Dear Tax Constituent:
The following is a summary of some of the major developments with tax implications specifically for California businesses:
WAYFAIR
In July, 2018, the U.S. Supreme Court decided one of the biggest tax cases in decades, which dramatically expands when states can require out-of-state businesses selling to customers in their state to collect and remit sales and use taxes. This change has a huge impact on anyone selling goods, particularly through the internet.
Prior to the U.S. Supreme Court’s decision in Wayfair, Inc. v. South Dakota, a state could only require a business to collect sales or use taxes from customers if the business had some type of physical presence in the state, usually by owning, leasing, or storing property in the state or having an employee or agent in the state.
Now states can require out-of-state sellers to collect and remit sales and use taxes if they make a minimum number of sales to customers in their state (in terms of dollars and/or transactions), even if they have no physical presence in the state. To complicate matters even more, each state and each local taxing jurisdiction may have different rules.
Most small retailers making only a few sales into a state should not be impacted because states are generally providing exceptions for businesses only making a minimum level of sales (e.g., less than $100,000 in annual gross revenues and/or less than 200 annual transactions). However, each state can set its own threshold.
California’s Thresholds
In late April 2019, California enacted AB 147 which provides some relief to small businesses. The bill:
Establishes an economic nexus sales threshold of $500,000, effective April 1, 2019. There is no transaction threshold, which means a seller can make an unlimited number of sales and not establish economic nexus as long as the total sales do not exceed $500,000;
Beginning April 25, 2019, requires both in-state and out-of-state retailers to collect district use taxes if the retailer has more than $500,000 of sales statewide;
Effective October 1, 2019, shifts the responsibility for collecting sales and use and district taxes to marketplace facilitators for all sales made over the marketplace; and
Provides penalty relief for small, out-of-state retailers who make a good faith effort to comply with the new collection requirements.
An out-of-state retailer is considered "engaged in business in California," and therefore must collect California state and district use taxes, if its total sales of tangible personal property for delivery in California exceed $500,000 in the current or prior calendar year. An in-state retailer with less than $500,000 in sales must collect state tax but only district taxes where they have physical presence.
Threshold Period
Taxpayers must look to their sales for the current and prior calendar years to determine whether they have met the $500,000 threshold.
If a retailer met the threshold in the prior year, they must collect state and district taxes in the current year, even if their sales in the current year do not exceed $500,000.
If a retailer did not meet the threshold in the prior year, they must still monitor their sales in the current year. Once a retailer meets the over-$500,000 threshold for the current year, the retailer must collect for the remainder of that year and the following year. Thus, for 2020, if the retailer did not meet the $500,000 in 2019, the retailer is not required to collect tax until and unless the total sales to California customers exceed $500,000.
District tax collection requirements
Many California businesses selling goods outside their taxing district may be impacted.
Effective April 25, 2019, AB 147 and SB 92 require retailers that make over $500,000 of sales in the state to begin collecting and remitting all district use taxes for sales made to customers in any district in the state, even if the retailer does not:
Meet the threshold in the district in which the customer is located; or
Have physical presence in that district. (R&TC §7262)
California businesses selling outside of California
Whether a California business must collect other states' state and local use taxes on sales made to customers in those states is determined by those states' rules, not California's rules. Most states have adopted the Wayfair economic nexus threshold of $100,000 in sales or 200 transactions.
INDEPENDENT CONTRACTORS
In 2019, the Governor of California signed AB 5. Under AB 5, most workers are presumed to be employees for purposes of the Labor Code, the Unemployment Insurance Code, and for most wage orders of the Industrial Welfare Commission unless a hiring entity satisfies a three-factor test, referred to as the ABC test. This means that many workers previously classified as independent contractors may now be considered employees under California law and the hiring entity must withhold California income and payroll taxes, and meet California’s minimum wage and overtime requirements.
The ABC test
Under the ABC test, all three of these conditions must be met in order to treat the worker as an independent contractor:
A. The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact, commonly known as the Borello “control test” (S.G. Borello & Sons, Inc. v. Dept. of Ind. Rel. (1989) 48 Cal.3rd 342);
B. The worker performs work that is outside the usual course of the hiring entity’s business; and
C. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
The ABC test means, for example, that a hospital who hires nurses to work in specialized areas, such as an anesthesia nurse or neonatal nurse, may not treat the nurse as an independent contractor if those nurses are filling in for employee-nurses and don’t work for multiple hospitals. While physicians have their own specific exemption from AB 5, the same treatment would apply to other medical services, as well as consulting services, the entertainment industry, truck drivers and most notably, rideshare and delivery service workers.
Exemptions
While applying the ABC test to workers will result in many more workers being classified as employees, the legislation provides for numerous exemptions to the application of the ABC test. The exemptions are complicated, and very specific. However, the exemptions do not mean workers are automatically independent contractors.
If an exemption applies, you are still required to apply the traditional tests to determine if a worker is an employee or an independent contractor. Under these traditional tests, the “B” part of the ABC test will still be considered, but it is not a make-or-break factor.
Penalties could apply
Be aware that California law includes severe financial penalties for willfully treating an employee as an independent contractor.
The penalties, which are in addition to other assessments, penalties, or fines, are:
$5,000 to $15,000 for each violation (a single misclassified individual); and
$10,000 to $25,000 for each violation if the Labor Commissioner, or a court, determines there is a “pattern and practice” of these violations.
With the exception of an attorney or other employee of the business, these penalties also apply to your tax professional or any paid person who advises you to incorrectly treat a worker as an independent contractor. This means that you may be required to obtain a legal opinion if there is a question as to the classification of employees.
Important points
There are three important points to understand:
Forming or operating as a corporation or an LLC is not an effective work-around. The corporation or LLC will be ignored if the worker does not meet the ABC test, and the worker who owns the entity will still be an employee of the payor;
In many cases the worker may still be an independent contractor for federal purposes if the “A” and “C” test apply; and
The effective date of the law is January 1, 2020, but could be applied retroactively.
We can discuss further employee v. independent contractor considerations with you, but an attorney’s opinion would be necessary for a more definitive classification.
CALSAVERS
In June 2020 California will begin mandating employer participation in the CalSavers program for employers with more than 100 employees. Under the CalSavers program (previously named the California Secure Choice Retirement Program), private employers that don't already offer a retirement plan must enroll their employees in a CalSavers account , unless:
The employees opt out; or
The employer has less than five employees.
The CalSavers program is essentially a payroll deduction Roth IRA program. Employers will be required to register, and if employees don't opt out, contributions will be taken from their paychecks.
Participation is not mandatory until 2020. The program will be phased in over a three-year period. Employers with:
More than 100 employees must register by June 30, 2020;
More than 50 employees must register by June 30, 2021; and
More than 5 employees must register by June 30, 2022.
The CalSavers program will notify employers of their requirement to register in the program. Once registered, the employer must provide CalSavers enrollment information packets to employees who are age 18 or older during an annual enrollment period. For employees who do not opt out, the employer must collect, remit, and report contributions for each payroll period.
An employee's initial default contribution rate is 5% the first year the employee is enrolled, increasing by 1 % each year, up to 8%. Employees choose how their money is invested and have the option to:
Opt out at any time; or
Pay lower or higher contribution rates.
Employer liabilities
Employers who fail to comply with the program requirements will be subject to a $250 per- employee penalty after receiving a notice of noncompliance from the EDD. The penalty will be increased to $500 per employee if the employer does not comply within 180 days.
Litigation pending
A federal district court has ruled that CalSavers, California's state-mandated retirement program for private employees, does not violate ERISA. (Howard Jarvis Taxpayers Association v. The California Secure Choice Retirement Savings Program (March 28, 2019) U.S. Dist. Ct., East. Dist. of Calif., Case No. 2:18-cv-01584-MCE-KJN) However, the court allowed the Howard Jarvis Taxpayers Association to file an amended complaint, so the litigation is far from over. As a matter of fact, the United States Department of Justice filed a "Statement of Interest" in the U.S. district court agreeing with the Howard Jarvis Taxpayers Association in the case. It's anticipated that the court will rule on the amended complaint before the end of the year, but there is no definitive timeline.
If you would like more information on these topics or another tax topic of interest to you, please contact our office.
—McAvoy + Co, CPA