California Issues Ruling on Sourcing of Income Paid to Independent Directors

December 10, 2019

Individuals who serve as independent members of a corporation’s board of directors may find that that their board compensation is not necessarily reported to the state where the board meetings are held.

By Betsy Tuck, SALT Manager

Do you receive compensation for serving as an independent board director of a corporation? If so, you probably travel several times a year to attend board/shareholder meetings, and those meetings likely occur outside you state of tax residence.  Have you ever wondered how you should be sourcing the income that you receive? The California Franchise Tax Board (“FTB”) recently opined on this issue when it published Chief Counsel Ruling 2019-03.  Interestingly, the FTB concluded that independent director income should not be sourced in part to California based on attendance at a board meeting in California. How did it reach this conclusion?

The taxpayer requesting the ruling is a corporation commercially domiciled outside of California. Under the rules of the New York Stock Exchange, the taxpayer is required to have a majority of its board members be independent, which means generally that the member must not be an employee.  Taxpayer inquired whether compensation paid to a board member that is a nonresident of California should be sourced to California to the extent that such member attends board/shareholder meetings in the state.

The ruling explains that nonresident individuals are taxable only on income earned from sources within California, and that means income from a trade, business or profession and income from personal services performed in California.  Income from personal services performed in California applies to non-resident employees.  Since the directors are not employees of the taxpayer, their income is sourced based on the rules for a trade, business or profession.  Essentially, independent board members are self-employed independent contractors conducting a business (whether as a sole proprietorship or in some other form).  Therefore, the regulations provide that the source of income from such business should be determined under the same rules as those used to apportion the income of a corporation.[1]

California will consider the director’s income to be income earned by providing a service. Sales from services are sourced using market-based sourcing rule for California which states that, “sales from services are in this state to the extent the purchaser of the service received the benefit of the services in this state.”[2]

In this case, the purchaser of the service is the taxpayer and the services provided are those services provided by the board members. These services, for example, may be to establish company policies or vote on major company issues.  The board as a whole gives authority to and directs company management (i.e., the officers) to take action. The FTB determined that the benefit of the independent director’s service is not received at the location where a board meeting is held and decisions are made, but rather based on the location where the ultimate decisions and actions of the board are executed. Thus, the ruling concludes that the source of the income should be to the location where the highest-ranking corporate officers of the taxpayer execute the decisions made by the board.

A couple of points are worth noting.  First, California is unique in that it generally requires businesses to withhold California income tax on non-employee compensation paid to nonresidents when such compensation is sourced to California.  While there is an exception to withholding for payments to nonresident board directors for director services, the payor may have a filing requirement both to the state and the director.[3]  Therefore, the company in this case requested this ruling since it must determine whether the director payments are sourced to California in order to make the applicable filings.

Other states do not generally have a withholding requirement on non-employee compensation.  However, this question of sourcing is still important for board members individually since they are engaged in a business (i.e., providing independent director services) as self-employed contractors. Therefore, for personal income tax purposes, board members may need to determine where their compensation is sourced in order to know if they need to report this income to other states.  Sourcing methodologies vary among the states, and as illustrated by this ruling, such compensation may not be reported to the state where the meeting is held.

Second, while this ruling might appear to be a victory for the taxpayer, since the state determined that board meetings held in California did not give rise to California source income for board members, remember that the converse will likely also be true.  In other words, a board member of a California-headquartered company that attends board meetings outside California may find that his or her board compensation should be reported to and taxed by California.

Aprio’s SALT team had extensive experience addressing multi-state sourcing issues.  We regularly assist businesses (whether corporations or sole proprietorships) understand where their income is earned for state income tax purposes so that they can properly report and pay their tax obligations and avoid unnecessary exposures and penalties.   We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Betsy Tuck, SALT manager, at or  Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at for more information.

This article was featured in the Nov./Dec. 2019 SALT Newsletter.

[1] See Cal. Code of Regs., title 18, §§ 17951-1 to 17951-5.  The corporate sourcing rules are set forth in Cal. Tax Code §§ 25120 to 25139.

[2] California Revenue and Taxation Code (“CRTC”) §25136.

[3] See Cal. Rev. & Tax Code § 18662(f) and (g)

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

Stay informed with Aprio.

Get industry news and leading insights delivered straight to your inbox.

Stay informed with Aprio. Subscribe now.