corporations, partnerships and individuals.

Author: Kent Schmidt

As a Partner in the Southern California office, Kent practices in virtually all types of general business litigation, with an emphasis in unfair business practices, First Amendment litigation, defamation, trade secret litigation, class actions, product liability, securities litigation and enforcement, commercial disputes, employment law, intellectual property and Prop 65 (environmental) claims. He is an aggressive and creative courtroom advocate, representing both plaintiffs and defendants. Having spent his entire legal career at Dorsey, Kent is adept at finding the right lawyers in the firm to collaborate with in order to provide the best representation for his clients.