Insights on California Tax Law with Michael Cataldo (Part 2)

Hosts & Guests

Stacey Roberts, State and Local Tax Director

Meredith Smith, State and Local Tax Senior Manager

Michael Cataldo, Shareholder at Cataldo Tax Law, P.C.


Insights on California Tax Issues with Michael Cataldo (Part 2)

[00:00:00] Introduction: Welcome to SALTovation. The SALTovation show is a podcast series featuring the leading voices in SALT, where we talk about the issues and strategies to help you make sense of state and local tax. Welcome back to part two of our conversation with Michael Cataldo of Cataldo Tax Law, P.C. and special guest host, Stacey Roberts.

Follow us and let us know your thoughts.

[00:00:28] Stacey Roberts: We don't always have. As practitioners guiding our clients. Early on to petition these states to say, oh, oh, oh wait, wait, wait, wait, wait, wait. We need to, you know, we need to do this or we'd like to do this. And so it's important though. I think for the listeners to understand that these, these rules do exist, but there's a process about how to apply them.

And it's not just, you can take a position on a return and the states are gonna let it sail through.

[00:00:57] Michael Cataldo: No. And in fact, California has a, a policy it's in a, it's in a. I think it's a notice, but you cannot take an alternative ment of position on an original return. You need to file a, so you need to go. You need, if, if you think it's unfair at 25, 1 37, the alternative ment statute should apply you file the return under the rules that are not fair.

Then you file. I would file a claim for refund for one, just to make sure wasn't losing anything, but then say we want alternative a Porsche it, and here's why, and if you have a good case, Great. If not, you can take it up. And you know, most of these cases that are close end up settling. So if you have something it's, uh, you know, you measure the value of it and the time and expense and how much you're talking about.

It's usually when there's a, a big sale, a big slug of. Yep.

[00:01:49] Meredith Smith: As we've been kind of been talking about apportionment, can we just, we'd love to kind of hear, you know, California has their legal ruling, the 2201 on kind of the sales of services

[00:02:03] Stacey Roberts: stuff. Mm-hmm what are


[00:02:09] Stacey Roberts: Technical term technical term

[00:02:10] Meredith Smith: stuff.

That is the. It depends and stuff. That is the language of a state tax professional.

[00:02:17] Michael Cataldo: How are you feeling about that? I understand why you said stuff because it's very hard to articulate exactly what was going on and what they're doing. You have to do a lot of reading between the lines to see what they're trying to do.

So taking just a step back and looking at what they did and what they moved away from. They are pushing more the look through concept of looking to the customer's customer, but they don't say it all that plainly they are bound by statute and the statute looks to it. Really, the statute says purchaser, the regulations just called purchaser customer.

For some reason, I wish they would change. Nevertheless, they say customers, customer, and they that's what this, this most recent legal ruling is kind of retracting a, uh, chief council ruling that earlier in, uh, 2017. And there was one in 2015, also that applied the rules for intangibles and rules for intangibles in the, in the regulations, breakout intangibles into marketing and non-marketing intangibles.

So marketing intangible would be like Jeffrey giraffe, trademark kind of stuff. Non-marketing intangible would be like a, a patent for manufacturing and in the rules for the, the distinction is in the marketing. Intangible, they look through to the ultimate customer. Um, so they won't just look at the, the Jeffrey store.

They'll look to what's where's the market for sales, but with non-marketing intangibles, they look to the immediate. Customer purchaser. So this legal ruling and it started with, uh, 2015 dash three. And so I'm gonna talk about 2015 dash three and 2017 dash one first, before I get into 2022 dash one, because you kind of need to know what they were doing first and why are they, what are they doing now to correct?

What they're, what they're they don't like anymore. So 2015 dash three. Is where this whole notion of analogizing, the marketing and non-marketing and tangible to services. So FTB looked at this situation and the situation involved, a company that sort of aggregated data for financial, uh, companies for investment advise and whatnot, and was all online.

And we sold it to the investment advisors who then used that for. Their clients and their clients use this stuff also. And so FTB came out and they said, all right, we don't look to under for services. We don't look to, we don't do the look through rule rule. It's we look to the customer, this is all gonna be really confusing and not make a lot of sense.

I'm trying to explain what they did. it's not me. um, so they say, okay, well that's what the statute says, but to reasonably approximate. How these, these, uh, sales revenue was sourced. We're gonna look to this CPU usage that the, uh, the client maintained, which was the, the, the customer's customers activity.

So the more activity they had, the more the cost was. So they said, okay, we looked to our client, the investment advisors, we look to them, but how do we figure out where they got the benefit? Well, we're gonna look to this. This CPU data is, is. So look at that. So that's how they ended that. And looking back now to, to what 2022 dash one says, so it seems like the answer's gonna be the same.

Uh, but I think it's the rational of this whole notion of Mar the non-marketing and marketing sales they're gonna do away with it. They, they have done away with it without saying as much 2017 dash one. This one's kind of. Really, I kind of think this is what they really did not like. And this was, it's kind of similar Meredith to the situation you brought up with the insurance companies, and this is a healthcare.

Provider. So you have a healthcare plans, they've got their, their subscribers who get prescriptions and whatnot. And so they contract with that is gonna fulfill all the subscriptions. So the rule, the question was, okay, so, uh, where does this, uh, revenue get sourced to when we're the, um, we're the, we're providing this service to the medical plans and, and we're delivering.

Medications to the ultimate users. And so they looked in, they said, okay, uh, we're gonna do marketing versus non-marketing again. Now this service is, we think they, they concluded, it was a, uh, non-marketing service. It wasn't marketing, it was fulfilling something. So then they said, all right, well, following that, we just looked to the customer.

We don't look to the customer's. So, what they concluded was, so this should be sourced to where the direct customer would have had to perform this. Had they not engaged you at all? So they, and they concluded, well, that would be at your office. That would be at the office of the healthcare companies. Not.

Where all of the, the patients are, or the subscribers were taking the medications are, so those are the two chief council rulings, which now we get into, uh, the legal ruling, 2022 dash one, and it goes through three different scenarios. The scenario one and scenario three, I don't nothing's changed. And they were pretty obvious.

But scenario two is exactly 2017 dash one, the exact scenario. And they came out the other way. They said, in this case, we, they didn't even mention this marketing and non-marketing service. At all, not a word of it. And they said, look to, and they kind of redefined refocus, how we're figuring out where the benefit of the service was received before they were really focused on where, where is it?

Where is it? Where is it? But in this new legal ruling, what they've done is they've said, we're not gonna look at where we're gonna look at what is, what is the benefit? And by defining the benefit. As seeing your customers, their drugs, they kind of answer the question of where it is. So that's how they defined it in the legal world.

Where, where are you getting your drugs? That's where the subscribers are. So that's where this revenue should, should be sourced. And then at the end they say chief council ruling 2015 dash three, and chief council ruling 2017 dash one are remotes. They don't explain why they say they're remotes, but that's my.

This is my 2 cents worth. As far as what all this means. And with that, I'm gonna take a drink.

[00:09:27] Stacey Roberts: This is not outside. You need something. I was gonna say, do you need something stronger than just water? I plead the fifth.

[00:09:34] Michael Cataldo: We don't judge here. We don't judge here.

[00:09:36] Meredith Smith: I mean, you can take a, you know, for those who may be seeing a clip, take a look at Stacy's over her right shoulder.

Oh, over here,

[00:09:42] Michael Cataldo: huh? Oh, any. No comment.

[00:09:52] Meredith Smith: Well, and so, Michael, we really appreciate your, you know, your insight and your knowledge and, um, getting a chance to talk to you. And just kind of, as we wrap up, don't wanna pigeonhole you and you are a multi-state tax, you know, experts. What is one of your. Most interesting or favorite non-California positions or cases that you've kind of gotten to play around with non-California let me think about this. A lot of ways to answer this. I'm always careful when I get the questions, I'll get back to 30 days. We do caveat. We do, uh, you know, This is not live. We can always edit. And we do caveat that we are not, we are not providing tax advice during these tapings.

[00:10:44] Michael Cataldo: so like, are you thinking about a, like a specific state or more like, like a vast holdings case and investigate apportionment is really interesting.

It, it really. It kind of doesn't really matter what state you're in. Now I know vast holdings, the Supreme court in Massachusetts said, Hey, it's not authorized by statute. Get accurate. You can't do it. Mm-hmm um, but I wonder what will happen with the legislature. Maybe they will say this is fine. And then is it okay?

They, they said it was constitutionally. And then we've got this Goldman Sachs case out of New York city, which is really doing the same thing. They said it was fine, constitutionally. To tax based on investee apportionment, something that like the things I get I get interested is where is this going from here?

And it takes a long time for things to develop in the state local tax worlds, to where this is going. Like investee apportionment that creates. Nexus like the states rely on this, uh, international harvester case and JC Penney's case and UC the Supreme court cases from authorities to say, Hey, due process.

No problem. but that's a long time ago. And due process has a lot since then. I mean, this is international shoe is the case. Everyone talks about in minimum contacts, international shoe. And we look at what the Supreme court has done recently, like in the Kimberly Rice trust case, uh, in Wayfair there's Wayfair, referring to Quill.

There's a separate due process requirement as well as commerce clause. So is it enough, or do we have to look at the contacts of the taxpayer or is it just enough that it's sourced to the state? Is that enough? Like the, and, and really like they, what the states will say to get jurisdiction is, are, uh, international harvester, has the state given anything for which it can ask to get a term it's such a vague concept and.

Six degrees of separation. At some point, you're gonna maybe find something there, but is that enough under current, uh, jurisprudence under the due process clause to, to allow me to do that, like we talked about Wayfair, but Wayfair's commerce clause case doesn't even talk about due process. The fact that taxpayers thought they had this sort of protection under the commerce clause via Quill.

That's gone now, but that was kind of like where all the action would've been like, Hey, we're protected. We got Quill. We're good. We don't even need to talk about due process. We're buying well, now that's gone. So I think due process is gonna have a, a revival we're gonna see more due process cases. And that's not just way, that's not just sales tax sales and use tax collection obligation, but you.

Look at Wayfair and say, you know, if for those states that don't already have a factor presence or economic nexus, Hey, we can do it. Now. We got Wayfair. We'll rely on that. Despite the fact that it's just a commerce clause case and a use tax case. And then what about the localities? Like the, the San Francisco?

And it was send, you know, localities throughout the country, economic nexus there. They can, why can't they do it then? And you look at, and Philly

[00:14:09] Meredith Smith: come out with something last year, two years ago. Yeah,

[00:14:12] Michael Cataldo: yeah. Yeah. San Francisco also, we've got a $500,000 threshold. Um, so there's gonna be, and for those folks who are making all their money online, I mean, SAS is the obvious one, but you know, technology's moving so fast and like what's not done online now.

Um, there's gonna be some challenges for them to figure. How to comply. Or when to, you know, because a lot of these cases come about because they didn't know, like, I don't know if very many taxpayers were like, let's just plan for litigation. They just like, oh, you're saying we have to do this. That doesn't seem right.

But we'll just do it anyway, because we don't want to spend our time on taxes. We don't like state local tax, like you do Mike . Okay. So there's gonna be a lot of sort of surprise. Assessments because of, because of this and then retroactivity, um, that's still up in the air. Yeah. There's a lot of arguments to be made activity for your state.

And I know that we're, you know, coming to a conclusion here shortly here, but I did wanna just kind of pick your brain some things that we've seen recently for some of our pure remote sellers. You know, they went ahead and they registered started collecting, started remitting in the state of California, based on that magical April one, you know, 20, 19 date.

And now they're starting to get notices from the FTB saying, Hey, where's your income tax returns. Mm-hmm . That seems to be a very common theme recently.

[00:15:39] Stacey Roberts: They share they're clearly they're matching up records. But I guess I go back to kind of that nexus discussion that we had early on about, you know, the magical number for, and, and again, this is where maybe we shouldn't hang our hat so much on the numbers, but you know, the Wayfair threshold being 500, but the income tax threshold being something more than that, mm-hmm and taxpayer our taxpayers gonna challenge that to say, Hey, that's I was at the threshold in 2019.

You know, I don't know. Does any, do any of those arguments even have legs, right?

[00:16:12] Michael Cataldo: Well, yeah. I mean, to me, they're two separate regimes. Yep. So, Hey, if you've got nexus under one, but not another, you don't file a California. If you don't have income tax nexus. Like, let's just say you got 600,000, you know, you've read the needle where you don't have to do well.

That's right. I don't know if FTV is gonna say you have, I don't think FTV is gonna say you have anyway, this statute and they've also come out. There was a legal ruling. Geez, sorry. Probably six or seven years ago about throwback. And basically they said the later came up with this and this is sort of constitutionally the limit.

So you need to hit this limit or you have to throw back in California, but you know, they change their mind depending on the, on the facts, in the case. It's all there. Yeah. Yeah. You gotta, you know, you could be subject to use tax collection and, uh, registration with the CDT, a sales tax, but not to the franchise tax it's possible.


[00:17:15] Meredith Smith: Well, or could you claim 86, 2 72. But under what condition of reinterpretation modernization that's always been there or traditional, like non modernized.

[00:17:31] Michael Cataldo: Yeah, the UN modern, the old rusting.

[00:17:34] Stacey Roberts: The old, yeah, the 1959 version. Right?

[00:17:38] Michael Cataldo: maybe it needs it. Una it's possible. I need tuna, but it's federal legislation, correct.

It's kind of, the law is what the law is. Uh, state arguments are, we're just interpreting facts, laws with the laws. And the big question is, are you activity in, in a state based solely on your customers going online and looking at stuff? Seems like a slippery, like if I send facts that's no, if I call you no, but if I click on the website that's yes.

All of a sudden. And then I wonder about the internet tax freedom act. Non-discrimination provisions like man, you are definitely picking on, uh, this is the only way we're chatting is via the internet and. Those people are using stamps or fax machine. We're not, but you know, their argument is eventually stamps of fax machines just don't exist anymore and it's all interconnected.

And if you use the internet, then you have nexus everywhere seems to defeat the purpose of the, the commerce clause. Uh, and the internet tax freedom act. And it just doesn't seem right. Like I'm sitting here in my office and I'm on the internet and I'm just creating nexus everywhere. Like what about the, and here's the other thing I, to wrap up, you guys could just say be quiet, but literally I told Stacy this, when we did a webinar together years ago that I could talk nonstop about salt.

Like, gimme I can just keep talking. There's so much to talk. So we talked about the market based sourcing. We talked about how market based sourcing can create sales, which create nexus. Now you're looking at these market based sourcing rules, which are Ify vague, you're unsure, but those gonna ultimately create nexus for you.

And now look at the jurisprudence of, uh, the due process jurisprudence of what creates nexus. It's like, man, you know what. I'm here in India. And I have a client in Japan that I do some stuff for remotely, and this Japanese company has customers in California. So I have due process nexus in California because of.

Well, I don't know. That's, that's one that's ripe for litigation, for sure. Yeah.

[00:19:54] Stacey Roberts: And probably not just in California.

[00:19:55] Michael Cataldo: No, no, no, no. These issues states, everybody stated.

[00:20:01] Meredith Smith: That's why the conversation's never ending. You get through all 50 of them. And then the first one that you started is back changed what they did by the time you got done talking about

[00:20:09] Michael Cataldo: all the other ones.

Yeah. Yeah, no doubt. But the constitution applies to all the. So these argument constitutional arguments apply to all of them. Yep.

[00:20:19] Meredith Smith: Well, Michael, we really appreciate your time and certainly kind of your, your insight. And it was a good reminder to think about what's next, when these. Kind of decisions come out.

These rulings come out, cuz oftentimes as tax practitioners, we're working in arrears, right? Mm-hmm , we're fixing the past. We're arguing the past. The current tax return we're working on is for last year. So it is a nice reminder to be thinking about what's next and getting away from that next or you know, that historical.


[00:20:54] Michael Cataldo: I'm even further back, I'm working five to 10 years. but always keeping track of the, the current too, but you know, audits to get, um, you know, another thing we should mention, if we're talking about California, it would be, we gotta mention the, the regulations. And there are so the, the, um, 25, 1 36, 2 market based sourcing regulations in California originally adopted in, uh, 2011 modified couple years later.

And since it started, there's been an open regulation project and there's still is one. Now they have proposed regulations that they went to the board to ask if they could go to. Can we go through the process final to finalize these now do that. They have to issue a notice and then have hearings and be all final.

They have interested parties meetings, which are all just draft stuff, conversation mm-hmm , but to actually get regulations final, they have to go through all of this process and they have to act to the board permission to do that. And they did that in December. So now they have the green light and they said, yeah, you know, a couple little things, but we're ready to go.

Then out of the blue, we get, uh, the wheel rolling 20, 22 dash one. And it's like, wow, where is this? So perhaps they cuz they haven't. Done anything yet, as far as the formal notice, perhaps they're re tinkering with it, but for anyone interested in their California liability, really gotta follow what's going on with these regs.

Cause there's some pretty big changes which we could talk about for another two hours. Hmm. Honestly, there's so many well, we'll

[00:22:32] Meredith Smith: meet in Nevada next time and talk about these over something a little stronger. You know, again, water absolutely mean halfway in a non income tax state.

[00:22:46] Michael Cataldo: I won't bring my phone cuz maybe that will get California. I don't know.

[00:22:50] Meredith Smith: Where am I? I have a non Colorado, uh, Zip code or area codes? A where am I?

[00:22:57] Michael Cataldo: Right, exactly. Oh yeah. What are those commercials where you can get a VPN and wherever you want. That's where you are. Yep.

[00:23:07] Meredith Smith: I�m just gonna start operating off burner phones, use 'em throw 'em out. Like I'm a crook. That's not, that's not suspicious or anything. Huh?

[00:23:13] Michael Cataldo: I can't get away with that. They're all, they all know where I am. They know where I am. I can't get away. So I, well, I was gonna

[00:23:19] Stacey Roberts: say you're in hotel, California.

[00:23:20] Michael Cataldo: What are you talking? Yes. yep. Yep. That's a whole nother hour conversation.

[00:23:28] Stacey Roberts: How do you leave? Exactly, exactly. Well, thank you everyone. This has been another episode of SALTovation until next time. Thanks, Michael.

[00:23:38] Michael Cataldo: Thank you.

[00:23:42] Closing: This podcast is for educational purposes only and is not intended, nor should it be relied upon as legal tax accounting or investment advice. You should consult with a competent professional to discuss specifics of your situation and the applicability of the information presented.

Topics Discussed in this Episode:

  • Recent ruling regarding California’s sales of services and market-based sourcing
  • California’s most recent ruling on sales of service

What You Will Discover:

  • [00:28] California’s policy on alternative proportment
  • [01:51] Sales of services in California
  • [09:51] Michael’s favorite cases outside of California
  • [15:05] Retroactive tax laws
  • [19:05] What creates nexus
  • [21:06] Regulations on market-based sourcing


  • “It’s very hard to articulate exactly what was going on, what they’re doing. You have to do a lot of reading between the lines, see what they’re trying to do.” – Michael Cataldo [02:21]
  • “The things I get interested in is where’s this going from here? And it takes a long time for things to develop in the state and local tax world to where this is going.” – Michael Cataldo [11:29]
  • “Technology is moving so fast and what’s not going online. There’s going to be some challenges for them to figure out how to comply.” – Michael Cataldo [14:27]
  • “But the constitution applies to all the states, so these constitutional arguments apply to all of them.” – Michael Cataldo [20:11]

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