Hundreds 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.