California Nexus Tax Audit

Nexus Audits in California: A Legal Guide for Businesses and Individuals
California’s aggressive tax enforcement and evolving nexus standards make it a focal point for businesses and individuals facing tax audits. The concept of “nexus” determines whether a taxpayer has sufficient connection to California to be subject to its tax obligations, including income, franchise, and sales and use taxes. Our tax lawyers have represented numerous taxpayers with California nexus tax audits. Legal basis, audit triggers, and defense strategies for California Nexus Tax Audit are becoming more common as remote workers and on-line sales proliferate throughout our country.

What is California Nexus Tax Audit?
Nexus, in tax law, refers to the minimum level of connection between a taxpayer (business or individual) and a state that allows the state to impose tax obligations. In California, nexus can trigger liability for:
Corporate Income and Franchise Taxes: Administered by the California Franchise Tax Board (FTB).
Sales and Use Taxes: Overseen by the California Department of Tax and Fee Administration (CDTFA).
Personal Income Taxes: Applicable to individuals with California-sourced income.
The significance of nexus has grown since the U.S. Supreme Court’s 2018 decision in South Dakota v. Wayfair, Inc. (138 S. Ct. 2080), which eliminated the physical presence requirement for sales tax nexus, allowing states like California to impose tax based on economic activity.

Tax Audit for Nexus in California
California’s nexus rules are grounded in federal and state law, shaped by constitutional principles and statutory frameworks. Below is an overview of the legal foundations:
1. Constitutional Limits
The U.S. Constitution imposes constraints on state taxation under the Due Process Clause and Commerce Clause:
Due Process Clause: Requires a taxpayer to have “minimum contacts” with the state and to purposefully direct activities toward its market. Felt & Tarrant Mfg. Co. v. Gallagher (306 U.S. 62, 1939) established that a California can tax entities with sufficient connection to the state.

Commerce Clause: Prohibits states from unduly burdening interstate commerce. Quill Corp. v. North Dakota (504 U.S. 298, 1992) historically required physical presence for sales tax nexus to California, but Wayfair overturned this position by using economic nexus as a new framework to tax in state.

2. California Statutory Framework
California has expanded its nexus definitions to maximize revenue, particularly after Wayfair. Key statutes include:
Cal. Rev. & Tax. Code § 23101: Defines “doing business” in California for corporate tax purposes. Since 2011, this includes economic nexus thresholds, such as:
Sales exceeding the lesser of $500,000 or 25% of total sales.
Property in California exceeding the lesser of $50,000 or 25% of total property.
Compensation paid in California exceeding the lesser of $50,000 or 25% of total compensation.
Cal. Rev. & Tax. Code § 6203: CDTFA sales and use tax nexus forces any business “engaged in business with California” to collect sales tax.
Economic Nexus for Sales Tax: Effective April 1, 2019, out-of-state businesses must register for a sales tax permit if they exceed $500,000 in California sales in the current or previous calendar year, regardless of physical presence.

3. Case Law and Precedents
Wayfair (2018): Upheld economic nexus, allowing states to tax remote sellers based on sales volume or transaction thresholds.
Amazon.com and Overstock.com (New York, 2013): New York’s highest court upheld “click-through nexus,” where in-state referrals via internet links create nexus. California CDTA applies similar tax nexus.

Types of Nexus in California
Nexus can arise from various activities, categorized as follows:
Physical Nexus:
Maintaining offices, warehouses, or employees in California.
Attending trade shows or delivering goods via non common carriers.
Economic Nexus:
Over $500,000 in California sales for sales tax (post-April 2019).
Meeting certain income tax thresholds (e.g., $500,000 in sales or 25% of total sales).
Affiliate Nexus:
Relationships with California Businesses (e.g., referral programs or shared corporate groups) that facilitate sales.
Click-Through Nexus:
Agreements with California residents providing customers via online links, triggering California sales tax obligations.
Individuals
Nonresident Attorneys: Admitted pro hac vice or sourcing income from California clients.
High Net-Worth Individuals: Relocating from California but maintaining ties. Athletes and entertainers.
Remote Workers: Employees working remotely in California for out-of-state employers, creating nexus for the employer.

California FTB or CDTFA Tax Assessment and Tax Appeals:
The FTB may issue a Notice of Proposed Assessment, which taxpayers can appeal to the Office of Tax Appeals.
CDTFA sales tax audits may lead to redeterminations or seller’s permit revocation.

Contact a Tax Attorney in California
Nexus tax audits in California pose significant risks for businesses and individuals due to the state’s expansive nexus rules and aggressive enforcement. Understanding the legal basis—rooted in constitutional principles, statutes, and case law—is critical to mounting an effective defense. By engaging experienced tax attorney, conducting nexus studies, maintaining robust documentation, and tax appeals, taxpayers can mitigate tax liabilities.

For businesses or individuals facing a California nexus tax audit, contact us to review your nexus status and protect your rights and minimize tax exposure. Tel: (310) 788 9820