When a seller sells businesses every few years, is a large sale "substantial and occasional" in California, and what does the exclusion do?

The rule and its two definitions

The regulation provides that "[w]here substantial amounts of gross receipts arise from an occasional sale of a fixed asset or other property held or used in the regular course of the taxpayer's trade or business, such gross receipts shall be excluded from the sales factor" (section 25137(c)(1)(A)). It gives as examples that "gross receipts from the sale of a factory, patent, or affiliate's stock will be excluded if substantial," and it aggregates "sales of assets to the same purchaser in a single year" (id., as quoted in Appeals of Amarr Company, 2022-OTA-041P, precedential). The words "or other property" and the affiliate's stock example mean the rule reaches the sale of an operating business held as stock and, on the same reasoning, as an interest in a pass-through entity, not only plant and equipment.

The Franchise Tax Board added definitions of both terms in an amendment operative January 1, 2001. A sale is substantial "if its exclusion results in a five percent or greater decrease in the sales factor denominator of the taxpayer or, if the taxpayer is part of a combined reporting group," of the group's denominator as a whole. A sale is occasional "if the transaction is outside of the taxpayer's normal course of business and occurs infrequently" (section 25137(c)(1)(A); FTB Chief Counsel Ruling 2017-03 (October 18, 2017), which quotes both definitions). Before the definitions existed, the FTB had extended the fixed asset rule to intangibles by ruling, reasoning that "[t]here is no logical basis for distinguishing between fixed assets and intangibles" and that substantial receipts from such a sale "do not fairly reflect the taxpayer's day-to-day business activity" (FTB Legal Ruling 1997-1 (October 15, 1997)).

The measure is gross receipts. The amount realized on a sale is not reduced by the basis of the property sold (Rev. and Tax. Code section 25120(f)(2), as stated in the FTB's 2025 Instructions for Form 100 Schedule R, Section G). A sale that produces a gain of $900 million on a basis of $300 million puts $1.2 billion of receipts into the factor computation, and the substantiality test runs on that number. A companion rule allows, but does not require, exclusion of insubstantial receipts from incidental or occasional transactions unless the exclusion would materially affect the income apportioned to California (section 25137(c)(1)(B)).

Infrequent is rarely the hard prong

Frequency has been read generously. Chief Counsel Ruling 2017-03 describes Appeal of Triangle Publications, Inc. (84-SBE-096), as holding that the sale of two corporate divisions and a building during a four-year period was "occasional" under the regulation. The ruling itself concerned a renewable energy developer's holding companies that sold their United States businesses in three transactions to different purchasers in one year. It counted the history at two levels, noting that "the Global Company has made four prior divestitures over an eight year period, and the Taxpayer had a single prior divestiture in a prior year," and concluded that the sales were infrequent. A chief counsel ruling binds the FTB only as to the taxpayer that requested it, but it shows how the FTB's legal staff measures the word: a sale every two or three years, by a group that does other things in between, has been treated as infrequent.

The normal course of business is where the serial seller's case turns

The first half of the definition does the work for a seller that sells businesses as a matter of course. Chief Counsel Ruling 2017-03 drew on the California Supreme Court's business income decision in Hoechst Celanese Corp. v. Franchise Tax Board (2001) 25 Cal.4th 508, for the proposition that the "controlling factor" in deciding whether a transaction occurred outside the regular course of business is the "nature of the particular transaction." The ruling found the divestitures outside the normal course because the taxpayer's business was to develop and operate its facilities, not to sell them, and its "ongoing and normal business model did not contemplate regular, reoccurring, and ongoing divestitures." It treated the transactional test as a guide rather than a rule, saying that test "does not control" the occasional analysis.

The reasoning runs the other way for a seller whose model is to acquire, grow and exit. Where an investment management group raises capital to buy operating platforms, builds them, and sells them to return capital, a platform sale is the transaction the business exists to produce, and an auditor can be expected to read the sale as within the normal course whatever its size. Because the definition is conjunctive, a sale within the normal course is not occasional however infrequent it is, and its receipts stay in the factor.

The evidence on that question is the seller's own record, created before the sale: - the governing documents and offering materials, and whether they describe exits as the strategy or as an event; - the number of comparable sales in prior years, their size relative to the business, and whether proceeds were reinvested in similar platforms; - how the seller has treated earlier sales on its own returns, since a prior-year return that kept a comparable sale's receipts in the factor is a statement that such sales are part of the business; and - the seller's financial statements and how they present sale proceeds against operating revenue.

Consistency carries weight. A taxpayer that included one platform's receipts when the inclusion lowered its California percentage, and excludes the next platform's receipts when inclusion would raise it, has a record that defeats either position. The exclusion is not elective, and the regulation applies to each year's facts, but a reviewer reads the earlier return as evidence of what the seller's normal course was. No decision of the Office of Tax Appeals or a California court was found that applies the normal course prong to a taxpayer whose business is buying and selling businesses, so the question is decided on the record.

The prong also tracks the character analysis, but does not duplicate it. A gain that satisfies the transactional test of section 25120(a), because selling platforms is the seller's regular trade or business, is almost by definition a gain from a transaction inside the normal course. A gain that fails the transactional test can still be business income under the functional test, and that is the paradigm occasional sale. In Amarr, there was no dispute that the sale of an S corporation's business, treated as a deemed asset sale, did not meet the transactional test, and OTA described it as "a once in a corporate lifetime occurrence"; OTA held the gain "apportionable business income" anyway and sustained the FTB's exclusion of the receipts from the factor. Classification comes first, and the library's article on whether a state may apportion a parent's gain on a separately run subsidiary covers that threshold.

The example: a platform sale by the operating partnership

The operating partnership is a Delaware LLC taxed as a partnership. Its partners are the REIT partner (about 90 percent), the management corporation (about 5 percent) and the executive partnership, through which senior executives hold the rest. Through lower-tier LLCs and LPs it holds real estate, loans secured by real estate, fund interests and a few taxable subsidiaries. In the year of sale it has about $400 million of receipts from rents, interest, fund distributions and management-related income, $100 million of them assigned to California. A lower-tier LLC sells an operating platform for gross proceeds of $1.2 billion and a gain of about $900 million. The group sold two smaller platforms in the five years before.

Substantial is not in doubt at the partnership level. Excluding $1.2 billion from a $1.6 billion denominator cuts it by 75 percent.

Two prior platform sales in five years leave infrequency in the seller's favor on the reasoning of Chief Counsel Ruling 2017-03, so occasional turns on whether selling platforms is the group's normal course, and the documents, the prior returns and the treatment of the two earlier sales decide it.

The test does not necessarily run once. For nonresident individuals who hold through the executive partnership, the operating partnership's business income is "apportioned at the partnership level" under sections 25120 to 25139 "and the regulations thereunder," and each partner's distributive share of the amount apportioned to California is California-source income (Cal. Code Regs., tit. 18, section 17951-4(d)). The substantiality test therefore runs on the partnership's own receipts factor. A corporate partner unitary with the partnership is different. Its share of the partnership's sales, determined by its interest in profits, enters its own sales factor, whose numerator and denominator are determined under Regulations 25134 to 25136 "and 25137(c)" (Cal. Code Regs., tit. 18, section 25137-1(a), (f)(3)). The text points to applying both prongs at the partner's level, against the partner's or its combined reporting group's denominator and the partner's normal course of business.

The two levels can give different answers on the same sale. If the management corporation is unitary with the partnership and belongs to a combined reporting group with $1.5 billion of receipts of its own, its 5 percent share of the proceeds ($60 million) is about 3.8 percent of a $1.58 billion denominator, below the five percent line, and the receipts stay in its factor unless excluded as insubstantial under section 25137(c)(1)(B). The same proceeds are excluded from the partnership-level factor that measures its nonresident partners' California income if the sale is occasional. A corporate partner that is not unitary with the partnership treats its share as another trade or business, apportioned by the partnership's factors (section 25137-1(g)). No authority was found applying the occasional sale rule to a partnership's receipts in a corporate partner's factor, and the regulations do not address it beyond the cross-reference.

What the exclusion does, and what it does not do

The exclusion removes receipts, not income. The gain stays in the apportionable base and is multiplied by a percentage computed without the sale. In Amarr, the gain was business income and the FTB removed the fixed portion of the sale price, not the earnout, from the sales factor; the regulation's purpose, OTA said, was "to remedy distortion in the sales factor."

If the receipts stay in the factor, they are assigned under the market rule for intangibles. For the complete transfer of an interest in a pass-through entity, the location of use is "the location of the use of the underlying assets" (Cal. Code Regs., tit. 18, section 25136-2(b)(12)). The look-through then assigns the receipts by the average of the platform's California payroll and property factors if 50 percent or more of its assets at original cost are real and tangible property, or by its California sales factor if more than 50 percent are intangible, with cash, cash equivalents, prepaid items and receivables excluded from the asset test for taxable years beginning on or after January 1, 2026 (section 25136-2(d)(1)(A)1.a., b., (j)(3)). The library's article on how a corporate partner sources gain on a partnership interest works through those rules.

Which answer lowers California tax depends on where the platform operated. Assume the partnership's apportionable business income, including the gain, is $1.05 billion: - Receipts excluded: the factor is $100 million over $400 million, 25 percent, and about $262.5 million is apportioned to California. - Receipts included, platform with a 10 percent California payroll and property average: $120 million of the proceeds is assigned to California, the factor is $220 million over $1.6 billion, 13.75 percent, and about $144.4 million is apportioned to California. - Receipts included, platform with a 60 percent California average: $720 million is assigned to California, the factor is $820 million over $1.6 billion, 51.25 percent, and about $538.1 million is apportioned to California.

Keeping the receipts in the factor lowers California tax in the second case and raises it in the third. The regulation does not ask which. Amarr shows the dilution in a decided case: the taxpayer reported the proceeds in the factor at 6.1 percent, the FTB's exclusion produced about 8.3 percent, and OTA sustained the FTB, noting that the reported percentage was out of line with the 7.8 and 8.0 percent factors of the two prior years.

A taxpayer that wants a result other than the one the regulation produces carries a heavy burden. Where the sale is substantial and occasional, a party arguing for inclusion "must show by clear and convincing evidence that: (1) application of the regulation would not fairly represent" its business activities in California and that its proposed alternative "is reasonable" (Amarr). The appellants there conceded the sale was substantial and occasional and lost on distortion.

How other states write the rule

California's rule is broader than the model it grew from. The Multistate Tax Commission's model regulation, in the form many states adopted, excluded substantial gross receipts from "an incidental or occasional sale of a fixed asset used in the regular course of the taxpayer's trade or business" (former model Regulation IV.18(c)(1), as revised through July 29, 2010; the Commission's 2017 amendments eliminated the Section 18 receipts-factor regulations). Arizona and Hawaii carry versions of that text, each with a factory or plant as the example and neither defining substantial (Ariz. Admin. Code R15-2D-903(1); Haw. Admin. Rules section 18-235-38-03(a)). Whether a sale of stock or a partnership interest is a "fixed asset" under those versions is a separate question that California's "or other property" language does not raise. An Arizona Department of Revenue hearing officer extended the rule's rationale to the goodwill in a deemed asset sale, adopting California's 1997 reasoning that no logical basis distinguishes fixed assets from intangibles (Decision of Hearing Officer, Case No. 201200235-C (May 31, 2013)).

Illinois goes further in the other direction. Its regulation excludes gross receipts from "an incidental or occasional sale of assets used in the regular course of the person's trade or business," with no substantiality threshold, and states that "[g]ross receipts from an incidental or occasional sale of stock in a subsidiary shall also be excluded" (Ill. Admin. Code tit. 86, section 100.3380(c)(2)). The rule is written for a "person" rather than for a corporation.

The Commission's amended Compact definition takes a different route. It defines "receipts" as gross receipts "received from transactions and activity in the regular course of the taxpayer's trade or business" (Compact Article IV.1(g), as amended). Under that definition, a sale outside the regular course is not a receipt at all, and the question becomes the transactional test itself. For a seller whose business is selling platforms, both forms lead to the same place: a sale inside its regular course stays in the factor.

Practice notes

The occasional sale analysis is made before the sale-year factor is built, and it is made at each level where a factor is computed: the partnership level that measures its nonresident partners' California income, and each corporate partner's own or combined group's level. The sound sequence is to classify the gain as business or nonbusiness income, measure substantiality on gross proceeds rather than on the net gain that federal schedules often show, and then test occasional against the seller's documents, its sales history and its prior returns. Where the receipts stay in the factor, the platform's own California factors at original cost, gathered from the platform before closing, decide the assignment. The direction of the effect varies with the platform's footprint, and the computation is run both ways before the position is taken. G&G State Tax Group provides sales factor analysis of large business and platform dispositions, including the occasional sale and look-through computations for partnerships and their corporate partners, alongside its state and local tax practice.