Corporate Tax Counsel

Corporate tax work divides into two categories: planning that determines what a company owes, and controversy that resolves what an agency says it owes. Both benefit from being handled by someone who understands the other.

For California companies, and for out-of-state companies selling into California, the recurring issues are apportionment, nexus, compensation structure, and the widening gap between federal and California law. California’s conformity date is January 1, 2025 under Senate Bill 711 — before the One Big Beautiful Bill Act — so the state does not follow most of what changed federally in 2025.

We advise corporations and their advisors in Temecula, Murrieta, San Diego, Riverside, and San Bernardino, and nationally for companies with California exposure.

Apportionment and Nexus

This is the issue most likely to produce an unexpected California liability, and it affects companies that have never set foot in the state.

California apportions business income using a single sales factor with market-based sourcing. For services, the receipt is generally sourced to where the customer receives the benefit — not where the work was performed. A consulting firm in Texas serving California clients is generating California-source receipts regardless of where its people sit.

California also applies an economic nexus standard: a company can be “doing business” here based on sales, property, or payroll exceeding statutory thresholds, without any physical presence. Public Law 86-272 provides limited protection for companies whose only California activity is soliciting orders for tangible personal property — but that protection does not extend to services, intangibles, or licensing, and states have taken increasingly narrow views of what counts as protected solicitation, particularly for internet-based activity.

The practical result is a population of out-of-state companies with California filing obligations they have not recognized. Because a return that was never filed leaves the assessment window open indefinitely, these exposures compound quietly. Voluntary disclosure programs exist and are substantially cheaper than being found.

Entity-Level Tax in California

• C corporations — 8.84% of net income, minimum $800, with a first-year exemption from the minimum
• S corporations — the greater of 1.5% of net income or $800
• LLCs — $800 plus a gross receipts fee on revenue, up to $11,790
• California corporate AMT — 7%, and California did not conform to the federal corporate alternative minimum tax on adjusted financial statement income

Combined reporting applies to unitary groups, and determining the scope of the unitary business — which affiliates are included, and whether a water’s-edge election is advantageous — is a planning decision with multi-year consequences.

The Conformity Gap

Federal provisions with no California counterpart:

• Bonus depreciation — 100% permanent federally, never adopted by California
• Section 179 — $2.5 million federally against California’s $25,000 with a $200,000 phaseout
• Section 199A QBI — no California equivalent for pass-through owners
• QSBS — no California exclusion, so a Section 1202 exit excluded federally is fully taxable here
• Section 163(j) interest limitation — California decoupled, applying Section 163 as of January 1, 2015 with no EBITDA-based cap, which is favorable for leveraged companies

Two areas where California is more favorable are worth planning around. It retains pre-TCJA Section 174, so domestic and foreign research costs are both fully deductible for state purposes — see the R&D credit. And the pass-through entity elective tax, extended through 2030 by Senate Bill 132, lets qualifying pass-throughs pay 9.3% at the entity level, deductible federally outside the SALT cap, with an owner credit — reduced by 12.5% of any June 15 prepayment shortfall for 2026 and later.

Every divergence produces a Schedule CA or state-adjustment entry. Mismatches between federal and California figures are visible to the FTB and generate assessments.

Compensation and Benefits

Owner compensation is examined from opposite directions depending on entity type, and both are live issues.

In an S corporation, the risk is compensation that is too low — distributions recharacterized as wages with employment tax, penalties, and interest. In a C corporation, the risk is compensation that is too high — salary recharacterized as a disguised dividend, denying the corporation its deduction while the shareholder is taxed either way.

Both are defended the same way: comparability data, advance approval documented in minutes, and consistency between what the documents say and what actually happens.

Deferred and equity compensation add their own exposure. Section 409A imposes severe consequences on nonqualified deferred compensation that fails its requirements — immediate income inclusion plus a 20% additional tax on the employee. Stock options, restricted stock, and profits interests each have distinct timing, valuation, and election rules, and an 83(b) election must be filed within 30 days of transfer, a deadline with no relief for missing it.

Reorganizations and Restructuring

Mergers, acquisitions, spin-offs, and recapitalizations can qualify for tax-deferred treatment under Sections 351, 368, and related provisions — but qualification depends on satisfying technical requirements that are easy to fail through drafting rather than substance.

Recurring considerations include continuity of interest and business enterprise, whether boot is received, the survival of net operating losses under the Section 382 limitation after an ownership change, and the effect on QSBS holding periods. That last point catches founders regularly: a restructuring undertaken for good business reasons can reset or forfeit Section 1202 eligibility.

California generally conforms to the federal reorganization provisions, but the apportionment and combined reporting consequences of a restructuring are separate questions that need their own analysis.

Controversy

Corporate examinations differ from individual ones in scope and duration. Federal corporate audits are conducted by revenue agents examining books and records rather than isolated line items, and the scope can expand to related entities and additional years.

The procedural path runs through the examination, a 30-day letter and the independent Office of Appeals — where hazards of litigation can be weighed and cases settle on a percentage basis — and then a 90-day statutory notice of deficiency with 90 days to petition the Tax Court. See IRS audits and business tax audits.

California runs a parallel and separate track: a Notice of Proposed Assessment with 60 days to protest, then a Notice of Action appealable to the Office of Tax Appeals, heard by three-judge panels.

One procedural point deserves emphasis. Under R&TC 18622, federal adjustments must be reported to the FTB within six months. Report within six months and California has two years to assess; report late and it has four; never report and the window never closes. Corporations that settle a federal examination and consider the matter finished frequently leave an open-ended California exposure behind.

Accounting Methods and Periods

Method decisions are quiet, permanent, and frequently worth more than the strategies that get more attention.

The cash versus accrual choice is available to more businesses than it once was — the gross receipts threshold permitting cash method use has risen substantially and is inflation-indexed, letting many mid-sized companies use a method previously reserved for small ones. Cash method timing can meaningfully accelerate deductions and defer income.

Inventory, long-term contracts, and revenue recognition each carry their own regimes. Businesses using the percentage-of-completion method for long-term contracts should note that California did not conform to certain TCJA amendments to the long-term contract rules, creating a state adjustment.

Changing a method generally requires IRS consent on Form 3115, with a Section 481(a) adjustment spreading the cumulative effect — favorable adjustments over one year, unfavorable ones over four. Many changes qualify for automatic consent, which makes them administratively straightforward but no less consequential.

The point worth emphasizing is that method changes are prospective planning tools with real deadlines, not corrections made during an examination. An improper method identified by an agent produces an involuntary change on the government’s terms rather than yours.

Frequently Asked Questions

Does my out-of-state company owe California tax?

Possibly. California applies economic nexus based on sales, property, or payroll thresholds with no physical presence required, and market-based sourcing assigns service receipts to where the customer receives the benefit.

Does Public Law 86-272 protect us?

Only for companies whose sole California activity is soliciting orders for tangible personal property. It does not cover services, intangibles, or licensing, and states read the protection narrowly, particularly for internet activity.

How does California apportion income?

Single sales factor with market-based sourcing. Property and payroll are not part of the apportionment formula, so a company can have substantial California income without any California presence.

Does California follow federal depreciation rules?

No. Bonus depreciation was never adopted, and Section 179 is capped at $25,000 against $2.5 million federally.

What is the deadline to protest a California assessment?

60 days from the Notice of Proposed Assessment. Missing it makes the assessment final and leaves only pay-and-claim-refund.

We settled an IRS audit. Do we need to tell California?

Yes, within six months under R&TC 18622. Failing to report leaves California’s assessment window open indefinitely for that year.

Can a reorganization affect QSBS eligibility?

Yes. Restructurings can reset or forfeit Section 1202 qualification and holding periods. Where an exit is contemplated, this should be modeled before the transaction closes.

Get the Structure Reviewed Before It Is Tested

Corporate tax exposure tends to be discovered rather than anticipated — an apportionment position that was never examined, a compensation arrangement never documented, a federal adjustment never reported to California. Each is manageable when addressed deliberately and expensive when found by an agency.

Pietro Canestrelli holds an LL.M. in Taxation and advises corporations on apportionment and nexus, compensation structure, reorganizations, and federal and California controversy. Schedule a consultation, or review our business law and tax planning services.