California Tax Resident or Non-Resident?
(and why you should care)
If you spend a considerable period of time in California each year and have developed significant contacts here you should be asking yourself this question. The State of California is hungry for tax revenue and believes that people who are present in California enjoying the benefits of all California has to offer for significant blocks of time each year should be paying their way.
“How will the California Revenue authorities become aware of my existence here?” The Franchise Tax Board has a number of programs designed to identify people who are here under circumstances that make them liable for filing a California income tax return. Those programs include, for example, looking at California homeowners who have a mortgage on their California property (and receive a Form 1098 from their lender), but don’t file a California tax return. They can also examine property tax payments made by persons having an out of state address on their tax bills. Rumor has it that they even resort to taking down out-of-state and foreign license plate numbers on luxury cars driving through the desert. Sometimes, somebody (like a disgruntled former spouse, lover or employee, or a jealous or vindictive neighbor) just turns you in.
Additionally, if you are filing a California tax return as a “nonresident” for any number of reasons (e.g., you derive rental income from property in California or earnings from working in California), that “nonresident” return requires the disclosure of your worldwide income in determining the amount of tax due on any California source income. Those returns are reviewed to determine whether you may be a good target for a “residency tax audit.”
“What’s California’s incentive to tax me?” A “resident” of California for California personal income tax purposes is subject to tax on their worldwide taxable income at rates reaching 13.3% in 2018. That tax is imposed in addition to whatever income tax the governments of the United States and your state or country of residence may impose on such income.
What about taxes I paid to another State, Province or Country on the same income? No credit or deduction is allowed in computing the California income tax for any foreign country or provincial income tax paid on your worldwide income. If you file and pay taxes in another U.S. state as a resident, California may allow you a state tax credit. However, the state tax credit is only allowed on income California considers to have its source in the other state and which would be taxable in the other state irrespective of where you are a resident or have your domicile there. Such income generally includes only compensation you earned while working in that state, income from land or other property located in that state and income from a business carried on there. Moreover, even if you qualify for a state tax credit on some of your income, it will only be for the tax rate you paid there, which is often considerably lower than the 13.3% tax rate applicable in California. If the difference in tax rates is substantial, California will be happy to tax the excess.
“What if I really am a California ‘nonresident’”? A “nonresident” of California is subject to California income tax only with respect to California source income, which is more limited in scope than one might expect. Among other things, it excludes income derived from this state from stocks, bonds and other intangible personal property (such as bank deposits), provided that those assets do not have a business situs in this state. For California tax purposes, such non-business income is taxable only by the country, province or state of residence.
On the other hand, any income from the ownership, control, management, sale or transfer of real property or tangible personal property in California is income from California sources. Thus, for example, income from renting a personal residence located in would be California source income. Other sources of California income include compensation for personal services performed in California and income from business carried on in the state, or partly within and partly without the state.
“How does California distinguish “residents” from “nonresidents”? Every person who is present in this state for other than a “temporary or transitory purpose” is taxable as a resident. The State’s intention is to include in the category of “residents” all individuals who are physically present in the State enjoying the benefits and protections of its laws and government, except individuals considered to be here “temporarily.”
Whether your purpose for being here will be considered “temporary or transitory”, and whether you will therefore be considered to be here “temporarily,” depends on the facts and circumstances of each particular case. In general, however, a person here for a brief rest or vacation, or for a purpose which will require his presence for only a short period, is considered to be here for a “temporary or transitory” purpose and will not become a resident by virtue of such presence here.
“What if my stays here are indefinite, rather than temporary?” For administrative convenience, the California has established presumptions about the character of an individual’s stay in California as either “temporary” or “indefinite,” based on the number of days on which he or she is present here during a particular year. An individual who spends in the aggregate more than nine months of any tax year in California will be presumed to be a California resident. Although his presumption may be overcome by satisfactory evidence that the person in question is in the State for temporary or transitory purposes only, overcoming the nine-month presumption is “ very tough sledding.”
A second presumption (which has several conditions) treats an individual as being in this state for “temporary or transitory” purposes if: (i) his presence in California does not exceed an aggregate of six months within the taxable year, (ii) he is “domiciled” in another state; (iii) maintains a permanent abode at the place of his domicile at all times during the year; and (iv) he does not engage in any activity or conduct within the state other than that of a seasonal visitor, tourist or guest.
“What if I can’t rely on the six-month presumption, or California challenges my qualification for it? If you cannot rely on the six-month presumption of non-residence, the analysis of your status here will depend largely on the circumstances of your life during each tax year in question, both here and wherever else you claim to live, and on the relative quality and number of your contacts with California and that place, respectively. If you are considered to maintain a closer connection with your country or state of residence than with California during the year in question, determined by evaluating the strength and number of your contacts with each location during that year, you may be treated as a California nonresident. On the other hand, it you are considered to have had a closer connection during that year to California than to your claimed state of residence, you may be treated as a California resident, even if you nominally qualify for the presumption of nonresidence.
“How would California know how many days I spend in California?” If the Franchise Tax Board (“FTB”) believes that they may be able to succeed with an attempt to treat you as a resident of California, they will themselves reconstruct the number of days you were present in California, rather than relying on what you tell them (based on information they gather from you via information and document requests). To do so, they will demand many different types of records tending to indicate where you were on each day of the year. Unless you are considerably more careful than the average person, you leave a significant paper trail from which the days of your presence and the nature of your contacts here can easily be recreated.
“What should I do to avoid becoming a California tax resident’? Many different types of contacts may be counted and weighed in a California residency audit and the type of contacts that may be taken into account for this purpose are limited only by the unique nature of each individual’s personal circumstances and lifestyle. Nevertheless, there are many ways in which your local lifestyle can be restructured to avoid exposing yourself to California income tax as a tax resident. Lance Crossborder Law and Tax can help you to identify areas of exposure in your present lifestyle and plan to make changes that will help to keep you from losing a California residency tax audit, before you find yourself confronted by one.
“What should I do I am contacted by the California tax authorities?” If you are contacted by the FTB for any reason:
• Don’t meet or talk with them yourself, particularly on the telephone, or get off the phone as quickly as possible; ask them for a call back number and let them know that you will have your tax professional contact them. In our experience, when a client engages in any conversations or correspondence directly with the tax authorities, they make statements which they intend to be helpful to their cause, but which often only get them in trouble. The FTB may also lead you into making statements or open up topics which are not in your interest to discuss with them. It is very difficult to rehabilitate statements made under these circumstances which are damaging to your interests. Additionally, evasive or untrue statements can also get you in trouble.
• Don’t correspond with them to learn more about what they want, attempt to explain the circumstances or for any other reason, without having your proposed inquiry or response reviewed first by an experienced cross-border tax attorney;
• Don’t attempt to resolve the question of your residency yourself. In our experience, doing it yourself often makes matters worse in a way that can’t be undone. All of your proposed contacts with the FTB should be drafted by an experienced cross-border tax attorney.
• Don’t procrastinate when you receive correspondence from the FTB. Time is almost always of the essence in these matters.
Please contact Lance Crossborder Law and Tax at once to schedule an appointment if any of the foregoing gives you cause for concern.
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