FTB 88-1: What Creates California Tax Nexus?

The rules determining when an out-of-state business must pay California income tax involve a mix of federal law and state-level interpretation. A key federal law, Public Law 86-272, enacted in 1959, sets limits on a state’s ability to tax businesses whose only connection is soliciting sales of physical goods. To clarify this, California’s Franchise Tax Board (FTB) issues guidance outlining which activities are protected and which are not.

Determining Taxable Nexus in California

A state must have “nexus,” or a minimum connection, with a business before imposing a tax. While this once meant physical presence, the concept has evolved. For 2025, California considers a business to be “doing business” in the state if it meets any of the following inflation-adjusted thresholds: sales exceeding $763,214, real and tangible personal property exceeding $76,322, or compensation paid exceeding $76,322.

Federal Public Law 86-272 provides a specific exemption from a state’s net income tax. This law protects out-of-state companies whose only business activity within a state is soliciting orders for tangible personal property. For this protection to apply, the orders must be sent outside the state for approval, and if approved, the goods must be shipped from a point outside the state.

The FTB’s guidance clarifies that this federal protection is narrow. It applies only to taxes based on net income and not to other types of taxes or fees. The protection is also strictly limited to the sale of tangible personal property, so it does not extend to the sale of services, real estate, or intangible property like digital goods or streaming services.

Protected Solicitation Activities

The FTB’s guidance details specific activities that are considered part of “solicitation” and are therefore protected. These activities are viewed as ancillary to requesting an order. For instance, sales representatives can carry samples and promotional materials for display or distribution without charge.

Sales staff can be furnished with a company car for business use. The law also protects passing customer inquiries or complaints on to the home office for resolution, so long as the in-state employee does not have the authority to resolve the issues themselves. A business can also engage in advertising within California without losing its tax protection.

Independent contractors are granted a wider range of protected activities. They can solicit sales, make sales, and even maintain an office in California without subjecting the out-of-state company they represent to the state’s income tax. However, a representative who works for a single company is not considered an independent contractor and is subject to the same limitations as a direct employee.

Unprotected Business Activities

Any activity that goes beyond the mere solicitation of orders for tangible personal property can create nexus and subject a business to California’s income tax. These actions include making repairs, providing maintenance, or offering technical assistance to customers within the state. Collecting payments, whether by cash or credit card, upon delivery of goods is also an unprotected activity.

Maintaining any kind of physical location, such as an office, warehouse, or stock of inventory in California, will disqualify a business from the protections of Public Law 86-272. This includes owning or leasing real or personal property in the state. Employees telecommuting from California can also create nexus if their work involves non-sales activities like business management or accounting tasks.

In 2022, the FTB issued guidance attempting to apply nexus rules to internet-based activities. A California court later ruled this guidance invalid because it was created without following proper administrative procedures. As a result, the FTB’s 2022 guidance on internet activities is void and cannot be relied upon.

Filing Obligations for Protected Businesses

A business may find its activities in California are protected from the state’s net income tax under federal law. However, this protection does not eliminate all tax obligations. If a corporation is shielded from income tax but still considered “doing business” in California, it is subject to the state’s annual minimum franchise tax.

The minimum franchise tax is a fixed amount paid annually by every corporation incorporated, registered, or doing business in California, regardless of its net income. For most corporations, this annual tax is $800.

To comply, a protected business must still file a California Corporation Franchise or Income Tax Return. On this return, the business will claim its federal protection to exempt its net income from taxation while also reporting and paying the minimum franchise tax.