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2982476-300x225Let’s go over the basics of California residency taxation.  They can be 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 that accrued while working in Ohio, California will tax that income.  The resident may get a credit for payment of taxes on income earned in other states or other countries (if a tax treaty permits), but the default rule is, the income is subject to California income tax. With a rate that is currently the highest in the nation (the distinction tends to go back and forth with New York), 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, from rents derived from California real estate to business operations to performing temporary work in-state.  To give a rather public example, when LeBron James, an Ohio resident, not a California resident, plays the Lakers at Staples Center, he pays California taxes on the income he made on game night, which in his case is no small amount.

So the stakes are high when determining whether a taxpayer is a California resident or not.

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sfHo7Ho8_400x400The global economy has enabled growing numbers of California residents to find employment overseas, often in Pacific Rim or European countries.  Many of these jobs are in financial services or high-tech industries and can be very lucrative.  The temptation is to pack up and leave without thinking about the California tax consequences.  But that can be a costly mistake.  California has special rules for changing residency to another country.  If they aren’t scrupulously followed, expatriates can find themselves facing a large California tax bill along with the cheerful balloons at their welcome home party.

Changing Residency To Another State vs Another Country

Changing legal residency from California to another state has fairly straightforward rules, if you’re willing to seriously pull up stakes.  If you keep a vacation home, or a business, or work remotely, then it gets complicated.  But the concept is direct enough: to change your legal residency from California to another state you have to (a) intend to change your residency (that is, intend to leave for other than temporary or transitory purposes) and (b) physically move to the new state (you can’t just think about moving).

How the Franchise Tax Board, California’s taxing authority, determines intent and what constitutes “moving” is another matter.  California residency law has few bright-line rules, and its “facts and circumstances” test can sometimes seem like a Kafka novel in its excruciating focus on seemingly casual details used to punish the unwary.  That said, if you follow the regulations and case law, and avoid common mistakes, you can have some degree of certainty about establishing yourself as a nonresident in another state, just by leaving and not looking back.     Continue reading →

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Bitcoin-California-Residency-300x300The fortunes currently being made in Bitcoin and other cryptocurrency investments and trading offer unique opportunities for tax planning that other appreciated assets often do not.  This article discusses one of those aspects: the importance of residency planning in reducing cryptocurrency tax liability at the state level.

What Makes Cryptocurrency Conducive To Residency Tax Planning?

Bitcoin and other cryptocurrencies are unique assets in many ways.  But for residency tax planning purposes, these three factors make all the difference.

First, much of the taxable gain in appreciated cryptocurrency investment remains unrealized – that is to say, the investors have yet to sell or exchange their initial investment.  This is due to the volatile nature of cryptocurrency values, but it’s also a result of the second factor.

Second, unlike traditional investments, the Bitcoin phenomenon has been driven by young disruptive investors, not the usual Wall Street sages with briefcases stuffed with earnings-to-value reports.  Many of my clients made relatively small investments, either directly or through mining, in their early twenties, and now, as they enter their thirties, they find themselves sitting on millions or even tens of millions of untaxed appreciated cryptocurrency.  Because younger people tend to be mobile, they can move anywhere before cashing out.  Which brings us to the third factor. Continue reading →

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 bribe-300x150Whistleblower 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.

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shutterstock_341354720-sm-jpg-300x185-300x185One of the major concerns of Canadians holding US real estate or other assets is whether the property will be subject to the US estate tax when they die.  It’s no small matter.  The estate tax top rate is 40%, and unlike Americans, foreign nationals who own US assets generally only qualify for a paltry $60,000 estate tax exclusion amount, not the $5.5 million unified credit available to American citizens.  Theoretically, if no planning were done and a foreign national died with a US vacation home worth $1 million, his estate would owe about $322,000 in US estate taxes.

Just as important, while American citizens have the benefit of the unlimited marital deduction when they leave their estate to a spouse (which is the typical estate plan), noncitizen couples cannot make use of the marital deduction to reduce or eliminate US estate taxes (unless they establish a QDOT, discussed below).

Fortunately for most Canadians, however, the US-Canada Tax Convention and its protocols, come to the rescue, if they plan right.  Here’s how.

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9baf90353963d26daaa1c54235b10b38-cool-pumpkin-carving-carving-pumpkins-300x300California’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.

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wireless-internet-connection-500x500-300x237With more and more companies forgoing brick and mortar by operating their business through the internet, tax authorities find it increasingly difficult to determine which enterprises are subject to state income taxes and which aren’t.  Typically, California has taken an aggressive stance.  In 2011, it passed a new law that defined “doing business” in California beyond being physically present by having offices or operations.  Instead California sought to define what constituted an “economic nexus” to the state, using factors such as sales, payroll, and inventory. In 2013, comprehensive regulations went into effect casting a broad net over the activities of out-of-state corporations and pass-through entities (LLCs, partnerships, S corporations) as doing business in California.  Judicial decisions interpreting those rules are just starting to trickle in.  The picture that is emerging indicates that non-California internet businesses need to be wary or they may find themselves subject to California taxation.

Why Does It Matter Whether Your Company Is “Doing Business” in California Or Not?

First, why does it matter if California determines an internet company is “doing business” in California?  It may matter a great deal.  The determination that an out-of-state entity is doing business in California is one of the ways California can impose income taxes on that business, even if they have no physical presence in California (the other is based on the entity earning California-source income).  In some cases, there may be a tax liability even if the company made zero income from California sales.

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FAQ-300x169Sanger & Manes has 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 taxed by California on “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 6 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 6 months in California does not make you a resident. In fact, no one thing will ever make you a resident. The test for legal residency is complex and involves many factors. You can spend more than 6 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. 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 9 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 9 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 so long a stay.

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Wave-goodbye-300x300It’s no secret that California has a high state income tax rate.  In fact the Golden State competes with New York and Hawaii for the highest rate in the nation — and usually wins (as of 2017 California is in fact the winner).  Nonetheless, despite somewhat overblown media reports, most Californians aren’t in a position to tear their businesses up by the roots and transplant them to low or zero income tax havens like Nevada and Florida.  Often those businesses have to operate in California, since that’s where the market for the product or service is, and typically for small businesses, the owner has to be present here in-state for the enterprise to operate and grow.

But that’s not always the case, especially when a taxpayer owns numerous entities and some of the income derives from service contracts (usually for management work) among the entities or between the entities and the owner.  Further, as e-commerce continues to grow in market share, a physical presence in California becomes less and less necessary for many businesses.  In cases like this, some strategic use of out-of-state entities can result in large tax savings that might make the major step of relocation worthwhile.

The Rules of California Residency Taxation


But before we can address the benefits and pitfalls of relocation, we need to first give an overview of California’s income tax system relating to residency. California taxes residents with respect to their “global” income.  This means that for a California resident, income from whatever source — whether in-state or out-of-state — is subject to California taxation.  There may be credits for payment to other states, and there may be other ways of mitigating the taxes due to California.  But leaving that aside, California residents generally must pay significant state income taxes on all the income they make, from whatever source.  Let’s call this Rule #1: taxation of all income based on the California residency of the taxpayer.

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Executors probating Canadian estates that include US real estate or other assets subject to the US estate tax system, need to know how the US-Canada Tax Treaty may work to their benefit.  Just as important, they have to understand how to timely “invoke” the treaty, so that the tax benefits they are entitled to accrue to the Canadian estate and aren’t lost.

What US Assets Are Subject To US Estate Tax?

Not all US assets owned by a Canadian or other foreign nationals are subject to the US estate tax system. Mainly, the value of their US vacation home or other real estate, and the value of their US securities (stock of US companies) are included in calculating any US estate tax. 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. Unfortunately, there is no exception for securities held by a Registered Retirement Savings Plan of a Canadian. The value of US securities held by a RRSP count in determining the US estate tax obligation of a Canadian decedent.