While 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 out firm often encounters 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.
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 for tax purposes. 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 this article on residency guidelines.
And now to the myths.
Myth #1: Less Than Six Months = Nonresidency
One of the most pervasive – and dangerous – myths goes like this: spend less than six months in California during any tax year, and put your residency worries aside. California can only claim you’re a resident if you spend more than six months here, right? Wrong. Without question, time spent in California is an important factor in determining residency. But remember: no one thing makes you a resident and vice versa. The fact is, you can spend no time in California (not to mention under six months) and still be a legal resident. Conversely, you can spend the entire year in California without becoming a resident (many of my clients who are in the entertainment industry under employment contracts which terminate at the end of the year do just that). The impact of time spent in and out of state on residency status depends on all the contacts a taxpayer has.
This myth is particularly perilous for more than one reason.
First, it misstates an actual rule: the rebuttable six-month presumption, which is discussed in more detail here. The six-month presumption rarely applies, or better stated, if it does, there is little reason for California residency tax planning. People in need of residency planning usually have high income paired with complex interactions with California, such as business interests, remote work, time spent in-state managing California companies, dealing with vesting stock options from California firms, and so forth. That category of taxpayers are excluded from benefiting from the six-month presumption, which applies only to nonresidents whose contacts with California are limited to a vacation home, a local bank account, and a country club membership.
Second, and more importantly, the six-month fallacy often leads to a false sense of security. The FTB expects nonresidents to spend more time in their home state than in California, not that they will spend less than a majority of time in California. The difference is important. It’s a plurality rule, not a majority rule. Generally, this means it’s California vs. your home state, not California vs. the world. Time you spend in other states doesn’t generally help you defend your nonresident status.
For instance, if you spend five months in California, four months in your home state, and the rest of the year traveling, the FTB will likely count that against you in an audit, and my be sufficient, taking all the other facts into consideration, to deem you a resident.
To give another example from a case, a nonresident married to a California resident was deemed a resident for spending only about three months in the state. The reasoning was, all things being equal, having a spouse who is California resident carries such weight in a residency adjudication, that spending a quarter of the year in California was enough to confer legal residency.
Again, no one thing makes you a resident and no one thing makes you a nonresident. There are circumstances where scenarios like these wouldn’t be indicative of residency. But the point is, while spending less than six months in California is always a good idea (the less time the better from a residency perspective), it’s not a residency plan. What you do in your home state also is part of the equation, as well as what other contacts you have with California. It certainly doesn’t guarantee that you won’t be deemed a resident. Indeed, if you are spending less time in your home state than in California, depending on your other contacts, it may provide the FTB with ample ammunition to deem you a resident in many cases.
Myth #2: Call It A Vacation Home . . .
Another myth, often linked to the six-month adage, is that if you call your property in California a vacation home, it’s a vacation home. Put another way, if you say you’re on vacation while in California, then you’re on vacation. Nonresidents often fall into this trap because they misconceive how the FTB goes about making a residency determination.
The FTB doesn’t rely on what you say about your California visits or the use of an abode here. Tax examiners look at your conduct. That means the FTB weighs all your contacts, in every jurisdiction. This includes obvious things like the purpose of your stays in California, whether you take a mortgage interest deduction on the California property or your out-of-state abode, and the quality of the accommodations and size of your second home versus the home in your state of residence. But there are also less obvious considerations: whether you take the homeowners property tax exemption on your California property (worth a whopping $70 maximum); the type of mortgage you have on the property; the representation in your homeowners insurance application; what sort of personal property is situated in your California home (family heirlooms, best art work, important documents, family albums?); whether you keep a California-registered vehicle there year round and how it is insured.
The rules that determine whether a second home is a vacation home or a primary residence are numerous and not particularly intuitive. For instance, if a nonresident is retired and spends more time in his California second home than in his purported home state – even if it’s less than half a year (see Myth #1) – the FTB is very likely to see that as a strong indication of residency. In short, residency planning for a California vacation home must deal with more than just the obvious.
This is a good segue to the next myth.
Myth #3: California Residency Rules Are Subjective
The concept here is that the FTB can interpret your contacts with California any way it wants. Under this narrative, there’s no way to plan for nonresidency status. You just have to avoid being audited – usually by some recommendation of subterfuge (like using only cash while in California and keeping no records). But in fact, California doesn’t lack for rules to determine residency. If anything, it has all too many rules, which can be all too complex. The problem is the rules just aren’t intuitive or easy to learn. They have been compiled helter-skelter over decades of case law, regulation, audit practices and chief counsel rulings. Accordingly, you can indeed plan to remain a nonresident, and it can be done with a great degree of certainty. But the grievous starting point is recognizing and understanding all the rules.
And one more thing: you have to be able to tolerate a level of inconvenience and cost the rules impose. Nonresidents can’t live like residents of California. If they could, nobody would be a California resident. The system of rules intentionally imposes inconvenience and cost on taxpayers who want to retain their nonresidency status. There is no such thing as California residency tax planning without keeping that in mind.
This is another good segue to the next myth.
Myth #4: Pay Cash And Your Worries Are Over
This myth urges that, if you don’t leave a record of being in California, you can pretend you weren’t here. It can be placed under the heading of “use cash while in California and the FTB won’t know you’re here.” But in fact it usually is accompanied by a number of suggested ploys: put your vacation home in a limited partnership, don’t keep track of the time you spend in California, title your car in the name of a relative and keep it at your vacation home year-round, and so forth. The problem with this myth is, it completely misunderstands the nature of a residency audit.
Using credit cards or checks, owning real property in your name, having a registered car in California, documenting the time spent in-state – none of that will ever lead to a residency audit. Residency audits are triggered by specific conduct, usually common mistakes. This is discussed more fully here. But the point is, once a residency audit or pre-audit (that is, 4600 Notice cases) is triggered, the taxpayer’s responses are for the most part under penalty of perjury. Or the FTB can arrange that to be the case, if there are indications a taxpayer is being less than forthcoming. If you spent nine months in California and used cash, and the FTB asks about how much time you spent in California (and it will), the idea of committing perjury to avoid a residency determination makes no sense, especially since, if you knew the rules and kept to them beforehand, you could have a great deal of certainty of a favorable determination rather than risking a fraud allegation.
More to the point, it won’t work, the FTB has full subpoena power. If enough is at stake, the FTB can and will subpoena records that follow people around no matter how stealthy they try to be. Further, the FTB can also interview witnesses, such as your neighbors or family. Finally, if you can’t prove how much time you spend in California and elsewhere, the FTB can use that against you and construct its own timelines based on whatever unfavorable evidence it can unearth. As a legal matter this is expressed as follows: “A taxpayer’s failure to produce evidence that is within her control gives rise to a presumption that such evidence, if provided, would be unfavorable to the taxpayer’s case. (Appeal of Don A. Cookston, 83-SBE-048, Jan. 3, 1983).
In short, unless you want your time in California to resemble the witness protection program, you should plan for nonresidency status by following the rules and keeping meticulous records of your time in California. Then, if you are audited (and good planning can also limit the risk of that), you will have the documentation you need to prove your nonresidency status. In short, you plan to be a nonresident by planning, not by not planning.
Pretending not to be in California and not keeping track is not a residency plan. It’s a recipe for disaster if you’re audited. And what causes residency audits is totally unrelated to the types of strategies proposed by the “Use Cash” myth.
Myth #5: More Than Six Months = Residency
Circling back to Myth #1, the corollary myth is, if you spend more than six months in California then you are a resident. No planning can save you.
Nothing could be further from the truth. The actual rule is, whether your stay in California makes you a resident or not depends first and foremost on its purpose, not its duration. If the purpose is temporary or transitory, then you retain your nonresident status. Duration, of course, can be a factor in determining purpose (quantity has a quality all its own). But six months, nine months, even over a year of physical presence in California does not automatically a resident make.
For instance, if an actress comes to California to make a film, and the contract requires her to be available for a period of seven months, that won’t in itself make her a resident. If the contract is clear about the duration of employment, her presence in California is on its face temporary. The same considerations apply to executives, software engineers, professional athletes, and other highly compensated individuals who are temporarily assigned under contract for a project or a season in California with a specific, limited duration.
Now, even with a contract with a definitive term, a nonresident present in California for a significant period should plan carefully to avoid handing the FTB a residency case. The taxpayer should only lease temporary accommodations in-state, rent a car or use Uber, make frequent trips back to his home state, etc. And of course, the income from the work actually performed in California is taxable by California because it is California-source. A nonresident tax return (Form 540NR) will need to be filed for the year the work is performed. This is why nonresidents have to remember that nonresidency is not a tax panacea if they have California-source income. If all your income is from work, and all your work will be in California for the term of a contract, for tax purposes it doesn’t matter what your residency is (though it may for other purposes). California will tax it. But if you have significant non-California-source income, then residency status may matter a great deal.
Again, there are rules to determine whether a stay is temporary or permanent; it isn’t subjective. But the rules aren’t particularly intuitive. For example, case law frowns on nonresidents who come to California with the idea of staying an indefinite period for health reasons. A short hospital stay isn’t a problem. But if a person with health issues moves to California for more than six months for the purpose of benefiting from California’s climate, the FTB is likely to deem that person a resident, if the matter gets to an audit (there are numerous cases to this effect). So too with “vacations” that last so long that it’s hard to distinguish them from living here. Theoretically, a rock band from Minnesota with the means to do so could rent a Malibu beach house between making records, and party for the next year and a half, without becoming residents. If partying is all they’re doing. But at some point, the mere fact that you are here for an extended period of time suggests the move is permanent. Similarly, there are limits to contracts for temporary projects. A contract for eight months to set up a branch office in California for an out-of-state firm, if planned properly, shouldn’t be a problem for the executive tasked with the project. A contract for two years to do the same looks like a permanent move.
Note that there is a nine-month presumption under California residency law, which states that taxpayers who spend in the aggregate more than nine months in California are presumed to be residents. But the presumption is rebuttable. The rebuttal would be just the type of facts discussed above, showing a temporary or transitory purpose.
California residency tax planning requires . . . planning. If a great deal of tax liability/savings is at stake, you have to know the real rules, not the residency lore often found on the internet.
Manes Law is the premier law firm focusing exclusively on comprehensive, start-to-finish California residency tax planning. We assist a clientele of successful innovators and investors, including founders exiting their 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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