California Residency Audit

California’s 4600 Notice “Request For Tax Return” – The Definitive Guide for Nonresidents

Published on: July 20, 2021 | by Chris Manes

The Issue

Nonresidents who own vacation homes, business interests, financial accounts, or have other significant contacts in California can receive a notice from the Franchise Tax Board, California’s tax enforcement agency, demanding they file a tax return or explain why they aren’t required to. The official notice number is 4600 (you can find the designation on the lower left bottom of the Notice). Hence the name, “4600 Notice.” It’s also called a “Request for Tax Return,” since the verbiage has appeared in bold on the Notice since about 2017. If a nonresident owns a second home or uses some other address in California, the Notice is often mailed there (which can be a problem if it’s an unoccupied vacation home without mail forwarding, since the deadline for responding may be missed before the recipient even knows the Notice has arrived). But it can also be sent to their out-of-state address. Nonresidents who receive the Notice are often perplexed and concerned about why they received the Notice, and how they are supposed to respond. This article clarifies what the Notice is about, the risk it poses, and the options nonresidents have for responding. Continue reading

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

Published on: July 6, 2021 | by Chris Manes

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. Continue reading

Do You Need California Residency Tax Planning? Not Everybody Does, But Those Who Do, Really Do

Published on: August 11, 2019 | by Chris Manes

The Issue

Nobody needs reminding that California is a high income tax state. Most people know there can be tax benefits from changing residency or maintaining nonresidency status where California is involved. With a top bracket rate of 13.3%, California residency at the time of a large capital gains event (such as a startup sale or IPO, for instance), can result in millions of dollars of state income taxes, while across the border in Nevada, the tax would be zero. But details matter. The amount of tax savings, if any, achievable through strategic residency tax planning depends on various moving parts: sources of income, types of compensation, connections people want to or must maintain with California, community property rules (for married couples), the cost and inconvenience of acquiring nonresident status, to name a few. The refrain found everywhere on the internet that huge tax savings beckon every resident to flee the state is simplistic at best. Accordingly, considerable forethought, usually with CPA assistance, is advisable before committing to a residency plan. This article discusses why.

How California Taxes Residents vs. Nonresidents

First the basics.

California residents are subject to California state income tax on all their taxable income regardless of the source. It doesn’t matter if the income comes from the moon, if it is taxable, then California tax system claims jurisdiction. It’s possible a California resident to qualify for a credit for taxes paid in another state for out-of-state income, and some income types are exempt on their face in California (such as social security retirement benefits), but the default rule remains: a resident’s worldwide income is subject to California income tax. Period. Continue reading

Five (More) Internet Myths About California Residency Rules

Published on: June 24, 2019 | by Chris Manes

Is Bigfoot a California Resident?

Manes Law discussed its top five internet myths about California tax residency rules in a previous article. Here are five more. Again, they’re in no particular order, but the commentary should provide some indication about how important they are and why.

Myth #1: Leave California, Sell Your Business, And You’re Home Free

Many of our clients are founders exiting startups, either through an IPO or purchase by another company. Or they are long-term business owners in traditional industries who plan to sell their California-based company after retiring out of state. The widespread internet meme insists these scenarios always result in zero California income tax on the gain, even though the sale is of a California business.

The basic concept is correct: if a nonresident sells his interest in a California business (that is, corporate shares, limited liability company memberships, partnership interests), the traditional rule is California can’t tax the gain. But not so fast. Numerous factors play a role in determining whether a business sale by a nonresident will escape California’s tax system.

The first is, the transaction must in fact be the sale of a business interest, not the sale of business assets. For good tax reasons, purchasers often prefer to buy assets, not business interests, if the value in the company is in the assets, not the brand. And in some industries, an asset sale is the standard for a business purchase. But take note: if the assets are situated in California, an asset sale by a nonresident results in California-source income, taxable by California regardless of the residency status of the seller. Generally, only interest sales are eligible for tax-free treatment by California when the owner is a nonresident. Continue reading

Five Internet Myths About California Residency Rules: And How They Can Cost You

Published on: June 16, 2019 | by Chris Manes

The Issue

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.

The Basics

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. Continue reading

Moving Overseas from California: A Residency Minefield for Expats

Published on: May 20, 2019 | by Chris Manes

The Issue: Even Casablanca Isn’t Far Enough Away to Avoid A California Residency Audit

The global economy has enabled growing numbers of California residents to find employment overseas, often in Pacific Rim or European countries. Many of these jobs are in financial services or high-tech industries and can be very lucrative. The temptation is to pack up and leave without thinking about the California tax consequences. But that can be a costly mistake. California has special rules for changing residency to another country. If they aren’t scrupulously followed, expatriates can find themselves facing a large California tax bill along with the cheerful balloons at their welcome home party.

Changing Residency To Another State vs. Another Country

Changing legal residency from California to another state has fairly straightforward rules, if you’re willing to seriously pull up stakes. If you keep a vacation home, or a business, or work remotely, then it gets more complicated. But the concept is clear enough: to change your legal residency from California to another state you have to (a) intend to change your residency (that is, intend to leave for other than temporary or transitory purposes) and (b) physically move to the new state (you can’t just think about moving).

How the Franchise Tax Board, California’s tax enforcement agency, determines intent and what constitutes “moving” is another matter. The FTB doesn’t ask taxpayers what they intended; rather, it derives intent from their conduct. For that, the FTB uses the “facts and circumstances/closest connection” test, which compares all of the taxpayer’s California contacts with all of the taxpayer’s contacts in their new home state, and weighs them, in totality. But not every contact weighs the same, and since there are few bright-line rules, an audit can sometimes seem like a Kafka novel in its excruciating focus on seemingly casual details used to punish the unwary. A more detailed discussion of the closest connection test is here. That said, if you follow the regulations and case law, avoid common mistakes, and endure the cost and inconvenience built into establishing and maintaining nonresidency status for taxpayers with significant California contacts, you can have some degree of certainty about establishing yourself as a nonresident in another state.

Increased Volume of 4600 Notices Sent in 2019, Explained

Published on: May 1, 2019 | by Chris Manes

Our office has experienced a significant increase in the number of taxpayers reporting they have received 4600 Notices “Request for Tax Return” sent by the Franchise Tax Board (California’s tax enforcement agency). The likely explanation is discussed below.

What’s Happening?

This July, our office saw a spike of 100% from the prior year in contacts from taxpayers seeking guidance after receiving a 4600 Notice from the FTB. There is a particular increase in nonresidents who have businesses out of state with no direct contacts with California. The notice relates to whether they are “doing business in California” as a result of sales to California customers. The upsurge could simply be more potential clients are choosing to contact our firm, but the more likely explanation is an actual increase in the volume of 4600 Notices sent, especially those relating to doing business in California.

What Is a 4600 Notice?

The FTB sends a 4600 Notice when it has reason to believe the recipient, usually a nonresident, was required to file a California tax return in a prior year, but didn’t. The notice is sent automatically when the FTB receives information to indicate that the non-reporting taxpayer earned or was distributed California-source income or may reside in California. The notice requires recipients to either prepare and file a California tax return or explain why they aren’t required to. If the FTB accepts the explanation, the matter ends there. If the FTB doesn’t, then a full audit follows. Continue reading

The Part-Time Resident Tax Trap

Published on: January 28, 2019 | by Manes Law

Sunny Taxxy California

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 tax enforcement agency, has tapped into a new revenue source: taxing seasonal visitors to popular vacation spots in California, where residents often have second home. Palm Springs is one such area. But so is Santa Barbara, Sonoma County, San Diego.

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 other vacation spots 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. Continue reading

Internet-Based Companies and “Doing Business in California”: Be Careful What Your Website Says About You

Published on: November 19, 2018 | by Chris Manes

The Issue

With more and more companies forgoing brick and mortar by operating their business through the internet, tax authorities find it increasingly difficult to determine which enterprises are subject to state income taxes and which aren’t. Typically, California has taken an aggressive stance. In 2011, it passed a new law that defined “doing business” in California beyond being physically present by having offices or operations. Instead California sought to define what constituted an “economic nexus” to the state, using factors such as sales, payroll, and inventory. In 2013, comprehensive regulations went into effect casting a broad net over the activities of out-of-state corporations and pass-through entities (LLCs, partnerships, S corporations) as doing business in California. Judicial decisions interpreting those rules are just starting to trickle in. The picture that is emerging indicates that non-California internet businesses need to be wary or they may find themselves subject to California taxation.

Why Does It Matter Whether Your Company Is “Doing Business” in California Or Not?

First, why does it matter if California determines an internet company is “doing business” in California? It may matter a great deal. The determination that an out-of-state entity is doing business in California is one of the ways California can impose income taxes on that business, even if they have no physical presence in California (the other is based on the entity earning California-source income). In some cases, there may be a tax liability even if the company made zero income from California sales. Continue reading

California Residency Audits: Three Year-End Tasks to Reduce the Risk for Nonresidents

Published on: November 11, 2018 | by Chris Manes

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. Continue reading