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…To evaluate this, the distinction between Rule #1 (California income taxes incurred due to residency), as opposed to Rule #2 (California income taxes incurred due to sourcing) is extremely important. Taxpayers are more or less in control of their residency; they can pull up stakes and move. However, the source of income is not as easily controlled. In many cases, the operations that bring in the income rely on California’s market, which is often the market the owner knows and understands. There is no point in moving out of state to avoid the application of Rule #1, if Rule #2 is still going to apply. The tax is the tax is the tax.

But let’s look at the nuts and bolts. It’s not unusual for a business owner to have a corporation and several related tax pass-through entities, such as limited liability companies or limited partnerships, which produce income by providing goods or services here in California. The corporation often provides the LLCs with administrative services, and charges accordingly. Generally, the owner will hold the corporate stock in a family trust. In case like this, creative relocation can have worthwhile tax benefits. Here’s how.

First, remember Rule #1. Since the point of most business enterprises is to get money into the pockets of the owner, if the owner remains a California resident, relocating the corporation won’t help a bit by itself. Assuming all the income from operations passes through the entities (including the trust) to the owner, it will be taxed by California because of Rule #1. All of a resident’s income is taxable by California. So in situations like this, if a strategic relocation is in the cards, step one is for the owner to change residency to a lower tax or non-income tax state. Obviously that’s a big step. It means major change. But if reducing state income taxes is the goal, it’s the sine qua non.

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Canadian visitors to Palm Springs, Rancho Mirage, Indian Wells and all of California may wish to take note of a new pilot program the US Department of Homeland Security and the Canada Border Services Agency is instituting for visitors from both countries crossing the US-Canada border. It’s a pilot program, which is not the official policy for US-Canada border crossings yet. But could easily become that (and probably will).

Which US-Canada Border Crossings is the Pilot Program Being Tested?

The following border crossings are where the program is initially being tested:

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It’s no secret that California has a high state income tax rate. In fact the Golden State competes with New Jersey and New York for the highest rate in the nation. 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 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. In that case, some strategic use of out-of-state entities can result in large tax savings that might make the major step of relocation worthwhile.

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 mitigations of the taxes due. 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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So, we get this question a lot in our Palm Springs law office. There is no one-size-fits all on this issue. Here’s an overview of many of the most popular methods for Canadians to minimize the estate tax. If you want to get into specifics, call our office at (760) 320-7421.

Non-Recourse Mortgage

What is it? A non-recourse mortgage is a mortgage secured by the house, with no personal liability for the borrower.

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Recall that the US imposes its estate tax on the value of property anybody (US citizen or not) owns in the US (the US “situs property”) upon their death. The following types of property constitutes US situs property for the purposes of the US estate tax:

1) All real estate located in the US;

2) Tangible personal property located in the US (these are objects which can be moved touched or felt, such as jewelry, boats and art (which the Canadian citizen might hang in their US home));

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As 2012 draws nearer to a close, we should all keep in mind that the opportunity for maximum estate and tax planning may also be drawing to a close. What are we talking about? Let’s look at the estate and gift tax changes which are scheduled to change at the end of 2012:

1) The $5,000,000 lifetime estate and gift tax exemption amount (actually $5,120,000) in 2012 is scheduled to revert to $1,000,000 in 2013.

2) The highest estate tax rate is 35% in 2012, which is scheduled to revert to 55% in 2013.

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So we’re on to Part 2 on this topic. Here, we’re talking about a US citizen who owns a California home (maybe in Palm Springs), but lives in Illinois.

Presumptions Generally

Let’s review the FTB’s presumptions on time spent in California. If you spend more than 9 months (in a calendar year) in California- you are presumed to be a California resident that year (but you can rebut it by going to the checklist). You can find this presumption in Cal Rev. & Tax Code §17016. There is also a lesser presumption (found in regulations as opposed to the Cal Rev and Tax Code) which provides if you are present in California less than 6 months a year, you are presumed to not be a California resident. This “lesser” presumption is found at 18 Cal. Code of Regs. §17014(b). I consdier it a lesser presumption since it comes from the Cal tax regs and not the Code (unlike the 9 month presumption). There is no presumption if you are present in California between 6 months and 9 months. But in all events, you still must go back and review the checklist.

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So we’re on to Part 2 on this topic. Here, we’re talking about a Canadian citizen who owns a California home (let’s say in La Quinta for example), and the likelihood that person is deemed in a California resident for tax purposes. Again, in fairness, it’s going to be highly unlikely the FTB (the California Franchise Tax Board…basically the IRS for the State of California) deems a Canadian citizen a California resident in a given year, because most Canadians are here on a B-2 Visa (they may not even be aware of this fact), where they simply show the US officials at the border their passport and they’re permitted entry in the US. Under the standard B-2 tourist Visa, the Canadian citizen is only legally permitted to stay in the US up to 6 months in a calendar year. Unless the Canadian citizen is violating the terms of the B-2 Visa (not a good idea, it could be hard to get into the US the next time), or is in the US on a visa other than a B-2 where the Canadian is permitted to stay in the US more than 6 months (like a work related visa), or the Canadian is a dual Canadian-US citizen or has a US green card (permitting the Canadian citizen to stay the entire year in the US if he or she likes), it’s difficult for the Canadian (in California less than 6 months) to be deemed a California resident. But not impossible. We must re-review the checklist of items the FTB looks at from Part 1 of this topic (e.g., location of your spouse/RDP and children; location of your principal residence; where your vehicles are registered; where you maintain your professional licenses, etc.). The FTB may still deem the Canadian a California resident if they have enough checks in the wrong category, even though the Canadian does not spend more than 6 months a year in California.

Presumption Generally

Let’s review the FTB’s presumption on time spent in California. If you spend more than 9 months (in a calendar year) in California- you are presumed to be a California resident that year (but you can rebut it by going to the checklist).

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It’s going to be harder for most Canadian snowbirds visiting California to be deemed California residents than it is Americans from other states to be deemed California residents, but it’s not impossible. The biggest reason for this is most Canadian snowbirds are in California (and the US) on a B-2 tourist visa, which means the Canadian snowbird (unlike other Americans) cannot be in California longer than 6 months in a calendar year (without violating their visa). Also, as the Canadian snowbird reviews the checklist below, it appears less likely (although not impossible) somebody who lives permanently in Canada could have too many negative checks on the checklist. On the other hand, the test for California residency is in some ways more dangerous to the Canadian snowbird than the test for US residency. Why? Because if the Canadian snowbird fails the test for US residency in a given year (we’ve discussed the test in prior blog entries), they could still fall back on the US-Canada Tax Treaty, which contains tie-breaker provisions between the two countries- which would probably lead to the determination that the Canadian who failed the US residency test (i.e., was in the US too much in a given year) was still a resident of Canada (and not the US) in a given year. California has no treaty with Canada (no US state does). So there isn’t any treaty to save the day for the Canadian who is deemed by the State of California to be a California resident in a given year.

The rest of the analysis for the Canadian snowbird is the same as it is for Americans from other states visiting California…

General Rules on California State Taxes

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We next start a detailed series on the consequences of, and how to avoid, being deemed a California state resident for state income tax purposes. We will track this discussion on our Canadian Snowbird blog.

General Rules on California State Taxes

Let’s start with some general principles of California state taxation: