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In brief

On September 24, 2020, the Franchise Tax Board of California (the FTB) released a proposed regulation — new section 17951-8 of Title 18 of the California Code of Regulations — which treats the compensation of a California nonresident, non-employee director of a corporation as California-source income subject to California personal income tax if the corporation’s commercial domicile is in California. A corporation’s “commercial domicile” is the principal place from which its trade or business is directed or managed.

In depth

The proposed regulation would codify the FTB’s current position, as outlined in Chief Counsel Ruling 2019-03, issued on October 7, 2019 (the “Ruling”). The Ruling held that the California-source income of a nonresident, non-employee director should be determined in accordance with the market-based sourcing rules set forth in the Uniform Division of Income for Tax Purposes Act rather than based on whether the director attended board or shareholder meetings in California. Under the market-based sourcing rules, fees for providing a service are sourced to the location where the benefit of the service is received. As applied to non-employee director services, the Ruling concluded that since the board gives authority to and directs management to act, the benefit from such director services is received by the corporation in the location where the corporation’s highest-ranking corporate officers carry out these directions. Therefore, the fees or other compensation paid to such directors would be sourced to California if the corporation’s highest-ranking corporate officers implement the determinations of the directors in California.

Under the somewhat more objective test of the proposed regulation, it appears that California nonresident, non-employee directors of companies with principal executive offices in California would be fully subject to California income taxes on their board compensation, regardless of where the non-employee director resides, where the company’s board meetings are held or where the non-employee director otherwise performs services.

The proposed regulation is intended to “clarify” current law

According to comments made by the representatives of the FTB at the public hearing on the proposed regulation on October 1, 2020, the proposed regulation is intended to clarify existing law rather than create new law. While the proposed regulation may not become effective until 2021 (or possibly even later), the comments by the FTB representatives suggest that directors are currently subject to the compensation sourcing rule contemplated under the proposed regulation given that it is consistent with the holding in the Ruling issued in 2019, which, therefore, could be viewed as having provided ample notice to taxpayers.

Unanswered questions

Company Obligations

The proposed regulation does not contemplate imposing a withholding obligation on corporations with a corporate domicile in California with respect to director compensation. And while the proposed regulation (and the Ruling) did not expressly impose an obligation on such corporations to report nonresident director compensation on a Form 1099 for California state income tax purposes (or Form 1042-S, as applicable), this reporting obligation can be inferred from the nature of the rule, which calls for sourcing of 100% of such director compensation to California. From the FTB’s recent public hearing, we understand that subsequent guidance will provide more express instructions on any specific reporting obligations that will apply if the proposed regulation is adopted.

Potential Double Taxation for Directors

The proposed regulation sources nonresident director compensation to California based on the corporation’s domicile and not based on the location of the director’s services, creating the potential for a director’s compensation to be subject to taxation in multiple jurisdictions. Yet the proposed regulation does not presently appear to accommodate any apportionment of the taxable amount for services performed by the director in other states. If the proposed regulation becomes law, in light of the potential for double taxation, impacted California non-resident, non-employee directors who are subject to income tax on their board compensation in the states in which they reside or perform services will need to navigate the often complex state tax crediting rules to determine whether they will be eligible to take a credit for the taxes that will be imposed under the new law. Depending on local laws, directors who are resident in non-U.S. jurisdictions may face even greater difficulty in alleviating any double taxation on their director fees, given that tax treaties rarely provide for crediting of state taxes. We also anticipate that the promised guidance will address tax crediting considerations.

Current considerations for corporations with commercial domicile in California 

The Ruling and the FTB’s comment that the proposed regulation is a “clarification” of existing law, taken together, could be interpreted as imposing a current obligation on California-domiciled corporations to report the entire amount of any nonresident director compensation on a Form 1099 for California state income tax purposes. However, the lack of direct and clear instructions requiring reporting is likely to cause some companies to take a wait-and-see approach until the FTB issues more definitive guidance on any specific reporting requirements. Regardless of whether a corporation reports the nonresident director compensation on a Form 1099, California-domiciled corporations should consider notifying their nonresident directors of the sourcing rule contemplated under the proposed regulation (and Ruling) to allow the directors to consider and consult their advisors regarding their income tax obligations in light of the sourcing rule.

Interested parties wishing to provide input on the proposed regulation may submit written comments to the FTB by November 5th, 2020.


Victor Flores is a partner in Baker McKenzie’s Employment & Compensation Practice, with a focus on Executive Compensation and Employee Benefits.


Sinead Kelly is a partner in the Firm's Compensation practice. She advises on US executive compensation and global equity and has practiced in the compensation field since 2005. She regularly speaks and publishes on compensation-related topics and is a contributing author to Lexis Practice Advisor and Wolters Kluwer’s “Practical Guide to SEC Proxy and Compensation Rules,” as well as a founder of the Firm's Compensation Connection blog. She is on the Advisory Board of the Certified Equity Professionals Institute (CEPI) of Santa Clara University and is a member of the Firm's Artificial Intelligence and Blockchain working groups. Sinead has been recognized by Chambers USA for Employee Benefits and Executive Compensation, most recently in 2024, where Chambers states that she is “extremely intelligent, responsive and solution-oriented.” She is a Thomson Reuters Stand-out Lawyer for 2024, and is ranked by Legal 500 as a "Leading Lawyer" for Employee Benefits, Executive Compensation and Retirement Plan Design.