August 2012 Archives

August 28, 2012
Posted by Michael Brooks

Canadians Visiting La Quinta California, You Too Need to Make Sure You're Not Deemed a Resident of California, Part 2

So we're on to Part 2 on this topic. Here, we're talking about a Canadian citizen who owns a California home (let's say in La Quinta for example), and the likelihood that person is deemed in a California resident for tax purposes. Again, in fairness, it's going to be highly unlikely the FTB (the California Franchise Tax Board...basically the IRS for the State of California) deems a Canadian citizen a California resident in a given year, because most Canadians are here on a B-2 Visa (they may not even be aware of this fact), where they simply show the US officials at the border their passport and they're permitted entry in the US. Under the standard B-2 tourist Visa, the Canadian citizen is only legally permitted to stay in the US up to 6 months in a calendar year. Unless the Canadian citizen is violating the terms of the B-2 Visa (not a good idea, it could be hard to get into the US the next time), or is in the US on a visa other than a B-2 where the Canadian is permitted to stay in the US more than 6 months (like a work related visa), or the Canadian is a dual Canadian-US citizen or has a US green card (permitting the Canadian citizen to stay the entire year in the US if he or she likes), it's difficult for the Canadian (in California less than 6 months) to be deemed a California resident. But not impossible. We must re-review the checklist of items the FTB looks at from Part 1 of this topic (e.g., location of your spouse/RDP and children; location of your principal residence; where your vehicles are registered; where you maintain your professional licenses, etc.). The FTB may still deem the Canadian a California resident if they have enough checks in the wrong category, even though the Canadian does not spend more than 6 months a year in California.

Presumption Generally

Let's review the FTB's presumption on time spent in California. If you spend more than 9 months (in a calendar year) in California- you are presumed to be a California resident that year (but you can rebut it by going to the checklist).

What does it Mean For a Canadian to Be Deemed a Resident of California?

It's significant. It means that California will tax the individual up to 9.3% of the income they earn anywhere in the world. And the key part is there will be no credit available in Canada on these taxes (unlike federal taxes imposed by the IRS). In addition, California does not allow a foreign tax credit or foreign earned income exclusion. There is no treaty or credit system between states and countries or states and provinces.

But it's Unlikely a Canadian Will Be Deemed a California Resident, So What California Taxes are Canadians Much More Likely to Owe?

Instead of owing 9.3% on the income the Canadian earns anywhere, it is far more likely the Canadian will owe tax, as a nonresident of California, solely on their California source income. So what are we talking about here?

Gain From the Sale of California Real Property- A big one. You sell your California vacation house, you owe tax in California. Count on 9.3% of the gain on the property (i.e, buy for $300,000, sell for $500,000, its 9.3% x $200,000= $18,600 in tax to the state of California). You're still going to owe tax to the IRS on top of this. By the way, upon the sale of your house, the buyer must withhold from you (the Canadian seller) either: 10% of the gross sales price ($50,000 in our example above); or 9.3% of the gain ($18,600), and send it in directly to the FTB. You, as the seller, can choose the withholding amount (you should choose the lower amount). The withholding amount isn't the final tax you owe, it's just the state of California's insurance policy that you won't shuffle back to Canada without paying the California tax. It's a security deposit if you will.

We'll talk about the tax on other sources of California income earned by the Canadian, like wages earned in California, business income earned in California, and California interest and dividends, in Part 3 of the series.

August 23, 2012
Posted by Michael Brooks

Canadians Visiting California, You Too Need to Make Sure You're Not Deemed a Resident of California

It's going to be harder for most Canadian snowbirds visiting California to be deemed California residents than it is Americans from other states to be deemed California residents, but it's not impossible. The biggest reason for this is most Canadian snowbirds are in California (and the US) on a B-2 tourist visa, which means the Canadian snowbird (unlike other Americans) cannot be in California longer than 6 months in a calendar year (without violating their visa). Also, as the Canadian snowbird reviews the checklist below, it appears less likely (although not impossible) somebody who lives permanently in Canada could have too many negative checks on the checklist. On the other hand, the test for California residency is in some ways more dangerous to the Canadian snowbird than the test for US residency. Why? Because if the Canadian snowbird fails the test for US residency in a given year (we've discussed the test in prior blog entries), they could still fall back on the US-Canada Tax Treaty, which contains tie-breaker provisions between the two countries- which would probably lead to the determination that the Canadian who failed the US residency test (i.e., was in the US too much in a given year) was still a resident of Canada (and not the US) in a given year. California has no treaty with Canada (no US state does). So there isn't any treaty to save the day for the Canadian who is deemed by the State of California to be a California resident in a given year.

The rest of the analysis for the Canadian snowbird is the same as it is for Americans from other states visiting California...

General Rules on California State Taxes

Let's start with some general principles of California state taxation:

Residents of California- are taxed on ALL income, including income from sources outside California. A California resident is any individual who meets any of the following:
• Present in California for other than a temporary or transitory purpose.
• Domiciled in California, but outside California for a temporary or transitory purpose.

Domicile means the place where you voluntarily establish yourself and family, not merely for a special or limited purpose, but with a present intention of making it your true, fixed, permanent home and principal establishment. It is the place where, whenever you are absent, you intend to return.

Nonresidents of California- are taxed only on income from California sources. A nonresident is any individual who is not a resident.

Part-year residents of California- are taxed on all income received while a resident and only on income from California sources while a nonresident. A part-year resident is any individual who is a California resident for part of the year and a nonresident for part of the year.

California Has a High State Income Tax

Individuals from other states and other countries will want to avoid being deemed a California State Tax Resident. Why? Because California state taxes are not low. For 2102, the highest rate of tax (for individuals earning over $98,000 approximately) is 9.3%. That's in addition to the federal income taxes (with a high rate of 35%). So this is a high state income tax, no question.

How Does the FTB (the California Franchise Tax Board) Determine Whether an Individual is a California Tax Resident?

It applies the "Closest Connection Test." This refers to the state with which a person has the closest connection during the taxable year. For the FTB, this literally means counting all the California contacts a person has and comparing that number with the non-California contacts. Of course, some contacts simply weigh more than others.

Factors to consider are as follows:
• Amount of time you spend in California versus amount of time you spend outside California.
• Location of your spouse/RDP and children.
• Location of your principal residence.
• State that issued your driver's license.
• State where your vehicles are registered.
• State in which you maintain your professional licenses.
• State in which you are registered to vote.
• Location of the banks where you maintain accounts.
• The origination point of your financial transactions.
• Location of your medical professionals and other healthcare providers (doctors, dentists etc.), accountants, and attorneys.
• Location of your social ties, such as your place of worship, professional
associations, or social and country clubs of which you are a member.
• Location of your real property and investments.
• Permanence of your work assignments in California.

So a determination of residency, at first instance, is a balancing test. Again, not all factors are created equally. A job or real estate ownership indicates a closer tie than merely enjoying a country club membership.

There's a lot more to discuss regarding California income tax, including how nonresidents are subject to tax on their California source income, in our next post....

August 20, 2012
Posted by Michael Brooks

I Own a House in Palm Springs, California, But I Really Live in Another State. How Do I Avoid Being Deemed a California Resident?

We next start a detailed series on the consequences of, and how to avoid, being deemed a California state resident for state income tax purposes. We will track this discussion on our Canadian Snowbird blog.

General Rules on California State Taxes

Let's start with some general principles of California state taxation:

Residents of California- are taxed on ALL income, including income from sources outside California. A California resident is any individual who meets any of the following:
• Present in California for other than a temporary or transitory purpose.
• Domiciled in California, but outside California for a temporary or transitory purpose.

Domicile means the place where you voluntarily establish yourself and family, not merely for a special or limited purpose, but with a present intention of making it your true, fixed, permanent home and principal establishment. It is the place where, whenever you are absent, you intend to return.

Nonresidents of California- are taxed only on income from California sources. A nonresident is any individual who is not a resident.

Part-year residents of California- are taxed on all income received while a resident and only on income from California sources while a nonresident. A part-year resident is any individual who is a California resident for part of the year and a nonresident for part of the year.

California Has a High State Income Tax

Individuals from other states and other countries will want to avoid being deemed a California State Tax Resident. Why? Because California state taxes are not low. For 2102, the highest rate of tax (for individuals earning over $98,000 approximately) is 9.3%. That's in addition to the federal income taxes (with a high rate of 35%). So this is a high state income tax, no question.

How Does the FTB (the California Franchise Tax Board) Determine Whether an Individual is a California Tax Resident?

It applies the "Closest Connection Test." This refers to the state with which a person has the closest connection during the taxable year. For the FTB, this literally means counting all the California contacts a person has and comparing that number with the non-California contacts. Of course, some contacts simply weigh more than others.

Factors to consider are as follows:
• Amount of time you spend in California versus amount of time you spend outside California.
• Location of your spouse/RDP and children.
• Location of your principal residence.
• State that issued your driver's license.
• State where your vehicles are registered.
• State in which you maintain your professional licenses.
• State in which you are registered to vote.
• Location of the banks where you maintain accounts.
• The origination point of your financial transactions.
• Location of your medical professionals and other healthcare providers (doctors, dentists etc.), accountants, and attorneys.
• Location of your social ties, such as your place of worship, professional
associations, or social and country clubs of which you are a member.
• Location of your real property and investments.
• Permanence of your work assignments in California.

So a determination of residency, at first instance, is a balancing test. Again, not all factors are created equally. A job or real estate ownership indicates a closer tie than merely enjoying a country club membership.

There's a lot more to discuss regarding California income tax, including how nonresidents are subject to tax on their California source income, in our next post....

August 14, 2012
Posted by Michael Brooks

I'm Not Happy About My Riverside County Property Tax Bill, How Do I Appeal It?

As a California property owner, you have the right to appeal the amount of your property taxes. You can use an attorney to represent you in your appeal, or you can do it yourself. Property taxes are assessed (and appealed) on a county-wide basis in California, so for those of us in Riverside, Banning/Beaumont and the Coachella Valley (Palm Springs, Rancho Mirage, Palm Desert, Indian Wells, etc.), our appeals are handled in Riverside County.

Am I really Challenging The Amount of My Taxes?

Actually no, what you are really challenging is the Riverside County Assessor's enrolled value of your property.

Appeals Generally

First of all, there is a chance (maybe unlikely) you can change your assessed value without even appealing. You can try contacting your Assessor and make the case informally. Absent a glaring mistake or omission by the Assessor, that's probably not going to work. So you can file an appeal with your local appeals board (for us in the Palm Springs area, this means the Appeals Board of Riverside County). Again, an attorney is not required, but property tax appeals frequently include legal issues, and attorneys are used to the appeals process (they do many of these), so it's not the worst idea. And by the way, the appeals process (with the Riverside Board) is going to take a while, in fact you can count on months (maybe 6 to 8 months until your hearing).

What Kind of Appeal Do You Want to File?

Decline in Value Appeal- Very common. You believe your property is no longer worth as much as the assessed value. If you are filing a decline in value appeal, you must file your appeal as follows:

If you received your assessment in the mail by August 1- you must file your appeal between July 2 and September 15.

If you did not receive your assessment in the mail by August 1 (you received it later)- you must file your appeal between July 2 and November 30.

Base Year Value Appeals- A little different than a decline in value appeal. Here, what you're auguring is that there should be a change in your property's "base year value", because (for example) a change in ownership of the property occurred, or perhaps there has been a change to the structure of the property (you added a garage). The concept of a base year value, of course, stems from California's Proposition 13. Under Proposition 13, once a base year value has been established (for example, when you buy a previously owned house, the property has now undergone a change in ownership, and a new base year value is established), the property value (for tax purposes) can only go up a small percentage each year. We'll speak more of Prop. 13 in detail in later blog posts.

Calamity Reassessment Appeal- A natural disaster has affected the value of your property (so a reassessment is required).

What Kind of Evidence Can You Present?

Obviously, most people will want to show evidence that their property is not worth what the assessor believes. The best evidence will be sales of houses which are comparable to yours (e.g., in your area, of like size, etc.). While the Appeals Board will consider this evidence, the only "comps" which generally count for their purposes are the sales that occurred between January 1 and March 30 of the year in question (sales prior to Jan 1 can be considered as well, but must be adjusted for elapsed time). You may wish to consider getting a formal appraisal (although evidence of three comparable sales of home sales in your area (within one mile radius of your home), of (generally) the same size and condition, will generally suffice.

For more information on the Riverside County Property Tax Assessment Appeals Process, give us a call.

August 13, 2012
Posted by Michael Brooks

I'm the Executor of the Estate of a Canadian Citizen who Died Owning a Palm Desert California House (or a House Owned Anywhere in the US), And I Need to File A US Estate Tax Return (and Claim the Protection of the US-Canada Tax Treaty). What do I do?

We've written before about Canadians being subject to the US estate tax. We know that a Canadian (or any non-US domiciled (also not a US citizen) individual) can be subject to the US estate tax on the value of some of their US property when they die. What property are we talking about? Mainly the value of their US house(s)/ real estate, and furnishings in the house(s), and (and this is important)- the value of their US securities (stock of US companies). US securities count no matter where the Canadian holds the stocks, but there is an exception for the US securities held by a Canadian mutual fund (but note, there is no exception for securities held by the RRSP of a Canadian...the value of US securities held in those count).

How Much May a Canadian Exempt From the US Estate Tax?

Recall that this year US citizens/or residents can exempt $5M from their US estate tax computation (that's a good deal for Americans, but on other hand they are subject to the US estate tax on the value of their assets held anywhere in the world, not just their US assets). But next year, as presently scheduled, US citizens may only exempt the first $1M from the estate tax (yikes).

As a general rule, non-US citizen/residents may only exempt $60,000 from the estate tax. So a Canadian who dies with a $250,000 house in the US is potentially subject to an estate tax based (generally) on the value of $190,000 in assets ($250,000 - $60,000). That could lead to the Canadian owing maybe $50,000 or so in the US estate tax. The estate of the deceased Canadian won't like that. That's why the executor must invoke the protection of the US-Canada Tax Treaty.

Remember, the US/Canada Tax Treaty Offers Relief, But the Executor Must Invoke the Treaty Relief...It's Not Given Automatically

Recall that the US-Canada Tax Treaty offers relief so that the estate of the deceased Canadian may not have to pay any US estate tax. Recall that the estate of a deceased Canadian may invoke Article XXIX(B)(2)(a) of the Treaty, which says the deceased Canadian may exclude an amount from the US estate tax based on the following formula: $5M (the US exclusion amount, at least for the rest of 2012) x (the value of Canadian decedent's US assets ($250,000 in this example) / the value of the Canadian decedent's worldwide assets (let's say $1M for this example)). So, its $5M x ($250,000/ $1M)= $1.25M the Canadian may exempt. So this amount the Canadian may exempt (1.25M in US assets) is well above the $250,000 in US assets the Canadian decedent died with, so there easily will be no US tax owed here, AS LONG AS THE EXECUTOR INVOKES THE TREATY!!!

How To Invoke the Treaty

The executor must oversee the completion of the IRS Form 706-NA. This is the US estate tax form which must be filled out for executors of non-US citizen residents who die with US assets. But, and here's the key part, the executor must also ensure that attached to the back of the From 706-NA is an IRS Form 8833. This is the IRS form which must be completed to take a treaty position (any treaty position, so it's a good form to get to know). Filing out the IRS Form 706-NA without the Form 8833 could lead (needlessly) to the estate of the Canadian paying $50,000 in US estate tax, when they didn't need to pay a dime. But the executor must actively invoke the treaty by having the Form 8833 completed and attached to the back of the 706-NA!!! The treaty protection does not come automatically.

August 6, 2012
Posted by Michael Brooks

I'm a Canadian Who Plans to Purchase California Real Estate Which I Can Rent Out, But I'm Worried About Possible Lawsuits. What is the Best Form of Home Ownership For This Purpose (Part 3)?

This is the third (and last) part in this series. We see a lot of Canadians here in the Palm Springs/ Palm Desert area/ Coachella Valley area who are interested in not just vacationing here, but in purchasing property which they will then rent out. This series has been about the best way to own California property which will be rented out, with the goal of minimizing any damage from a tenant who likes to sue landlords. While this series has been directed towards Canadians purchasing local property, everything we've written in this series (with the exception of the discussion about LLCs and why they don't currently work for Canadians) applies to people from any country, and for that matter much of it applies to Americans wanting to purchase and rent out California property as well.

We've concluded that the limited partnership is likely the best structure (for now) for the Canadian looking to purchase and then rent out Palm Springs/ Palm Desert area/ Coachella Valley property. Let's look at a few more questions and answers on this topic.

Why Don't I Just Use a Corporation to Buy the Property, But Instead of My Corporation Selling the Property with the High Tax Rate, I'll Sell My Corporation' Stock (with the Property in it) at the Low Tax Rate?

This is an interesting way to get around the problem of the high corporate tax rate (35% rate), (and then the tax on the dividend back to the shareholder (if it's a US corporation with Canadian shareholders, the dividend is subject to withholding to boot- maximum rate of 15%)). Why not just sell the stock of the corporation instead of the property in the corporation (we will steer clear of the US real property holding company issues for this discussion)? Corporate stock sold by an individual shareholder will likely be taxed at the good individual capital gains rate of 15%. So maybe I can have the great individual great tax rate (15% rate) and have my limited liability in a neat corporate structure too? The biggest problem I see with this concept is marketability. It may not be so easy to find a buyer of your corporation, when all the buyer really wants to buy is the real estate in the corporation (particularly, by the way, if it's a Canadian corporation which holds the property....is an American really going to want to buy a Canadian corporation?). The buyer wants real estate, not a corporation with real estate in it.

Are There Negative Tax Elements to the Limited Partnership Structure?

The biggest negative is that a partnership with foreign (Canadian) partners must withhold tax annually on income, regardless whether that income is distributed to the partners (at the highest individual rate...today that's 35% on the annual income of the partnership). I view this required withholding as more problematic on paper than in realty. What income is the partnership going to have every year? Well, if you're renting out the property, clearly that will be rents. But as we've discussed (and will again), if the partnership is taking deductions on the expenses that go into the property, there should not be much rental income (if any) on an annual basis. And if the partnership sells property for a gain, yes, this withholding tax rule will kick in. But remember, the withholding tax isn't the real tax, it's just a security deposit for the IRS. Your accountant will do your taxes in the year after the sale, and the 35% tax will turn into a 15% (i.e, more than half the tax withheld should be returned).

How Many Limited Partnerships Should I Form to Own My California Properties?

So this is a question we get a lot. I'd like to buy several US properties to rent out, how many limited partnerships do I need? Each limited partnership you own is going to cost money. It will cost some to set each one up, and then each limited partnership will require an annual fee to the state (that fee in California is $800 a year, but some states are much less expensive). But you don't want to skimp here. Remember that in a worst case scenario, if your tenant has a really bad accident and sues the owner of the rental property- limited partnership, you (as the 99% limited partner in the lim. partnership...and again, we think the general partner should probably be a 1% regular (c) corporation) can end up losing every asset in the limited partnership. So the more properties you stuff into one limited partnership, the more than you stand to lose in a worst case scenario. The most careful strategy would be to just put only one property into each limited partnership. Maybe if they're relatively low value properties you could live with a couple stuffed into a single partnership, but you probably wouldn't want to go much beyond that, if at all. The safest play: each rental property to go in its own limited partnership.