California Residency Tax Planning

California and Nonresident Whistleblower Awards: No Good Deed Goes Untaxed – Or Does It?

Published on: January 27, 2018 | by Chris Manes

Whistleblower awards are big business. In 2016 alone, the IRS paid over $60 million to whistleblowers. The SEC awarded a similar amount. A patchwork of other whistleblower laws involving 57 federal statutes and 44 states, including California, also result in tens of millions in annual payouts. Not all whistleblower laws involve awards, but rather damages for retaliation. For instance, Penn State was ordered to pay coach Michael McQueary $12 million after firing him for reporting the notorious Jerry Sandusky to college officials. Though the amounts vary widely year to year, the trend is more tips filed, more whistleblower cases, bigger awards.

Whistleblower cases usually take a long time, with many obstacles along the way that can derail final payment. The average is three years. It’s a long wait, but it does provide an opportunity for tax planning for those who don’t want to be taxed by California for an award that can run from hundreds of thousands to tens of millions of dollars (my practice has involved tax planning for clients who received awards along most of this spectrum).

How Are Whistleblower Awards Taxed?

At the federal level, the taxation of whistleblower awards has been highly litigated and subject to Congressional tinkering. But the ultimate result is the proceeds of the award are taxed as ordinary income. How to calculate the amount of the “proceeds,” and whether a deduction for attorney’s fees (which are usually a large percentage of the award) is allowed, depends on the particular federal statute that applies. Continue reading

Happy Halloween for Nonresidents: It’s 4600 Notice Time Again

Published on: October 26, 2017 | by Chris Manes

California’s Franchise Tax Board (FTB) sends out 4600 Notices “Request for Tax Return” when it gets a tax “information return” with a California address on it, but the taxpayer doesn’t file a California return, either as a resident (a Form 540) or as a nonresident (a Form 540NR). An “information return” are documents like a 1098, 1099, K-1 or W2. There are other reasons, but this is a major one.

To give a common example, if a nonresident owns a vacation home in California with a mortgage, and he told the lender to send the Form 1098 mortgage interest form to his vacation home address, he has likely just earned a 4600 Notice. That’s because the FTB will see a 1098 with a local address associated with a person who hasn’t filed a California tax return.

This is a common mistake. It also happens with Form 1099-INT involving bank interest from a local bank account (often involving de minimis amounts), or payments from brokerage accounts or out-of-state pensions. The lesson is, nonresidents should never use a California address (whether it’s a vacation home or a relative’s place) for any tax information document.

Frequently Asked Questions: California Residency Rules

Published on: October 8, 2017 | by Chris Manes

Manes Law has over two decades of experience in advising clients on California residency law, handling residency audits, assisting businesses relocate out of California, and appealing residency determinations. Based on this experience, we have assembled this list of frequently asked questions and provided brief answers.

1.Q. How does California tax residents versus nonresidents?

A. California taxes residents on all their income, from any source, no matter where it is generated. In contrast, nonresidents are only subject to California income taxes with respect to “California-source” income (that is, income generated in California). If a nonresident has no California-source income, then the nonresident should owe no taxes to California.

2.Q. I am a nonresident who owns a California vacation home. If I spend more than six months in California, am I automatically a resident?

A. No. There is a lot of mythology on the internet about the “six-month presumption.” While it’s always better from a residency perspective to spend less time in California, spending more than six months in California does not automatically make you a resident. In fact, no one thing will ever make you a resident, and no one thing makes you a nonresident. The test for legal residency is complex and involves many factors (discussed here). You can spend more than six months in California without becoming a resident, but you should plan carefully to make sure an extended stay plus other contacts don’t result in an audit or unfavorable residency determination. Nor is it a good idea to spend more than six months year in and year out. Doing so suggest a closer connection to California than your home state. In addition, beware of the nine-month presumption, discussed in the next question. See our article, “The Six-Month Presumption In California Residency Law: Not All It’s Cracked Up To Be“.

3.Q. I’ve heard that if I spend more than nine months in California, I am definitely a California resident. Is that true?

A. California law applies a “nine-month presumption” to visitors. That is, if you spend more than nine months in California in any tax year, you are presumed to be a resident. But the presumption is rebuttable. Other factors may apply that result in you not being a legal resident, despite the extended stay. Prudence, however, suggests you shouldn’t tempt fate with a stay of such length. As a practical matter, there is only one old case in which a taxpayer spent more than nine months in California and was able to rebut the nine-month presumption. So, be forewarned. Continue reading

Guidelines for Determining California Residency: A Primer for Serious Snowbirds

Published on: September 1, 2017 | by Chris Manes

Seasonal Visitors to California and Residency Anxiety

Out-of-state visitors who own vacation homes in California or otherwise spend significant time here on a seasonal basis (traditionally known as “snowbirds” because the season is inevitably winter) are often anxious about their residency status. There’s good reason to be. California rules for determining residency are notoriously difficult to grasp. It’s altogether possible for the innocent actions of a nonresident to trigger a residency audit. And sometimes the audit has a bad outcome, with tax consequences that bite. Let’s go over the basics of how California determines residency for tax purposes. They can be confusing, and sometimes brutal.

How Residents And Nonresidents Are Taxed

California residents are subject to California state income tax on all income regardless where earned. It doesn’t matter what or where the source. If a California resident derives income from investments in Saudi Arabia or from pensions accrued while working out-of-state, California will tax that income. The resident may qualify for a credit for paying taxes to other states, but the default rule is, a resident’s global income is subject to California income tax. Period. With a top bracket rate that is currently the highest in the nation, California residency comes with a significant tax impact.

In contrast, nonresidents are only subject to California state income tax on their “California-source” income. That may be zero or it may be significant. California-source income takes many forms, some obvious, some more subtle. It could be rents derived from California real estate or income from business operations or wages for performing temporary work in-state (obvious). Or it could be a portion of the sales proceeds attributed to a noncompete clause when a founder sells his California business, or the gain from non-statutory stock options vested while the employee worked in California (not obvious). To celebrity name drop, when LeBron James, an Ohio resident, used to play the Lakers at Staples Center for the Cleveland Cavaliers, he paid California taxes on the income he made on game night, which in his case was no small amount. [By the way, now that James signed with the Lakers, he has a different problem: whether he can work for a California employer, train and practice here for a significant part of the year, and still remain a nonresident – the answer is yes, but that’s a different analysis (see, “Nonresidents Working Remotely for California Businesses: How to Take Paul Newman’s ‘The Sting’ Out of Your Taxes“).

So, the stakes can be high when determining whether a taxpayer is a California resident or not.

They’re Back! – FTB 4600 Notices Coming Soon to You

Published on: May 17, 2017 | by Chris Manes

It’s that time of year again. The time when the Franchise Tax Board sends out its 4600 Notices, “Request for Tax Return,” the bane of snowbirds and other part-time residents of California, especially those with vacation homes. And a potential trap for the unwary.

What Is A 4600 Notice?

A 4600 Notice is sent by the FTB because it believes the recipient, usually a nonresident, was required to file a California tax return, but didn’t. The notice usually goes out a month or two after the April 15 tax filing deadline, but it can show up any time after that, even years later. There is no statute of limitations. As a practical matter, however, the FTB generally sends the notice within a short period after the tax filing deadline or not at all. That’s because, as explained below, the notice is usually triggered by information provided by third parties (such as banks, mortgage lenders, employers) in the same tax year at issue.

The notice requires you to file a return, or explain why you are exempt. It’s usually directed at nonresidents, who for various reasons discussed below, have the misfortune of popping up on the FTB’s radar scope.

Why Did You Get A 4600 Notice?

When I say the FTB believes a nonresident was supposed to file a California tax return, I’m speaking metaphorically. 4600 Notices are mostly sent out through an automated system. No thinking is involved. The typical scenario goes like this. You’re a nonresident who doesn’t file a California tax return because you don’t live in California and didn’t have any California source income. But you do have a mortgage on your vacation home, or a small local bank account that bears interest, or you work remotely for a California firm which for convenience sake uses your local address for correspondence. As a result, the bank, lender or employer sends a Form 1099-INT (bank interest) or Form 1098 (mortgage interest) or a Form W-2 (wage income) to Sacramento with your name and local address on it. Come April 15^th, FTB computers cross-reference these “information returns” with filed tax returns. When nothing comes up, a 4600 Notice issues. Continue reading

LEAVING YOUR CALIFORNIA LLC BEHIND – How California Taxes The Sale of Business Interests by Nonresidents

Published on: December 12, 2014 | by Chris Manes

The Issue

California residents who plan to move to another (by definition lower income tax) state, either to retire or for business purposes, often face the problem of how to handle their business interests situated in California. Mostly these interests are LLCs, the preferred entity for many modern business operations. The taxpayer often wants to hold onto the LLC interests and continue to get the income stream until some later date after the move. The question that arises is, what are the California income tax consequences of selling a California LLC interest after the taxpayer changes residency to another state?

Overview