California Residency Audit

The Franchise Tax Board Modifies Ruling: After Unfavorable “Doing Business in California” Case

Published on: October 23, 2018 | by Chris Manes

The Franchise Tax Board, California’s taxing authority, has consistently taken an aggressive stance in claiming out-of-state businesses have income tax reporting requirements for “doing business in California.” The FTB reached a limit in Swart Enterprises, Inc. v. Franchise Tax Board, Cal. Ct. App. (5th App. Dist.), 7 Cal. App. 5th 497 (2017). In that case, a California appeals court ruled against the FTB’s claim that a foreign corporation with a passive .02% ownership in a California LLC was doing business in California. As a result, the FTB was forced to modify its ruling on doing business in California by members of multi-member limited liability companies.

FTB Walks Back Prior Ruling

Specifically, the FTB has modified California FTB Legal Ruling No. 2014-01, 07/22/2014, which sets forth the FTB’s analysis on a number of “doing business” scenarios involving members of multiple-member LLCs that are classified as partnerships for tax purposes. The ruling had asserted that the distinction between “manager-managed” and “member-managed” LLCs, made no difference in determining whether a member of the LLC was doing business in California. The reasoning in Swart Enterprises made that assertion untenable. As a result, the FTB has removed the language and replaced it with the innocuous phrase: “a narrow exception may apply in limited circumstances.” Continue reading

“Request for Tax Return” Time for Nonresidents: How Not to Make that Mistake Again

Published on: April 28, 2018 | by Chris Manes

With 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

Happy Halloween for Nonresidents: It’s 4600 Notice Time Again

Published on: October 26, 2017 | by Chris Manes

California’s Franchise Tax Board (FTB) sends out 4600 Notices “Request for Tax Return” when it gets a tax “information return” with a California address on it, but the taxpayer doesn’t file a California return, either as a resident (a Form 540) or as a nonresident (a Form 540NR). An “information return” are documents like a 1098, 1099, K-1 or W2. There are other reasons, but this is a major one.

To give a common example, if a nonresident owns a vacation home in California with a mortgage, and he told the lender to send the Form 1098 mortgage interest form to his vacation home address, he has likely just earned a 4600 Notice. That’s because the FTB will see a 1098 with a local address associated with a person who hasn’t filed a California tax return.

This is a common mistake. It also happens with Form 1099-INT involving bank interest from a local bank account (often involving de minimis amounts), or payments from brokerage accounts or out-of-state pensions. The lesson is, nonresidents should never use a California address (whether it’s a vacation home or a relative’s place) for any tax information document.

Frequently Asked Questions: California Residency Rules

Published on: October 8, 2017 | by Chris Manes

Manes Law has over two decades of experience in advising clients on California residency law, handling residency audits, assisting businesses relocate out of California, and appealing residency determinations. Based on this experience, we have assembled this list of frequently asked questions and provided brief answers.

1.Q. How does California tax residents versus nonresidents?

A. California taxes residents on all their income, from any source, no matter where it is generated. In contrast, nonresidents are only subject to California income taxes with respect to “California-source” income (that is, income generated in California). If a nonresident has no California-source income, then the nonresident should owe no taxes to California.

2.Q. I am a nonresident who owns a California vacation home. If I spend more than six months in California, am I automatically a resident?

A. No. There is a lot of mythology on the internet about the “six-month presumption.” While it’s always better from a residency perspective to spend less time in California, spending more than six months in California does not automatically make you a resident. In fact, no one thing will ever make you a resident, and no one thing makes you a nonresident. The test for legal residency is complex and involves many factors (discussed here). You can spend more than six months in California without becoming a resident, but you should plan carefully to make sure an extended stay plus other contacts don’t result in an audit or unfavorable residency determination. Nor is it a good idea to spend more than six months year in and year out. Doing so suggest a closer connection to California than your home state. In addition, beware of the nine-month presumption, discussed in the next question. See our article, “The Six-Month Presumption In California Residency Law: Not All It’s Cracked Up To Be“.

3.Q. I’ve heard that if I spend more than nine months in California, I am definitely a California resident. Is that true?

A. California law applies a “nine-month presumption” to visitors. That is, if you spend more than nine months in California in any tax year, you are presumed to be a resident. But the presumption is rebuttable. Other factors may apply that result in you not being a legal resident, despite the extended stay. Prudence, however, suggests you shouldn’t tempt fate with a stay of such length. As a practical matter, there is only one old case in which a taxpayer spent more than nine months in California and was able to rebut the nine-month presumption. So, be forewarned. Continue reading

They’re Back! – FTB 4600 Notices Coming Soon to You

Published on: May 17, 2017 | by Chris Manes

It’s that time of year again. The time when the Franchise Tax Board sends out its 4600 Notices, “Request for Tax Return,” the bane of snowbirds and other part-time residents of California, especially those with vacation homes. And a potential trap for the unwary.

What Is A 4600 Notice?

A 4600 Notice is sent by the FTB because it believes the recipient, usually a nonresident, was required to file a California tax return, but didn’t. The notice usually goes out a month or two after the April 15 tax filing deadline, but it can show up any time after that, even years later. There is no statute of limitations. As a practical matter, however, the FTB generally sends the notice within a short period after the tax filing deadline or not at all. That’s because, as explained below, the notice is usually triggered by information provided by third parties (such as banks, mortgage lenders, employers) in the same tax year at issue.

The notice requires you to file a return, or explain why you are exempt. It’s usually directed at nonresidents, who for various reasons discussed below, have the misfortune of popping up on the FTB’s radar scope.

Why Did You Get A 4600 Notice?

When I say the FTB believes a nonresident was supposed to file a California tax return, I’m speaking metaphorically. 4600 Notices are mostly sent out through an automated system. No thinking is involved. The typical scenario goes like this. You’re a nonresident who doesn’t file a California tax return because you don’t live in California and didn’t have any California source income. But you do have a mortgage on your vacation home, or a small local bank account that bears interest, or you work remotely for a California firm which for convenience sake uses your local address for correspondence. As a result, the bank, lender or employer sends a Form 1099-INT (bank interest) or Form 1098 (mortgage interest) or a Form W-2 (wage income) to Sacramento with your name and local address on it. Come April 15^th, FTB computers cross-reference these “information returns” with filed tax returns. When nothing comes up, a 4600 Notice issues. Continue reading