For California's other-state tax credit, is S corporation business income sourced by the corporation's activities even if IRC section 469 calls it portfolio income?

Plain-English summary

California Chief Counsel Ruling 20-0322 said an S corporation shareholder's share of business income was sourced by the corporation's activities when calculating California's credit for net income taxes paid to another state.

The result did not change merely because IRC section 469 classified the same income as portfolio income for the limited purpose of the passive-activity rules.

FTB used the same sourcing approach for the resident credit that California used to source business income of nonresidents.

The question

The ruling concerned business income from an S corporation's asset sales that passed through to its shareholders.

The requester asked whether source should still be determined at the S corporation level when the income was also portfolio income under IRC section 469.

The source mattered because Revenue and Taxation Code section 18001 required qualifying income to have a source in the other state before a California resident could claim the credit.

Corporate activities controlled the source

FTB said the source of S corporation business income depended on the corporation's activities, not the shareholders' activities.

If the corporation conducted business entirely within one state, the ruling said all of its business income was sourced to that state.

If it conducted business in multiple states, the ruling described the then-applicable general apportionment formula using property, payroll, and a double-weighted sales factor.

FTB applied those nonresident sourcing rules to the resident-credit calculation.

Why the portfolio-income label did not change the answer

Treasury Regulation section 1.469-2T(c)(3) classified certain income as portfolio income to exclude it from passive-activity income limitations.

FTB treated that classification as limited to IRC section 469.

It did not alter the state-source analysis for the resident credit.

Holding

For purposes of Revenue and Taxation Code sections 18001 and 18006, an S corporation shareholder's share of business income was sourced by the location of the corporation's business activities.

The income's separate classification as portfolio income for section 469 did not change that sourcing result.

Important limits

FTB did not decide:

• Whether the named taxpayers were California residents.
• Whether they satisfied the other requirements for the tax credit.
• Whether the income actually was business income.
• Whether the income actually was portfolio income.

The ruling addressed only how to source S corporation business income that was also classified as portfolio income.

What this means for you

S corporation shareholders

For this credit analysis, the corporation's operational footprint controlled the source of pass-through business income under the ruling, not the shareholder's personal activities.

Multistate businesses

Keep records showing where the corporation conducted its business and how income was apportioned under the rules applicable to the relevant year.

Tax professionals

Analyze source, credit eligibility, residence, and federal passive-activity classification as separate questions. A federal portfolio-income label did not resolve California source.

Common questions

Q: Did shareholder residence determine the source of the S corporation's business income?

A: No. FTB looked to the corporation's activities.

Q: Did IRC section 469 portfolio treatment change the state source?

A: No. That classification served the limited passive-activity purpose described in the ruling.

Q: Did FTB confirm that the shareholders qualified for the resident credit?

A: No. It did not decide their residency or compliance with the credit's other requirements.

Q: Did FTB decide that the asset-sale income was business income?

A: No. The ruling assumed the classification for purposes of answering the sourcing question.

Key source language

• General rule: “The source of S corporation business income is determined by reference to the activities of the S corporation and not its shareholders.”
• Portfolio-income issue: “The fact that the business income may also be portfolio income for the limited purposes of Internal Revenue Code section 469 does not change this result.”
• Conclusion: “The source of an S corporation shareholder's pro rata share of S corporation business income is determined by the location of corporate activities in the same manner that such income is sourced for nonresidents.”
• Federal-rule limit: “Such classification is limited to the application of Internal Revenue Code section 469 in other contexts and has no effect upon the sourcing of income for tax credit purpose.”

Citations and references

• Cal. Rev. & Tax. Code §§ 17551, 18001, 18006, and 21012(a)(1)
• I.R.C. § 469(c)
• Treas. Reg. § 1.469-2T(c)(3)
• Valentino v. Franchise Tax Board, 87 Cal. App. 4th 1284 (2001)

Source

• Landing page: Chief Counsel Ruling index
• Official ruling: Chief Counsel Ruling 20-0322
• Identifier check (2026-10-07): this May 3, 2001 PDF prints “Chief Counsel Ruling 20-0322.” A distinct February 23, 2001 ruling prints the same number; FTB published both under different official URLs.

Original ruling text

STATE OF CALIFORNIA
KATHLEEN CONNELL
FRANCHISE TAX BOARD
Chair
Legal Branch
CLAUDE PARRISH
PO Box 1720
Member
Rancho Cordova, CA 95741-1720
(916) 845-5316 Fax (916) 845-3648
B. TIMOTHY GAGE
Member

May 3, 2001
Chief Counsel Ruling
20-0322

Re: ****

Dear *****,

In your letter dated **, you asked the following question:

When calculating the resident credit for net income taxes paid to another state, is the source of business income resulting from the sale of assets by the * **** and passed through to the named shareholders determined at the S corporation level in the case where the business income is properly classified as portfolio income for purposes of the passive activity loss provisions of Internal Revenue Codes section 469? (Revenue and Taxation Code section 17551.)

The rules for determining the source of income for allowing a resident credit for net income taxes paid to another state are those applied in determining the source of income for imposing tax on nonresidents generally. These rules provide that the source of S corporation business income is determined by reference to the activities of the S corporation and not its shareholders. Accordingly, the source of such income for allowing a credit pursuant to Revenue and Taxation Code sections 18001 and 18006 is determined by reference to the activities of the S corporation. The fact that the business income may also be portfolio income for the limited purposes of Internal Revenue Code section 469 does not change this result.

We specifically do not rule on whether the named taxpayers are residents of California and thus entitled to compute a credit for net income taxes paid pursuant to Revenue and Taxation Code section 18001 or 18006, or whether any of the other requirements of those sections are satisfied. We also do not rule on whether the income to which you refer to is in fact business income or portfolio income. This ruling is expressly limited to the question of whether business income of an S corporation also classified as portfolio income has a source by reference to where the corporate business activities are conducted for purposes of allowing residents of California a credit for net income taxes paid to another state pursuant to Revenue and Taxation Code sections 18001 and 18006.

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****.
Control Number 200136
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Revenue and Taxation Code section 18001 allows residents of California a credit for net income taxes paid to another state if certain requirements are satisfied, one of which is that the income must have a source in the other state.

Revenue and Taxation Code section 18006 states that, for purposes of determining a credit for taxes paid to other states, a shareholder of an S corporation may treat his or her pro rata share of taxes paid by the S corporation as if paid by the shareholder individually, if certain conditions are satisfied.

Neither section, nor the regulations issued thereunder, provides rules for determining the source of income entering into the credit calculations. For purposes of determining gross income of nonresidents, however, the source of an S corporation shareholder's pro rata share of business income is determined by reference to the location of corporate activities. If the S corporation is conducting business entirely within one state, all of the business income has a source in that state. (Valentino v. Franchise Tax Board (2001) 87 Cal.App.4th 1284.) If the S corporation is conducting business in more than one state, business income is generally apportioned between the states by the use of the four-factor formula consisting of property, payroll and double weighted sales factor.

We agree that the same sourcing rules should be applied in allowing credits to residents as those applied in imposing tax on nonresidents. Accordingly, we conclude that the source of an S corporation shareholder's pro rata share of S corporation business income is determined by the location of corporate activities in the same manner that such income is sourced for nonresidents.

Treasury Regulation section 1.469-2T(c)(3) classifies certain income as portfolio income for the limited purpose of excluding such income from the definition of passive activity income subject to limitation. Such classification is limited to the application of Internal Revenue Code section 469 in other contexts and has no effect upon the sourcing of income for tax credit purpose. (Internal Revenue Code section 469(c).)

Please be advised that the tax consequences expressed in this Chief Counsel Ruling are applicable only to the named taxpayers and are based upon and limited to the facts you have submitted. In the event of a change in relevant legislation, or judicial or administrative case law, a change in federal interpretation of federal law in cases where our opinion is based upon such an interpretation, or a change in the material facts or circumstances relating to your request upon which this opinion is based, this opinion may no longer be applicable. It is your responsibility to be aware of these changes should they occur. This letter is a legal ruling by the Franchise Tax Board Chief Counsel within the meaning of Revenue and Taxation Code section 21012(a)(1).

Please attach a copy of this letter and your request to the appropriate return(s) (if any) when filed or any notices or inquires which might be issued.

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****.
Control Number 200136
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Sincerely,

Richard Gould
Tax Counsel