Articles Posted in 4600 Notice

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California Residency AuditsHundreds of thousands of nonresidents have vacation homes, investments, business operations, and other substantial contacts in California.  Many fear those contacts will trigger a residency tax audit – California’s system for determining which taxpayers are legal residents and hence liable for California’s state income tax.  The concern is warranted, if often exaggerated by internet myths about the Franchise Tax Board, California’s tax enforcement agency, peeping through your keyhole.  California is in fact notably aggressive among the states in claiming out-of-state taxpayers as residents.  With the highest state income tax in the nation, California cares about residency status much more so than do low or zero income tax states.  Because it matters, the FTB wants the facts, ma’am.  A residency audit is California’s unpleasant way of getting them.

Fortunately, however, once you understand how California’s residency audit system works, you can plan to reduce your risk.  Let’s discuss three end-of-year actions nonresidents can take to avoid the most common scenarios that lead to a residency audit.

What Is A Residency Audit?

First, it helps to know what a residency audit actually is and how they are triggered.

It’s critical to understand that California residency audits are not typical financial audits.  Most taxpayers – and tax professionals – are only familiar with tax audits involving financial and business matters.  These usually revolve around underreported income, disputed deductions and losses, charitable gifts, business expenses.  The taxpayer’s role in the examination is often limited to instructing a CPA to handle the matter and enduring a disagreeable meeting or two with the auditor.

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ill-never-make-that-mistake-again-ill-never-make-that-mistake-again-lyric-1-233x300With Tax Day having come and gone, the Franchise Tax Board, California’s tax authority, is now busy sending out its annual 4600 Notices, also known as “Request for Tax Return” letters.  Almost all 4600 Notices are sent to nonresidents, mostly those who own a vacation home or have a business interest in California, and have made one of several common mistakes.  For a full discussion of what a 4600 Notice is, see “They’re Back: FTB 4600 Notices Coming Soon to You.”

If you receive a 4600 Notice, the first order of business is to timely and effectively respond.  Whether that means filing a nonresident tax return (a Form 540NR) or providing a proper legal explanation for why you don’t have to, depends on the circumstances.  Second, assuming the notice gets resolved favorably, the next task is preventing the same problem from recurring in future years.

Automatic vs “Reviewed” Triggers

4600 Notices don’t just happen.  They are triggered.  The trigger is usually one of several common, avoidable mistakes by nonresidents.

In my practice, the typical 4600 Notice involves a nonresident who owns a vacation home in California with a mortgage.  Out of convenience or just as an oversight, the nonresident tells the mortgage lender to send the Form 1098 Mortgage Interest Statement to the vacation home.  Form 1098 is the “information return” mortgage lenders generate to report loan interest.  They send one copy to the FTB and another to the borrower.  If the “Payer/Borrower” address on the 1098 is in California, and the borrower doesn’t file a state tax return, the FTB will automatically send a 4600 Notice.  Continue reading →

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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.