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Doing Business in California and other states? Understand the difference between “Business Income and Nonbusiness Income .” It can make a big difference in determining CA tax.

In broad terms, net income, which arises from the conduct of the taxpayer’s trade or business operations, is business income.  

R&TC §25120(a) defines business income as:  "income arising from transactions and activity in the regular course of the taxpayer's trade or business and includes income arising from tangible and intangible property if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations.

"  R&TC §25120(d) defines nonbusiness income as "all income other than business income."  Nonbusiness income is simply defined as "all income other than business income."  Furthermore, CCR §25120(a) states that "the income of the taxpayer is business income unless clearly classifiable as nonbusiness income."  The classification of income as business or nonbusiness is essential to the determination of the California tax base for two reasons:  

  • Business income is apportioned by formula to the various jurisdictions in which the trade or business activity is conducted.  Nonbusiness income is allocated to a specific location under a series of statutory rules; and
  • Unitary business income is determined on a combined basis.  Nonbusiness income may only be reflected in the measure of tax of the taxpayer incurring the nonbusiness income or loss.  

The classification of income by labels such as interest, rents, royalties or capital gains is of no aid in determining whether income is business or nonbusiness.  Income of any type or class and from any source is business income if it arises from transactions and activities occurring in the regular course of a trade or business. (R&TC §25120 (a))  The gain or loss recognized on the sale of property, for example, may be business income or nonbusiness income depending upon its relation to the taxpayer's trade or business.  You must look beyond the labels and focus on the relationship of the income to the unitary business activity. 

For more information click here:

https://www.ftb.ca.gov/aboutFTB/manuals/audit/matm/4000.pdf

steve@stevesimsea.com. Your California tax specialist.