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One of our customers recently informed us of the following:

"In accordance with the California Franchise Tax Board, Publication 1017 and Revenue and Taxation Code Section 18662, we are required to withhold 7% from all payments made to non-California service providers for services rendered or rents paid.

We are not exempt (the only exemption is if you file a California Tax Return, which we do not).

California is probably the most aggressive state when it comes to out of state business and I'm not sure of the best course of action.

  1. Does this apply only to California government and state institutions?
  2. Are we legally allowed to charge a 7% surcharge to California businesses?
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This provision is to force you to comply with the California tax law. If you have California-sourced income, you must file California income taxes and register in California (and once you do - you become exempt from the withholding). – littleadv May 22 '12 at 23:14

2 Answers

up vote 2 down vote

You don't want an answer from users on this forum. Uncle Sam takes his income seriously. Taxes need accurate information. Call tax office of the state where you are located.

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You're probably right. I was looking for other people that have run into this same issue as it's kind of weird to me... – Michael Pryor Oct 21 '10 at 19:04
True, they may have other insight on how they handled this issue, but it always works best for my own piece of mind to pick the phone and talk to someone in IRS. – usabilitest Oct 21 '10 at 19:16
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For clarification, it's not an IRS issue. It's a california franchise tax board issue. – Michael Pryor Oct 21 '10 at 22:05
If you are in california, and your customer is in california you need to collect sales tax... its around 7% but varies by county, you need to break it down for California BOE by county. If you are in a different state (Nevada) and your customer is in california you need to collect a 7% use tax. But as you can see most retailers online dont. I think california has no way to enforce its collection. Please consult a local CPA – Frank Oct 22 '10 at 22:59
You're right, this is a franchise tax issue. IRS is the automatic term that came to mind in response to TAX question... Good catch. – usabilitest Oct 23 '10 at 17:19
up vote 1 down vote accepted

I found this info when looking at the official documentation:

Are there exceptions to withholding?

Yes. Withholding is not required if one of the following exceptions is met:

  • The individual, S corporation shareholder, or partner is a California resident.
  • The payee meets one of the exemptions on Form 590, Withholding Exemption Certificate.
  • The total payments or distributions of California source income to the nonresident are equal to or less than $1,500 for the calendar year.
  • The payment is for goods.
  • The services provided by the nonresident are not performed in California.
  • The nonresident payee or the withholding agent receives written authorization from us waiving the withholding.
  • The payments are income from intangible personal property, such as interest and dividends, unless the property has acquired a business situs in this state.
  • The payments are compensation from a motor carrier providing transportation in two or more states, subject to section 11504(b) of title 49 of the United States Code.
  • The payments are wages paid to employees. For information on employee wage withholding, contact California Employment Development Department.
  • The payee is a bank or banking association.
  • The payments are made to a nonresident corporate director for director’s services.
  • The distribution is exempt income.
  • The partner has certified that the income was previously reported on the partner’s California tax return.
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