Was a payment to cancel a nonresident's personal-service contract California-source income when all contracted services had to be performed in Hollywood?

Plain-English summary

California Legal Ruling 133 held that a payment to cancel a nonresident's personal-service contract was California-source income because every service under the contract had to be performed in Hollywood.

The payment substituted for future earnings contemplated by the contract. It was not treated as proceeds from selling an intangible contract right.

FTB also treated payment for release from the California performance obligation like payment for actual California performance and denied the taxpayer's withholding refund.

Facts addressed by the ruling

The nonresident taxpayer signed a contract with a motion-picture company in July 1949.

The contract required all services to be performed in Hollywood.

In July 1953, the parties mutually agreed to cancel the contract. The company paid the taxpayer a substantial sum after deductions for state income tax, federal withholding, and Social Security taxes.

The taxpayer sought a refund of the withheld California income tax.

Historical personal-service sourcing rule

Former regulation 17211-17214(b) included compensation for personal services performed in California within California-source income.

The contract itself fixed the location of every contemplated service in Hollywood. No out-of-state performance was part of the bargain described by the ruling.

Why cancellation did not change the source

The ruling characterized the payment as replacing future earnings that would have been received under the service contract.

That characterization defeated the argument that the payment arose from an intangible contract right with a different situs.

Releasing the taxpayer from an obligation to perform services in California stood on the same footing as paying for those services after performance.

Wage treatment supported the conclusion

The motion-picture company withheld state income tax, federal withholding, and Social Security taxes.

FTB viewed those deductions as evidence that the company treated the payment as wages. Together with the California-only service requirement, that supported California sourcing.

What this means for you

Nonresident service providers

Under the historical ruling, a buyout or cancellation payment could retain the source of the compensation it replaced. Nonperformance after cancellation did not automatically turn the payment into non-California intangible income.

Employers

Contract terms specifying where services must be performed and the payroll treatment of a cancellation payment can materially affect sourcing and withholding.

Accountants and tax professionals

Review the underlying service obligation, permitted work locations, payment purpose, wage reporting, withholding, and whether the payment substitutes for future compensation. Apply current California sourcing rules to the actual agreement.

Common questions

Q: Was the cancellation payment California-source income?

A: Yes, under the ruling.

Q: Why, if the taxpayer did not perform the future services?

A: The payment substituted for earnings under a contract that required those services to be performed in Hollywood.

Q: Was the payment treated as proceeds from an intangible contract right?

A: No. The ruling expressly rejected that characterization.

Q: Did withholding matter?

A: Yes. FTB cited the tax and Social Security deductions as evidence that the company treated the payment as wages.

Q: Was the taxpayer entitled to a California withholding refund?

A: No.

Citations and references

• Former California regulation 17211-17214(b)
• Gann v. Commissioner, 41 B.T.A. 388

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 133

Original ruling text

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Legal Ruling 1958-133

California Franchise Tax Board
Legal Ruling No. 133

June 23, 1958

Income: Source in California

Amounts paid in cancellation of a personal service contract have their source within California when under the contract all of the personal services must be rendered in California.

Taxpayer, a nonresident of California entered into a contract with X Corp., a motion picture company, in July, 1949. Under the terms of the contract all services were to be performed in Hollywood. In July, 1953, X Corp. paid taxpayer a substantial sum, less deductions for State income, Federal withholding, and Social Security Taxes, as a result of a mutual agreement of the parties to cancel the contract. Taxpayer claims a refund of the amount withheld for State Income Taxes. Advice is requested whether the payment had its source in California.

Regulation 17211-17214(b) defines income from sources within this State to include "compensation for personal services performed within this State." The contract in question specifically provided that all services would be performed in Hollywood. Payments of this kind are in substitution of future earnings originally contemplated in the contract rather than in performance of the obligation to pay them. Therefore, this forecloses the contention that the payment was an intangible stemming from the contract itself. It must be noted that similar payments are held to be ordinary income rather than capital gain for Federal tax purposes. George K. Gann, 41 BTA 388.

It is evident X Corp. considered the payment as wages in view of the fact that they made deductions for taxes. Since it was considered as wages for those purposes, and the services could only be performed in California under the contract, the conclusion must be that the payment had its source in California. Further, payment in release of an obligation to perform in California stands on the same footing as payment for actual performance. Therefore, the payment has its source in California and taxpayer is not entitled to a refund.

Last updated: 11/26/2025