When does California throwback apply, and what makes a taxpayer taxable in another state?

The rule

Revenue and Taxation Code Section 25135(a)(2) assigns a sale to California if the property is shipped from an office, store, warehouse, factory, or other place of storage in this state and either the purchaser is the United States government or the taxpayer is not taxable in the state of the purchaser. The rule is origin-conditioned: it reaches only sales that physically leave California, so goods shipped from an out-of-state warehouse or fulfillment center are outside it, though not necessarily outside the numerator, because the regulations add a further rule for sales made through California. Under the double throwback rule of the regulation, where a salesperson operating from a California office makes a sale to a purchaser in a state where the taxpayer is not taxable and a third party ships the goods directly from a state where the taxpayer is also not taxable, the sale is assigned to California (Cal. Code Regs. tit. 18, section 25135, subd. (a)(7)). Section 25135(b) then states the group rule for combined reports: sales assigned to California come into the numerator regardless of which member made them, and a sale is not thrown back if another member of the combined reporting group is taxable in the state of the purchaser.

Taxable in another state: the operative test

Section 25122 supplies the definition, and it deserves close reading because each clause carries weight. A taxpayer is taxable in another state if (a) in that state it is subject to a net income tax, a franchise tax measured by net income, a franchise tax for the privilege of doing business, or a corporate stock tax, or (b) that state has jurisdiction to subject the taxpayer to a net income tax regardless of whether, in fact, the state does or does not. The first prong turns on taxes actually imposed; the second turns on the state's power whether exercised or not. A taxpayer needs only one.

The first prong: taxes that count

The first prong's list runs well beyond net income taxes, and that is where much of the modern relief lives. A franchise tax for the privilege of doing business qualifies without regard to its measure, which matters because Public Law 86-272, the federal statute that protects sellers of tangible personal property whose in-state activity is limited to solicitation, protects them only from taxes on net income. A state that imposes an entity-level tax measured by capital, gross margin, or gross receipts can collect it from a seller fully protected against that state's income tax, and a taxpayer paying such a tax is subject to it in the ordinary meaning of the term. The statutory list includes a franchise tax for the privilege of doing business without limiting that category by measure (Rev. & Tax. Code section 25122, subd. (a)), which supports treating privilege taxes measured by gross receipts or margin as qualifying taxes. The consequence is concrete: destination states with capital-based franchise taxes, margin taxes, or business gross receipts taxes belong in the analysis even where the taxpayer's income tax footprint is fully protected, and the returns and payments actually filed in those states are the cleanest first-prong evidence a workpaper can hold.

The second prong: jurisdiction, exercised or not

The second prong asks only whether the destination state could impose a net income tax on the taxpayer. Two developments since the older generation of throwback workpapers have expanded the answer. Economic nexus standards, which spread broadly after the Supreme Court's Wayfair decision discarded the physical presence requirement, give states jurisdiction over sellers with in-state sales above modest thresholds, and jurisdiction is what the prong tests. Public Law 86-272 still limits that jurisdiction for a seller of tangible personal property whose activity in the state does not exceed solicitation, so the second prong analysis for a protected seller is an 86-272 analysis: the prong is satisfied in any state where the taxpayer's activities exceed the protection. That is where fulfillment logistics decide the question. Inventory owned in a state, including inventory positioned in a marketplace or third-party fulfillment center, is not solicitation, and a taxpayer with stock on the ground in a state has given that state jurisdiction to tax its income. The Franchise Tax Board's 2022 guidance on internet activities, Technical Advice Memorandum 2022-01 and the related Publication 1050 revisions, was invalidated in December 2023 on procedural grounds as an underground regulation and has not been re-adopted by regulation, while several other states have adopted the broader reading by rule, so positions built on the outer edge of protection should be documented with both sides in mind.

What this does to a California-based seller

For a seller shipping from California, the arithmetic of these rules has shifted across the open years. A workpaper that threw back one hundred percent of sales because the company had no out-of-state payroll or property answered the question as it stood when physical presence governed and the destination states' non-income taxes went unexamined. The same facts run through the current test differently: destination states where the group pays a franchise or gross receipts tax fall out under the first prong, states where inventory sits in fulfillment centers fall out under the second, economic nexus states fall out to the extent activities exceed protection, and the group-level rule credits any member's taxability. Sales shipped from an out-of-state fulfillment center leave the throwback rule entirely, and goods the taxpayer owns in a third-party fulfillment center usually make the taxpayer taxable in that origin state, which also takes those sales outside the double throwback rule. The direction of the change is not one-way relief, because taxability in more states also means filing obligations in more states, but a numerator carried forward from old workpapers is worth recomputing before it is defended.

Practice notes

The throwback file is a matrix, not a memo. First, build the state-by-state taxability schedule for each open year: the taxes the group actually paid in each destination state, prong by prong, with the returns attached, because throwback is tested year by year and state by state, and last year's matrix is evidence rather than an answer. Second, inventory the inventory: where fulfillment stock sat, in whose name, and for which periods, since those facts move states between prongs and move shipments in and out of the rule itself. Third, reconcile the exposure and the refund in the same schedule: the analysis that defeats throwback in a destination state usually implies a filing obligation there, and the position is coherent only when the numerator relief and the destination-state compliance tell the same story. G&G State Tax Group provides throwback and taxable-in-another-state analysis alongside its state and local tax practice.