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Criminal Tax Fraud in California Residency Cases: Will the Trump/Weisselberg Indictment Give the FTB Ideas?

 

California Tax Fraud

What’s Happening?

There’s a noteworthy residency-related Easter egg in the criminal tax fraud indictment against the Trump Organization and its CFO, Allen Weisselberg. The complaint includes the charge that Weisselberg fraudulently failed to file tax returns as a New York City resident, thus evading the municipality’s income tax on the city’s inhabitants. Monetarily, it’s one of the lesser offenses. It isn’t even mentioned in much of the media coverage. But it shines a spotlight on a question that sometimes arises in California residency tax planning: are there criminal tax fraud risks in asserting nonresidency while retaining or establishing significant contacts with California?

The Short Answer

The short answer is no. You would have to blatantly abuse California’s unique system for determining residency status, or commit outright perjury, to incur criminal tax fraud charges for claiming nonresidency. However, the long answer is, while California residency rules aren’t the same as New York’s, the two systems are enough alike that the Weisselberg case may embolden the FTB to think otherwise.

Background

First, the obvious point: the Weisselberg indictment was brought by the State of New York. Accordingly, no matter how the case is resolved, it can’t have a direct precedential impact on the enforcement of California’s residency rules. California draws on its own robust jurisprudence to adjudicate residency tax issues. It rarely needs to look to the outcomes and opinions from out-of-state courts in that regard.

That said, California and New York both belong to a relatively small class of like-minded high-income-tax states (others in the ranks include Hawaii, New Jersey, Oregon, Minnesota, and Vermont). In addition to the state income tax, the denizens of New York City face a city-level income tax, which can approach 4% in the top bracket. Both California and New York take taxpayers’ residency status seriously because it can have a large impact on tax revenues. In contrast, zero- or low-income-tax states generally have anemic bodies of law addressing residency. It just doesn’t matter much to the treasury of Nevada or Florida or North Dakota whether any particular taxpayer is a legal resident or not.

Second, criminal tax fraud has effectively been off limits when it comes to residency disputes in most states. That’s particularly true for California. As far as this author can tell, no charges of criminal tax fraud have ever been brought where residency was the central issue. In particular, no nonresident who filed a nonresident return has ever been charged with willful intent to falsely avoid taxation as a resident, even where the arguments for non-California status were dubious. This conclusion is based on the author having focused exclusively on this area of law for over two decades and researched the matter for this article, though it is important to note that Manes Law’s practice does not include criminal tax defense.

The dearth of criminal tax fraud cases involving California residency isn’t difficult to understand. California residency law has few bright-line rules. Rather, in a residency case, the FTB compares all the contacts a taxpayer has with California with all the taxpayer’s home-state contacts, and then it weighs them, in totality. It’s like a ledger. How much weight each item brings to the residency ledger isn’t easily parsed by reviewing applicable law or the facts. To put it another way, generally, no one thing makes you a California resident, and no one thing makes you a nonresident. Instead, the determination is based on the weight of all the contacts combined. Unfortunately, not every contact weighs the same, and the rules to gauge the differences aren’t particularly intuitive and can in fact be outright puzzling. California doesn’t even have a serviceable method to calculate the date a person changes residency, though the state requires every departing taxpayer to identify and disclose just such a date. See Manes Law’s “Liquidity Events, the Interim Home Problem, and Determining the Date for Changing California Residency: A New FTB Case Sheds Some Light.”

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quote for NFT sourcing article

Residency is determined by all the facts and circumstances, not by bright-line rules, a system that doesn’t lend itself to criminal prosecution

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Having to prove criminal intent in a system where so much is left indeterminate has consistently deterred the FTB from bringing criminal fraud charges where disputed residency is central to the outcome. It would be futile in most cases for the FTB to act otherwise.

What Might Criminal Residency Tax Fraud Look Like?

That doesn’t mean California wants taxpayers to think it would never bring such charges. On the contrary, California recently enacted a law establishing an intergovernmental task force, which includes the FTB, to coordinate the investigation and prosecution of criminal tax fraud. As for the FTB, the first item listed on the “Tax Fraud” page of the FTB’s website is: “Claiming to be a resident of another state while residing in California.”

But it’s hard to construe what the FTB intends by this admonition. It’s something of a tautology: the very thing at issue in most residency tax cases is whether the taxpayer was “residing in California,” which is a legal, not a factual, determination, made by applying rules without exact edges. In California, a person can spend more than six months in-state and own a large, expensive home, and still not be a resident, depending on what contacts they have in their declared home state; and it’s quite possible for a taxpayer to never set foot in California during an entire tax year or more, own no home, and still be deemed a resident. Residency is determined by all the facts and circumstances, not by bright-line rules, a system that doesn’t lend itself to criminal prosecution. The only way the FTB’s reference to “residing in California” would make sense in the context of a criminal tax fraud case would involve situations where a taxpayer stayed in California for long uninterrupted periods of time knowing he is a resident (because, say, he has no significant contacts with any other state), but deliberately pretends he isn’t, while taking benefits only available to residents (such as health care insurance, the homeowners’ property tax exemption, or owner-occupied loans or home insurance rates).

Procedurally, this would unfold one of two ways. Either the taxpayer doesn’t file a California tax return at all, or he files a nonresident return.

In the first instance, criminal tax fraud for failure to file a tax return in a year “while residing in California” simply begs the question of whether the taxpayer’s time in California constituted “residing.” Deciding that may not be that difficult once the facts are known; but proving that the taxpayer knew the time spent in California constituted legally residing there is another matter, given the notorious uncertainties in California residency law. Willfully failing to file is a criminal offense under Rev. & Tax. Code section 19706, which is a “wobbler” statute, meaning it can proceed either as a misdemeanor or a felony, depending on how egregious the circumstances are. It would only apply to a putative nonresident in the kinds of circumstances just mentioned: a taxpayer living in California essentially continuously with no out-of-state contacts knowingly making residency representations in order to obtain tax or other benefits, with no other reason for spending that much time here other than wanting to live in California. That just doesn’t happen. It’s so obviously risky, and where significant tax liability is at stake, so blatantly unnecessary, given legitimate ways to plan for nonresidency.

If the taxpayer does file a nonresident return (Form 540NR), a different set of considerations apply. Nonresident taxpayers who report to California have to accurately disclose the number of days spent in California and whether they own a home in-state, directly or indirectly through an entity or trust they control, along with their global income (by attaching their Form 1040). The disclosure is under penalty of perjury. If a taxpayer spent an entire year in California and reported it accurately on a 540NR, while disclosing high income and ownership of a California abode, the FTB would almost inevitably initiate a residency audit based on that information. The issue would be whether or not the taxpayer had a defense for claiming nonresidency under those circumstances. The defense could be anything that would indicate a temporary purpose to the California stay, from having to take care of a sick relative, to getting a temporary job, to being stranded in-state due to the COVID emergency. Of course, the taxpayer might not prevail in the audit. Indeed, any taxpayer who spends in aggregate more than nine months in California during a tax year will almost certainly be deemed a resident as a result of the all-but-unrebuttable nine-month presumption under Rev. & Tax. Code section 17016. But the point is, the case would be a garden-variety residency adjudication, not a criminal fraud proceeding. (Note, I’m leaving aside procedural matters such as the fact that usually a local district attorney would bring a criminal tax fraud proceeding, not the FTB, but you get the picture).

If, in contrast, the taxpayer reported the number of days in California on the 540NR inaccurately, that’s a different matter. Arguably, if the understatement were significant and material to residency status, the FTB could bring a criminal fraud charge under Rev. & Tax. Code section 19705, for filing a false return. But usually, a defense of mistake, excusable negligence or the like is enough to forestall the issue from ever arising. I have been involved in various residency audits where it turned out the taxpayer’s 540NR grossly understated the number of days spent in California, but the inaccuracy, once discovered, didn’t lead to accusations of criminal fraud. It simply impeached the credibility of the taxpayer in the eyes of the auditor (which is bad enough in a residency audit). The reality of the situation is nonlawyers don’t usually appreciate the legal significance of accurately reporting time in California on a 540NR (and that applies not only to taxpayers, but many non-California CPAs). As a practical matter, the FTB takes that into consideration. I am unaware of any reported case involving a nonresident undercounting days on a 540NR leading to a charge of criminal tax fraud.

Note that it’s obviously easy to avoid this problem entirely. If you have to file a nonresident return, keep meticulous track of the days spent in California, and report the correct number. But that’s a subject for another article.”

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quote for NFT sourcing article

The likelihood that a taxpayer would face criminal tax fraud charges in a California residency dispute is vanishingly small

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Differences Between California and New York   

Circling back to the Weisselberg case, the State of New York alleges Weisselberg committed criminal tax fraud by not reporting as a New York City resident for a number of years, thus evading the municipal income tax. The allegation is that Weisselberg lived full-time in a Manhattan apartment and concealed the fact from tax authorities by using a Long Island address for tax purposes. The charge that the Manhattan apartment was also paid for by the Trump Organization without Weisselberg reporting this financial benefit as income has more serious criminal implications, which has eclipsed the residency aspects of the indictment. But this count is criminal tax fraud relating to a residency dispute, which makes it a rarity.

It should be noted that, unlike California, New York has some history of bringing criminal fraud cases in residency matters, though the instances are rare. The difference is likely due to the fact that New York residency rules are more specific than California’s. New York law focuses on time spent in the state, with the basic rule being, if you spend more than an aggregate of 183 days in the state while owning a permanent abode, you’re a resident. Since this is a relatively clear standard, New York has an easier time proving willful intent to evade taxes by people who are aware of how much time they spend in the state and under what circumstances, but conceal or misrepresent the facts to escape reporting as a resident.

Our Thought Bubble

The likelihood that a taxpayer would face criminal tax fraud charges in a California residency dispute is vanishingly small. This is all the more certain in cases where taxpayers actually plan for nonresidency, legitimately using the (admittedly ambiguous) rules for their benefit, while making all required disclosures to the tax authorities. Even the most aggressive FTB investigator wouldn’t get near a fraud charge in that context.

That said, there is no reason to tempt fate. The type of reckless disregard for residency rules hypothesized in this article (and alleged in the Weisselberg case) should obviously be rejected, if not only to avoid risk, but because it’s totally unnecessary. Most nonresidents can keep the ongoing contacts they might want with California, if they plan carefully and accept the reality that maintaining nonresidency accompanied by significant California contacts inevitably requires enduring various costs and inconvenience. It’s built into the system. If it weren’t, nobody would be a resident of California. But any degree of cost and inconvenience is better than an unfavorable residency audit, not to mention a tax fraud prosecution.

Finally, not only is The People of the State of New York v. Weisselberg (and The Trump Organization) a high-profile criminal residency case, for obvious reasons it’s likely to become one of the most publicized criminal tax fraud cases since Leona “only the little people pay taxes” Helmsley went to jail. It’s reasonable to wonder if it will encourage the FTB to consider changing its historic practice of steering clear of criminal fraud cases in residency disputes. The answer is probably not. But if Weisselberg is convicted and sent to prison for lying about his residency to get a tax benefit, you have to imagine the FTB will probably look longingly toward Gotham.

 

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Manes Law is the premier law firm focusing exclusively on comprehensive California residency tax planning, on a fixed-fee basis. We have over 25 years of experience in successfully assisting Californians to change their legal residency, businesses relocating to other states, and nonresidents purchasing vacation homes or investment property in California. We serve a clientele of successful innovators and investors, including founders exiting startups through a sale or IPO, Bitcoin traders and investors, professional actors and athletes, and global citizens able to live and work anywhere. Learn more at our website: www.calresidencytaxattorney.com.

 

 

 

 

 

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