Recently a client contacted me wondering why his corporation had received a “Demand for Tax Return” notice from the Franchise Tax Board (“FTB”) since he has never filed in California and the corporation was incorporated in Nevada. During our conversation, he stated that “the whole purpose of setting up the corporation in Nevada was to be immune to California”. This is a huge misconception that business owners need to understand or they will have very costly consequences like my client. This particular business is a service-based business in California, and it pays wages in California; therefore, it would be impossible to “avoid” filing a tax return and paying taxes in California on the income earned for services performed in California.
The State of California and its tax arm, the FTB, have become very aggressive in finding ways to garner additional revenue. The different state agencies share digital information and in my client’s case, the corporation paid wages in California, therefore, the FTB received information from the Employment Development Department that this particular corporation had paid employer withholding taxes in California. The FTB then applied a formula to calculate estimated income based on the average income reported by businesses in the same industry as this corporation. In my client’s case, the FTB is accessing $6,700 in delinquent and demand penalties alone in addition to the actual corporate income tax. This is a hefty penalty that the client will be unable to avoid and will put a big financial strain on his new business.
Most companies that do business in California, even if incorporated in a different state, will have to register and file a tax return in California. If the company does business in other states in addition to California, the business will have to apportion its income by allocating part of it to California. The rules are complex and special rules may apply to businesses that normally do not do business in California, but are considered as a foreign corporation for California purposes.
As a business owner, you should always consult with your CPA so they can advise of your filing requirements In California and any other states.
If an attorney or other consultant advises you to incorporate in a different state to avoid taxes in California, you may want to find a new attorney and contact us at LSL CPAs and Business Advisors!
