Articles Posted in 4600 Notice

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Residency mythsWhile not quite as prevalent as Bigfoot videos, myths about California’s residency tax rules abound on the internet. Of course, believing in Bigfoot won’t increase your chances of a residency audit, or cost you tens or hundreds of thousands of dollars if the audit goes against you. In contrast, misinformation about California’s rules for determining residency can have just that result. This article discusses the top five California residency tax fictions I often encounter at websites offering residency advice. They’re in no particular order, but my comments should provide some indication about how misguided they are and why.

The Basics

First, the basics. You can’t understand what’s misleading about many of the residency myths without first grasping the legal framework for California residency. The key concept is this: No one thing makes you a resident of California, and no one thing makes you a nonresident. Rather, California follows a “facts and circumstances” test. This means the Franchise Tax Board, California’s tax enforcement agency, weighs all the contacts a taxpayer has with California and every other jurisdiction. To determine residency status, the FTB scrutinizes the contacts under legal precedent, regulations, chief counsel rulings, and audit practices. Since this is what California tax authorities do, effective residency planning must do the same. Therefore, whenever someone says that this in-state contact results in California residency, or that out-of-state contact means you’re safely a nonresident, a fundamental misconception is at work.

Why It Matters

The reason residency status matters for tax purposes is also often misconstrued. California taxes residents on all their taxable income, from whatever source. That’s obvious to almost everyone who would broach the topic. But online discussions of California residency often miss the equally important corollary: California taxes nonresidents on all their taxable California-source income. Ignoring this second element of California’s tax law can lead to residency plans that go horribly astray.

For a more detailed discussion of how California determines residency status, see “Guidelines for Determining California Residency: A Primer for Serious Snowbirds”.

And now to the myths.  Continue reading →

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Manes Law Blog Tax Trap Most of the world knows the Palm Springs area for its picturesque golf courses, celebrity homes and halcyon weather. Among the taxing authorities in Sacramento, however, the words “Palm Springs” conjure up less carefree images. Spurred by the state’s appetite for tax revenues, the Franchise Tax Board, California’s main taxing authority, has tapped into a new revenue source; taxing seasonal visitors to our area as state residents.

Seasonal Visitors As Tax Targets

This is how it works. California taxes residents based on their worldwide income, from whatever source, no matter how far-flung. In contrast, California taxes nonresidents only on their income derived from California sources. For instance, these might include a limited partnership operating in California or rent from an investment property. Since California has the highest income tax rate in the country, visitors who suddenly find themselves defined as “residents” may face a large and unexpected tax liability.

Obviously, the FTB  would like to claim everybody who sets foot on California soil as a resident and subject their income to California tax. That’s their job, after all. As many seasonal visitors have discovered, the FTB’s policies sometimes seem not to fall too far short of that mark.

A special division of the FTB has for years systematically targeted seasonal “part-time” residents for audit (I use the term “part-time” loosely, since we are talking about nonresidents who spend part of the year here, not part-time legal residents per se; but the term has stuck). Though Santa Barbara, Los Angeles and Sonoma counties experience their share of audits, historically the most common casualties are affluent “snowbirds” who own vacation homes in the Palm Springs area as an escape from the winter blasts of the Midwest or northern states.  In fact, many of the major cases in residency taxation are eerily similar: they usually involve Midwesterners who own winter vacation homes in Palm Springs and environs. If the FTB finds significant taxable income coupled with meaningful contacts with California (such as a vacation home, business interests or long visits to the state), it can lead to the launch of a full-blown residency audit.

Continue reading →

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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. Rather, they turn on a taxpayer’s legal status with California as a result of lifestyle. 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


Manes law pull quoteBut what makes a person a resident of California has nothing to do with tax concepts per se. It is a separate body of law, built up helter-skelter over many years, through regulations, FTB rulings and court decisions


examination is often limited to instructing a CPA to handle the matter and enduring a disagreeable meeting or two with the auditor. But again, California residency audits are not financial audits. They rarely involve the usual suspects found in standard tax examinations. The auditor is inquires into where the taxpayer spends his time, what he is doing while in California as opposed to other states, what assets he owns and where, what organizations he belongs to and why, what goods and services he purchases, the location of the gym where you can find him running on a treadmill. In short, a residency audit is very intrusive and pries into a taxpayer’s private life more than his business activities. Continue reading →

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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.