California State and Local Tax Update—Fourth Quarter 2023

California’s fourth quarter, just like the rest of the year, was busy with state and local tax updates and legislation. As an election year approaches, it will be interesting to see how the 2023 SALT updates start taking shape in 2024, as well as what will come into place as California tries to lower its $38 billion deficit.

Single Sales Factor Apportionment

On Oct. 23, 2023, the California Court of Appeals confirmed Proposition 39, which voters approved through a ballot initiative and enacted in 2012.

Proposition 39 required the use of single sales factor apportionment for taxpayers and eliminated the use of the previously established three-factor apportionment formula. The court determined that Proposition 39, which removed the option to apportion income, was valid and would be moving forward.

Previously in California, multistate businesses had two options available to them when calculating taxes. The first option used three factors: property, payroll, and sales. The second option focused solely on sales.

The three-factor method considered sales based on income-producing activities, while the single sales factor method used market-based activities. These two options were comparable to various other states’ apportionment methods for computing tax.

Proposition 39 was proposed in the hopes of boosting tax revenue by making the single sales factor method mandatory versus offering options. However, many companies pushed back, claiming it violated the California Constitution single subject rule.

The court ruled that the proposition’s components were constitutionally reasonably connected and functionally related to its proposed purpose. Further, the court clarified that Proposition 39 is constitutionally valid, requiring the use of single sales factor apportionment for taxpayers going forward.

Alternative Apportionment Procedures

Effective Nov. 3, the California regulation for requesting alternative apportionment methods has been amended to provide more formal and defined procedures for filing petitions. The amendments add rules, conditions, and deadlines for filing petitions with the California Franchise Tax Board. They also clarify the briefing process and specify the procedures related to hearings on the petitions, as well as address the application of the ex parte communication rule.

The regulation states that if appropriate, it may elect to hear and decide alternative apportionment options. Further, the regulation provides extensive procedural rules for petitions that are publicly heard by the three-member FTB board.

Taxpayers are directed to file their petitions with the FTB’s chief counsel explaining why their requested alternative apportionment methodology is appropriate or why the alternative apportionment imposed by the FTB staff is no longer appropriate. The regulation also provides deadlines for filing the petitions as well as instructions for filing and drafting briefs.

Once the briefing session is complete, the FTB may schedule a hearing during an open session at a regularly scheduled meeting to consider the taxpayer’s petition. The regulation includes procedures for conducting the hearing.

As always, we highly suggest that taxpayers seeking the use of an alternative apportionment methodology in California should review these new detailed procedures or consult with a tax professional who can adequately guide them through this new process.

Affordable Housing Tax Credits

California State Treasurer Fiona Ma on Dec. 8 announced that $1.9 billion in federal and state low-income housing tax credits would be allocated to 66 various projects, and nearly $2.17 billion would be allocated toward tax-exempt bond financing for the development and rehabilitation of affordable housing projects throughout the state of California.

The projects will create roughly 7,345 housing units for low-income renters, including 451 for individuals who are currently experiencing homelessness. The hope is that with this funding and program, California will be able to lower housing costs for one of the nation’s most expensive rental markets.

Public Law 86-272

On Dec. 13, a California court found Technical Advice Memorandum 2022-01 and Franchise Tax Board Publication 1050 invalid.

Technical Advice Memorandum 2022-01 for California outlined specific internet-based actions. These include activities such as placing cookies on customer computers and offering post-sale assistance via chat, email, or follow-up contact. According to the memorandum, these actions go beyond the protections provided by Public Law 86-272, which restricts states from imposing income taxes, including corporate or franchise tax, under certain conditions.

Franchise Tax Board Publication 1050 provided guidance on the interpretation of tax protections under Public Law 86-272 for internet-based activities. The federal law currently limits the state’s ability to impose income taxes on certain out-of-state businesses if their online activities are limited within the state.

Publication 1050 explained how the Franchise Tax Board views the operations of these tax protections, in relation to the guidance issued by the Multistate Tax Commission in August 2021.

The court decreed that Publication 1050 was invalid on only on procedural grounds, as it was deemed to have the characteristics of a regulation and should have followed the procedures outlined in the California Administrative Procedure Act, requiring notice and public comment.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Allison Soares is a tax attorney at Vanst Law who focuses on audits, collections, appeals, international disclosures, and all other tax problems.

Lauren Suarez is an attorney at RJS Law who has been practicing tax law for almost 10 years. She has a wide array of knowledge in federal and state tax controversy matters.

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