California Tax Law Changes – Impacting Individuals and Businesses
In the recent November elections, among other propositions, California voters passed Propositions 30 and 39, which have an immediate impact on the state’s income and sales taxes for both individuals and businesses.
Individual Income Tax Rate Increases:
Proposition 30, a measure to increase taxes and fend off nearly $6 billion in education cuts, increases personal income taxes for the next seven years on California individuals earning more than $250,000. New income tax brackets will be created and the income tax rate increases will be implemented retroactively, beginning January 1, 2012. Individuals earning more than $250,000 but less than $300,000 face a 1% marginal tax rate increase. Those making more than $300,000 but less than $500,000 will have a 2% marginal tax rate increase and those making more than $500,000 face a 3% increase in the California marginal income tax rate, which previously topped out at 9.3% for most taxpayers and 10.3% for those individuals making over $1,000,000 in annual California taxable income. This means that with the passage of Proposition 30, individuals in the top California income tax bracket can expect a California income tax rate of 13.3%.
Proposition 30 also increases California state-wide sales tax by 0.25% over current rates. The increase in sales tax will begin January 1, 2013 and last four years.
The temporary funds generated from Proposition 30 will primarily be allocated to K-12 schools and community colleges. The proposition was backed by California Governor Jerry Brown and passed with nearly 54% of California voters in favor of the proposition. The income tax increase is estimated to affect only the top 3% of California individual taxpayers.
Changes in Apportionment Methods and Revenue Sourcing for Businesses:
Proposition 39 is a measure that replaces an existing law which gave businesses the option of choosing either a single sales factor apportionment to calculate taxable income or the traditional three factor formula consisting of property, payroll and a double weighted sales factor. For taxable years beginning on or after January 1, 2013, businesses no longer have this option and most businesses will be required to use the single sales factor apportionment. Businesses in the agricultural, extractive, savings and loan, and banking and financial industries will continue to use a three factor formula (property, payroll, and single weighted sales) to apportion California taxable income.
With the passage of Proposition 39, California joins a growing number of states moving to the utilization of a single sales factor apportionment formula to calculate state taxable income. Proposition 39 passed with approximately 60% of California voters in favor of this change.
In addition to the use of the single-sales factor for apportionment, Proposition 39 also requires taxpayers to utilize “market based sourcing” for purposes of determining the amount of revenue apportioned to California. Under market based sourcing rules, revenue (other than for sales of tangible personal property), will be sourced to California if the purchaser or customer receives the benefit of the service in California. Market based sourcing is much different from the prior “cost of performance” methodology which focused on where the primary costs were incurred in performing the services. For service providers located outside of California the change to market based sourcing will likely create an increase in the amount of revenue apportioned to the state while California based companies may actually see a reduction in the amount of revenue reflected in their California apportionment factor. Each business should evaluate this change and the impact it may have on the amount of revenue reported in the California sales factor. The California regulations contain a series of tiered rules for determining where the customer receives the benefit of various types of revenue.
Supporters of Proposition 39 claim that this will close a tax loophole that previously rewarded out-of-state businesses for taking jobs out of California. The funds generated from Proposition 39 will be directed to fund public schools and create jobs in California, with a specific concentration toward jobs in the clean energy sector. Proposition 39 is estimated to generate approximately 40,000 new jobs and over $1 billion per year in revenue for the state.
To find out how these California tax law changes affect your personal income taxes or your business, please contact your Marcum Tax Advisor.