With remote work, freelancers and digital nomads have the opportunity to work with clients nationwide. But with the addition of California, taxes can get complicated. Earning income from clients out of California does not automatically mean that income is not subject to California taxes.
California residents may be taxed on all their income for a variety of reasons.
California imposes income tax on the income earned by taxpayers from all sources, including from wages, freelance fees, consulting fees, investment income, from sources outside California, from California, or from an employer outside the state.
For instance, if a California resident creates websites for a Texas or New York business, the income is considered taxable in California. Just because a client is from out of state doesn’t make the income non-California income. Find a tax professional (like a San Diego EDD attorney) who can help you during difficult times.
It’s also not an easy thing to count the days of residency. California takes into account absences, length of time, purpose, family ties, property, and domicile. Just because you are traveling or working in another state temporarily does not mean that you are no longer a California resident.
Market-Based vs. Origin-Based Sourcing
The power to tax specific business receipts rests in the hands of the state in which the money is generated. The rules vary based on income type, taxpayer, and state law.
Generally, market-based sourcing will allocate to the customer location certain receipts for services and intangible property. In the calculation of California apportionment of business income, California implements market-based rules for a significant number of business receipts.
Generally, origin-based sourcing is concerned with the location of the income-generating activity. Origin-based systems are adopted by some states for specific receipts, and some states have different rules for each transaction. When you are facing major IRS tax problems resolution, it is better to look for an expert.
In the hypothetical, assume an out-of-state consulting firm is serving California customers. California may take some receipts even if the firm has offices and/or consultants in other states, depending on the rules that apply and the nature of the firm’s activities. Just because there is a sale does not mean there is a California filing requirement; there is also a nexus, apportionment, and entity type requirement to consider.
This is not the case with remote employees. Generally, California receives wages of nonresidents for services actually rendered in California, but subject to certain rules. Some employment arrangements may be impacted by special sourcing requirements, such as the convenience of the employer rule.
Tax Credits Can Avoid Double Taxation
A California citizen can be liable to pay tax to another state on income earned in another state and may also be liable to pay tax to California on the income. The State of California may allow a credit for net income taxes paid to another state on income subject to both state and federal tax.
In some cases, though, the credit paid may not be the same as the entire amount paid elsewhere. The amount is dependent on eligibility, income sourcing, and statutory limitations. Don’t forget to hire a professional (like a personal tax attorney) if you have no prior experience dealing with tax issues.
To support a claim, taxpayers should retain:
- Out-of-state Tax Returns and assessments.
- Evidence of tax payments to the other state.
- Records of income to show proof of service.
- Documentation to support residency and sourcing positions.
Residents of California usually report an eligible credit on Schedule S, as directed and required by the instructions to the form.
The Following Are Some of The Most Effective Tips for Remote Workers and Freelancers
To prevent expensive sourcing errors, here are some proactive steps to take:
- Keep records of the location of work: keep calendars, travel records, contracts, and invoices showing where services were rendered.
- Review residency status: If you moved, record the date and reason; determine if you truly lost your residency in California.
- Distinguish between income sources: Wages and freelance income, profits from business activities, and income from investments can be sourced differently.
- Review state filing requirements: Falsely assuming that out-of-state operations are exempt when they actually have nexus in California, are subject to market-based sourcing, or are subject to apportionment requirements is a mistake that businesses should avoid.
Coordinate multistate returns: Be sure to know each state’s rules for claiming credits to make sure income is reported similarly, and eligible taxes are credited.
Don’t let Unexpected Multistate Tax Bills Get in the Way
The flexibility a remote working arrangement provides doesn’t eliminate state tax obligations. California residents are typically taxed on their worldwide income, and nonresidents and out-of-state businesses must determine whether they have California-source income according to the rules that apply to them.
Knowing the different methods of sourcing, documenting the work, and making sure that the interstate tax credits are claimed can help minimize the risk of double taxation and avoid incorrect filings. If your residency changes, you have multiple states to track your income, and/or business apportionment becomes involved, you should seek advice from a qualified tax professional to plan a compliant strategy for reporting.
