Articles Tagged with California Residency Tax

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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.

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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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Image for Guidelines for Determining California Residency

Out-of-state visitors who own vacation homes in California or otherwise spend significant time here are often anxious about their residency status.  Let’s go over the basics of California residency taxation.  They can be confusing, if not brutal.

How Residents And Nonresidents Are Taxed

California residents are subject to California state income tax on all income regardless where earned.  It doesn’t matter what or where the source.  If a California resident derives income from investments in Saudi Arabia or from pensions accrued while working out-of-state, California will tax that income.   The resident may qualify for a credit for paying taxes to other states, but the default rule is, a resident’s global income is subject to California income tax.  Period.  With a rate that is currently the highest in the nation, California residency comes with a significant tax impact.

In contrast, nonresidents are only subject to California state income tax on their “California-source” income.  That may be zero or it may be significant.  California-source income takes many forms, some obvious, some not so obvious.  It could be rents derived from California real estate or income from business operations or wages for performing temporary work in-state (obvious).  Or it could be a portion of the sales proceeds attributed to a noncompete clause when a founder sells his California business, or distributions from non-statutory stock options vested while the employee worked in California (not obvious).  To celebrity name drop, when LeBron James, an Ohio resident, used to play the Lakers at Staples Center for the Cleveland Cavaliers, he paid California taxes on the income he made on game night, which in his case was no small amount.  [By the way, now that James signed with the Lakers, he has a different problem: whether he can work for a California employer, train and practice here for a significant part of the year, and still remain a nonresident – the answer is yes, but that’s a different analysis.]

So the stakes are high when determining whether a taxpayer is a California resident or not.

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