California income tax on non-resident sole proprietorship independent contractors?

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AmericanCanadian
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Joined: Mon Apr 17, 2017 10:41 am

California income tax on non-resident sole proprietorship independent contractors?

Postby AmericanCanadian » Mon Apr 17, 2017 11:15 am

I have been searching and reading the historical posts in this forum for days now without being able to locate the answer for this particular situation... So I'm hoping this will provide an interesting discussion and yield some answers!

In point form:

  • I am a US citizen (ex-Nevada resident), who moved to Canada in February 2016 after being sponsored by my Canadian citizen spouse for permanent residency.
  • I am a self-employed writer operating as a sole-proprietorship for several years now (doing business under own legal name -- so not actually 'registered').
  • Since I've immigrated to Canada, I am fully-taxed on worldwide income at both the Federal and Provincial (i.e comparable to State) level there since February 2016.
  • Over the last several years I've had clients in many different states, but for all of 2016 I worked nearly exclusively on a large contract I received from a company in California. To make the math easy, let's say I received $45k from the California client (reported on 1099-MISC), and $5k from clients elsewhere in the US and Canada.
  • For the most part, I work remotely from my home in Canada except for business trips throughout the year to California.

The US federal income tax situation is quite straightforward and covered in depth by the Foreign Earned Income Exclusion, Foreign Tax Credits, the US-Canada Tax Treaty, US-Canada Social Security Totalization Agreement, etc. (despite the need to pro-rate the proportion of time I was in the US before moving to Canada and after) -- it's the California Income Tax situation that appears to be a doozie.

So, how exactly does California tax non-resident sole proprietor independent contractors?

There is an example on the FTB website (https://www.ftb.ca.gov/businesses/Sales_Factor.shtml) that is quite disconcerting:

Jill, a nonresident of California, owns a web design business that she holds as a sole proprietorship. She works from her home out of state but has customers in various states including California. For the 2013 taxable year, Jill's sales receipts from California customers are $300,000 out of the total sales receipts everywhere of $1,000,000. Does Jill have a filing requirement in California?

Yes, nonresident individuals are taxed on all California source income. Jill's sole proprietorship is carrying on a business in and out of California and will be required to apportion its income to California using UDITPA rules. Under market assignment, sales of services are assigned to California if the purchaser of the service received the benefit of the service in California. Accordingly, $300,000 will be assigned to the California sales factor numerator for Jill's sole proprietorship and Jill would apportion 30% ($300,000 CA sales/$1,000,000 total sales) of its business income from her sole proprietorship to California.


If I were to apply this example at face value -- it would mean that I would be fully taxed on the entire $45k of income I received from the single California purchaser of my services. I would have thought that I'd be paying tax on some pro-rated amount of days I've spent in California during business trips.

Am I reading this correctly?

Of course, I am fully-taxed on my worldwide income in Canada, as Canada considers the "source" of income to be where the work is being done (that seems to be the "standard" definition). But, California seems to consider the "source" of income as where the purchaser receives the benefit. In my case, these two definitions are completely contradictory. So, Canada (and the province where I live) wants to fully tax me, and so does California. (Funnily enough I owe very little at the US Federal level due to all the tax breaks for expats.) And ugly enough, I cannot seem to deduct the Income Tax I'd pay to California as a Foreign Tax Credit on the Canadian side, because Foreign Tax Credits are only valid for foreign-sourced income, and Canada considers this income to be domestic-sourced due to their definition that the source is where the work is performed!

This appears to lead to a double taxation situation.

The ideal situation is if I were to pay California income tax on the prorated number of days I actually physically spend in California, but is this even possible?

And before you ask -- Yes, I've actually spoken to many CPAs about this, and none of them know how to deal with this situation despite claiming to be "Cross-Border Tax Experts". Out of 10 I've called, none have heard of this kind of situation (more than one calling it "uncharted territory"), which is shocking to me -- so I did not sign up to be their client. If anybody has a recommendation for a Cross-Border CPA who understands California Income Tax situation as it relates to Canadian residents, I'm all ears!

Obviously tax returns are due tomorrow April 18th, I'll probably have to file an extension to work all this out...

Thanks in advance for any insights!

AmericanCanadian
Posts: 4
Joined: Mon Apr 17, 2017 10:41 am

Re: California income tax on non-resident sole proprietorship independent contractors?

Postby AmericanCanadian » Tue Apr 18, 2017 1:06 pm

Bumping this... Hoping someone has an idea about this.

random_walker_77
Posts: 377
Joined: Tue May 21, 2013 8:49 pm

Re: California income tax on non-resident sole proprietorship independent contractors?

Postby random_walker_77 » Tue Apr 18, 2017 4:12 pm

Ouch. That sounds bad. This article seems on topic but doesn't sound good.

https://www.amexpattax.com/news/allevia ... ate-level/

DrCheese
Posts: 1
Joined: Wed Apr 19, 2017 2:20 pm

Re: California income tax on non-resident sole proprietorship independent contractors?

Postby DrCheese » Wed Apr 19, 2017 2:35 pm

I believe you are misreading the California example with Jill. Please note that I have no experience with Canada/California tax. However, I live in NJ and work in NY and believe the California tax is the same way I have to figure out my NY tax.

First of all, it has nothing to do with how many days you work physically in California. It is how much money you made from California sources.

On the NY state nonresident form, there are two columns, one for all income earned and one for all income earned from a NY source. Then you figure out how much tax you owe on all income earned. Then you figure out the ratio of (all NY income / all income). Then you multiple the tax on all income by the ratio.

This makes your tax be spread out evenly in all tax brackets. If you just figure out the NY tax on NY income, you might not hit the higher tax brackets.

This is why the Jill examples says "Accordingly, $300,000 will be assigned to the California sales factor numerator.

AmericanCanadian
Posts: 4
Joined: Mon Apr 17, 2017 10:41 am

Re: California income tax on non-resident sole proprietorship independent contractors?

Postby AmericanCanadian » Thu Apr 20, 2017 10:21 am

DrCheese wrote:On the NY state nonresident form, there are two columns, one for all income earned and one for all income earned from a NY source. Then you figure out how much tax you owe on all income earned. Then you figure out the ratio of (all NY income / all income). Then you multiple the tax on all income by the ratio.


That's it right there (where I have highlighted in bold). The ratio of (all CA income / all income) is in my case 90%. (45k from 'California sources' = numerator, 50k total income = denominator), so it's punishingly high.

At issue is the definition of "California source". As I said before:

Canada considers the "source" of income to be where the work is being done


And so Canada wants to take the whole amount,

But, California seems to consider the "source" of income as where the purchaser receives the benefit.


And so does California!

I'm not sure we have any disagreement DrCheese. Your description of the calculation method appears to be correct. At issue is what to put as the numerator! California happens to define 'source' in a different way than tax treaties define it, but I have since learned that California doesn't respect tax treaties!

random_walker_77
Posts: 377
Joined: Tue May 21, 2013 8:49 pm

Re: California income tax on non-resident sole proprietorship independent contractors?

Postby random_walker_77 » Fri Apr 21, 2017 9:29 pm

This thread also says you owe CA taxes. Instead of CA taxes on top of US federal taxes, think of it as CA taxes on top of canadian taxes. That's California for you... On the other hand, for the amounts you're talking about, you're probably in a 4% bracket and averaging closer to 3% in taxes on your CA income, right? Consider it the privilege for taking on a big CA client... :(

"By statute CA does not provide a foreign tax credit. This may seem unfair from your thinking above, but you're approaching the issue backwards. You're effectively asking for a dollar for dollar credit twice on taxes you paid once.
joemesser82 2 years ago"

https://ttlc.intuit.com/questions/28026 ... ble-taxing

http://www.r2iclubforums.com/forums/sho ... California)


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