California, often associated with business innovation, has been working on some new ways, whether they mean to or not, to financially hurt small businesses. One--a new law called AB 5--was intended to address the gig economy.

Just as the dust settles, dampened by the tears of many who see themselves as potentially hurt by the law, there's an even bigger problem on the horizon. California says it has the right to tax income from the state, even if an individual or company hasn't stepped foot there and did the work in another state.

AB 5 was bad enough. The intent seemed reasonable on the surface. Companies like Uber and Lyft and all the other on-demand workforce platforms have overstepped boundaries. These often-big companies call their workers independent contractors even as the platform businesses control pricing and customer relations. How can you really be in business for yourself if someone else sets all the rules?

But in their zeal, lawmakers went too far and decided that many formerly independent workers should be traditional employees. For freelance journalists, as an example, that easily appeared to clear the top of outrageous when the law set a limit on the number of times a person could work for a publisher in a year without having to be an employee. Although, according to Veena Dubal, an associate professor of law at the University of California Hastings, there's a lot of misinformation and many freelancers who assume that they're covered under the restrictions of 35 pieces per year for a client aren't if their work is considered sufficiently "creative." (That doesn't apply to straight reporting on facts.)

Not that the misinformation will matter if companies assume the world and limit the assignments to people they work with as a safety precaution.

But if AB 5 is a call too close for some and a measure that will push others into becoming employees who will lose important tax deductions (and likely not get enough hours of work to qualify for healthcare coverage), the next action the state has taken will be a potential nightmare.

As Forbes.com contributor Robert Wood wrote (disclosure: I also write there), California has taken to assessing taxes on people outside the state. As in people who do business with California clients but who don't work or live in the state.

The matter is Blair S. Bindley, OTA Case No. 18032402 (May 30, 2019). Bindley is a screenwriter who received, according to the California Office of Tax Appeals (OTA) record, $40,000 for writing two screenplays for two different companies. The Franchise Tax Board (FTB)--the state's tax revenue collector--was able to match the income to the Arizona-based Blair and demand he file a California return for that year or explain why he needn't.

Blair replied that he undertook all the work in Arizona, so didn't have income from California. The FTB disagreed and said that being paid by California companies constituted income from the state. As the OTA noted, "California imposes a tax on the entire taxable income of a nonresident, such as appellant, to the extent it is derived from sources within this state." Also, "'Taxable income of a nonresident' is broadly defined as 'gross income and deductions derived from sources within this state.'"

There are some other qualifications as well. Taxes vary depending on how the business is done (in-state, out-of-state, or both), the type of business entity (sole proprietorship, partnership, or S-corp), and whether the business in unitary (where business inside and outside of California are not distinctly separate). The bottom-line: Bindley will have to pay.

In other words, if you provide goods or services to a person or company in California, from the state's view, you have income from there and have to file a state tax return. Oh, and pay it.

And an even worse thought: What happens when other states decide to do the same? Tax filings could get far worse than today.

Published on: Oct 25, 2019
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