Can an Individual File a California Composite Return?

Filing taxes can be a complex task, especially for individuals with income from multiple sources. In California, the composite return simplifies tax obligations by allowing certain groups to file collectively rather than individually, reducing administrative burdens.

Who Is Eligible

Eligibility for filing a California composite return is determined by criteria set by the California Franchise Tax Board (FTB). Composite returns are available for nonresident individuals who are members of a pass-through entity (PTE), such as partnerships, S corporations, or limited liability companies (LLCs), that elect to file on behalf of their nonresident members. This option consolidates multiple individual returns into a single filing for those with income from California sources but no residency in the state.

Per California Revenue and Taxation Code Section 18535, only nonresident individuals with no other California source income outside of the PTE can participate. The PTE’s managing partner or officer typically makes the election to file a composite return, in accordance with the entity’s operating agreement or bylaws.

Resident individuals, trusts, estates, and corporations are excluded from composite returns. Nonresidents with additional California source income, such as wages or rental income, must file individual returns. Composite returns strictly cover income derived from the PTE.

Withholding Rules

Withholding rules ensure compliance and proper tax collection for composite returns. Nonresident members of PTEs participating in a California composite return are often subject to mandatory withholding. The California Franchise Tax Board requires PTEs to withhold tax at the highest California personal income tax rate, currently 13.3% for 2024.

The withholding amount is based on the California source income attributable to each nonresident member. The PTE’s managing partners or officers must calculate and remit withholding to the FTB on time to avoid penalties and interest.

PTEs must provide nonresident members with a California Schedule K-1 (568) form, which details the member’s income, deductions, credits, and withholding. Additionally, PTEs must file Form 592, Resident and Nonresident Withholding Statement, with the FTB to report withholding amounts.

Income Apportionment

Income apportionment determines how a PTE’s income is allocated among its nonresident members. California uses a single-sales factor formula, focusing on the proportion of sales made within the state relative to the entity’s total sales, as outlined in California Revenue and Taxation Code Section 25128.7.

This method is essential for PTEs with operations both inside and outside California. For example, if a PTE has $10 million in total sales, with $4 million occurring in California, 40% of the entity’s income is apportioned to California. This percentage is applied to each nonresident member’s share of the income.

PTEs must maintain accurate records of sales within and outside California to calculate the apportionment percentage properly. Regularly reviewing apportionment calculations is critical to account for changes in business operations or sales patterns. Errors can lead to audits or disputes with the FTB.

Filing Steps

Filing a California composite return involves several steps to ensure compliance with state tax regulations. Attention to detail is crucial throughout the process.

Information Collection

The first step is gathering financial records, including income statements, balance sheets, and sales data, to determine income attributable to California. PTEs must also compile information on each nonresident member, such as their share of income, deductions, and credits. Reviewing operating agreements or bylaws is necessary to confirm the election to file a composite return.

Completing Forms

Once the information is collected, the required tax forms must be completed. The primary form is Form 540NR, California Nonresident or Part-Year Resident Income Tax Return, which is filed on behalf of all participating nonresident members. This form requires detailed entries for each member’s apportioned income, deductions, credits, and total tax liability. PTEs must also complete Form 592 to report withholding amounts.

Payment of Tax

The final step is remitting the total tax liability for all nonresident members by the original due date, typically April 15th. Payment options include electronic funds transfer (EFT), credit card, or check. Ensuring the payment is correctly applied to the composite return is essential.

Noncompliance Penalties

Noncompliance with California’s composite return requirements can result in significant penalties. The California Franchise Tax Board enforces strict rules to ensure accurate reporting and timely payment.

Late filing or late payment can result in a penalty of 5% of the unpaid tax per month, up to 25%. Late payment also incurs a penalty of 0.5% of the unpaid tax per month, capped at 25%.

An accuracy-related penalty of 20% applies if the reported tax liability is understated by more than 10% or $5,000, whichever is greater. Failure to withhold taxes for nonresident members can result in penalties under California Revenue and Taxation Code Section 18668, including a penalty equal to 10% of the amount that should have been withheld.

Repeated or severe noncompliance may trigger an audit, during which the FTB examines the PTE’s financial records, apportionment methods, and withholding practices. To avoid these outcomes, PTEs should establish strong internal controls, periodically review tax compliance practices, and seek professional guidance when necessary.