What’s Happening
A recent poll of adult California residents shows the vast majority are satisfied with the state, but about 40% are considering leaving. Only 18% of those say they are considering a move “very seriously.”
The major reason given for a possible move is economic: over 60% say living expenses are motivating their planning.
The Issue
After years of wrangling with the issue, California has just enacted legislation to eliminate a state income tax savings strategy some California residents have pursued by establishing a non-grantor gift trust (ING). These trusts are often called WINGs, DINGs, and NINGS, a reference to the three states that first marketed them: Wyoming, Delaware, and Nevada. INGs can offer significant federal estate planning advantages. But they also allow residents of states with high income-tax rates, like California, to avoid paying state taxes on undistributed non-California-source income. The income can then grow free of state income taxes in the trust and be distributed later to the taxpayer (presumably after moving to a state with lower income taxes), or to their beneficiaries. But the new legislation has nullified the state tax benefits for California residents, leaving taxpayers who pursued the ING strategy in the lurch. Continue reading
The Case
A recent case from California’s Office of Tax Appeals brings some clarity to how strictly California dates a change of residency for income tax purposes when a nonresident claims to have moved to California shortly after a liquidity event. The case, Appeal of Housman, OTA Case No. 18010200 (November 2022), in some ways is the flipside of Appeal of J. Bracamonte, a case involving a resident who claimed to move to another state shortly after a stock sale. Bracamonte is discussed in detail in this article. Both cases went badly for the taxpayers, and for many of the same reasons: failure to plan, failure to keep residency related records, establishing or retaining superior living accommodations in California, spending more time in the state than in their home jurisdiction during the year at issue.
Overview: The Importance of Timing
As discussed in the Bracamonte article, changing residency from California is binary: it happens on a specific date. Indeed, the date has to be reported on Schedule CA of the 540NR “part-year” return, which exiting taxpayers, with few exceptions, have to file for the year they move. The converse is also true for nonresidents moving to California. Schedule CA of the part-year return requires those taxpayers to disclose the date they become California residents. Continue reading
The Issue
If you’re in the habit of reviewing California residency cases (and only a tax attorney specializing in the field or a masochist would be), you will occasionally come upon a reference to the Franchise Tax Board’s “Integrated Nonfiler Compliance” system, sometimes called the INC program. The court opinion will mention that the audit was initiated under INC and move on from there. This article discusses how this somewhat secretive program works, and how it affects a nonresident’s risk of a California residency audit. Understanding INC is central to residency planning, particularly for former residents who no longer file tax returns in the state.
Good News, Bad News
The good news is that nonresidents are often in control of the actions required to minimize that risk. The bad news is it usually takes a concerted, systematic effort to avoid the INC system. A single mistake can earn you a residency audit.
Which Nonresidents Does INC Target?
The INC system only targets a certain subset of nonresidents. Specifically, as the somewhat sinister name indicates, it focuses on nonfilers. For nonresidents who in fact file a nonresident California tax return (Form 540NR), the FTB doesn’t need INC to decide whether to audit for residency or not. That’s because a 540NR delivers most of the relevant information to the FTB on a silver platter. The 540NR requires a nonresident to disclose the number of days spent in California during the tax year, ownership of California residential property (directly or indirectly through an entity or trust), and perhaps most importantly the nonresident’s global income. That’s usually more than enough material for the FTB to decide whether to pursue a residency audit, or at least to provide grounds for investigating the taxpayer further by reviewing available databases (including Google and Zillow) before deciding to go forward. Continue reading
The Case
A new case from California’s Office of Tax Appeals brings some clarity to how strictly California dates a change of residency for income tax purposes when a resident moves out of state shortly before a liquidity event. The case, Appeal of J. Bracamonte, OTA, Case No. 18010932 (May 2021), emphasized the importance of how much time a resident spends in California after the purported move. Bracamonte also sheds light on the “interim home” problem, which occurs when a resident moves into an out-of-state rental pending purchase of a permanent home in their new home state, while retaining ownership of their former primary residence in California. Finally, the ruling – probably inadvertently – seems to provide guidance on the date for determining when a taxpayer’s residency status is relevant to a liquidity event (the date of the closing, the date of the income receipt, or the date when an enforceable agreement is in effect). The case can be found here.
Background: How Does California Date a Change of Residency?
Changing residency from California is binary: it happens on a specific date. How do we know that? The Franchise Tax Board, California’s tax enforcement agency, requires that a resident leaving California identify the specific date of the residency change on Schedule CA of the Form 540NR “Part-Year” return, which exiting taxpayers, with few exceptions, have to file for the year they move. The exact question on the schedule is: “I became a California nonresident (enter new state of residence and date (mm/dd/yyyy) of move).” By the way, nonresidents moving to California also have to complete Schedule CA, conversely disclosing the date they become residents.
It bears mentioning that changing residency is a legal concept, and most taxpayers don’t know the rules or how to apply them to a calendar. This means there is no easy answer to when a residency change occurs. In fact, it can be totally counterintuitive. When the FTB asks an ambiguous question, it’s usually intentional. The FTB hopes the taxpayer will make a mistake that might be advantageous to the tax authority. Serendipitously, the taxpayers in Bracamonte did just that, originally putting a move-date on their 540NR that made no sense factually, something they were grilled about during trial, presumably eroding their credibility in the eyes of the court. Continue reading
The Issue
With the rise of ecommerce, advanced telecommunications, and the new prevalence of remote work due to the COVID pandemic, more and more people are choosing the option of living in one state while working for an employer in another, sometimes without ever setting foot at the employer’s place of business. The possibilities for reducing state income taxes through this scenario haven’t been lost on founders, hi-tech C-suite, and other key employees in California. By moving across state borders and working for a California business (or even running it) through Zoom and other telecommunications, they become nonresidents, potentially free of California’s high income tax rates, while still being able to participate in California’s thriving economy.
Of course, this situation isn’t lost on California’s tax enforcement agencies either. Because remote work can attract audit scrutiny, nonresidents working for California firms need to be careful and understand the tax rules governing remote work, especially when it comes to highly compensated former residents.
California Tax Rules For Remote Employees: The Basics
Generally, if you work in California, whether you’re a resident or not, you have to pay income taxes on the wages you earn for those services. That’s due to the “source rule”: California taxes all taxable income with a source in California regardless of the taxpayer’s residency. In other words, nonresidents pay California income taxes on taxable California-source income. With respect to employees, the source of income from services compensated by W-2 wages is the location where the services are performed, not the location of the employer. This is true even if you are a nonresident, even if you don’t work out of a California branch or office, and even if the wages are paid to you outside of California and booked as payments to a nonresident worker. Continue reading
Hot as a Recalled MacBook Battery
The non-fungible token market has become as hot as a recalled MacBook lithium battery (if that’s possible). You’ve probably seen the figures: digital artist Beeple sold an NFT for a remarkable $69 million; a LeBron James non-fungible dunk clip lasting ten seconds went for $200,000; Jack Dorsey’s first tweet 
was auctioned for $2.9 million (though shortly after the sale, the tweet’s value plummeted 99% at a subsequent auction).
Various funds and exchanges now tally NFT transactions in the hundreds of millions of dollars.
The lucky beneficiaries of the market have surely taken into consideration federal taxes. But if they are nonresidents of California, they may not be thinking of how California might treat NFTs for tax purposes. Specifically, depending on the location of the buyer and the status of the seller, the income from NFT sales might be sourced to California, making it subject to California income tax. Oddly, in that case, due to favorable federal capital gains treatment of NFTs, it’s even possible that the California income tax might be higher than the federal tax. To add further complexity, NFTs are almost exclusively sold in exchange for cryptocurrency, adding cryptocurrency tax issues on top of the transaction.
What is an NFT?
People are used to non-fungible assets in the analog world: Action Comics #1 (the first Superman comic book), a stretch of beachfront real estate, the Mona Lisa. You might be able to copy these assets one way or another, but only the original has value. A snapshot of the Mona Lisa or a video of a beach house isn’t worth much. Hence, the non-fungible designation.
In contrast, media on the internet has always been susceptible to unlimited reproduction (whether in violation of copyright or not) without much loss in value. A copy of a YouTube video of Milli Vanilli has pretty much the same value, or lack thereof, as the original. Then came blockchain. The same public-ledger technology that authenticates bitcoin transactions can be used to validate the original digital file of a work of online art, or the NBA’s official slam-dunk competition clips, or Jack’s first, fateful tweet. Blockchain transformed digital media that could be infinitely reproduced with no significant diminishment of value, into a class of assets, like comic books or baseball cards, that could never be copied without a total loss of value. You can still copy an online version of an NFT as a screenshot or other facsimile. But the result is equivalent to a photo of the Mona Lisa. Continue reading
The Issue
E-commerce, advanced telecommunications, and the new prevalence of remote work have combined to give many married couples more flexibility in their working and living arrangements than in the past. One of these options, rare until recently, is for spouses to assert they live in different states for tax purposes. An increasing number of marriages have the mobility to allow one spouse to reside in California, while the other elects to establish or maintain legal residency elsewhere. This is especially true for high-income couples, where supporting two households is economically feasible, one spouse wants to enjoy the benefits of living in California (often with the couple’s children), and the tax benefits of the other spouse having nonresident status are significant.
That said, it is no simple matter to establish or maintain nonresidency status while married to a spouse who is a California resident. There are traps for the unwary.
To Each His Own Residency
Many taxpayers are surprised to learn California even allows separate residency status for spouses. But in fact, there is no such thing as “marital” residency. Residency status always belongs to an individual, whether married or not. Of course, a spouse’s residency status can have a substantial influence on the other spouse in a residency audit. It’s typical for married couples to live together, and the Franchise Tax Board, California’s tax enforcement agency, has a bias for the typical when it comes to residency determinations. But even leaving that aside, married couple tend to spend time together, and if a substantial amount of that time is spent in California, where one spouse resides, the other spouse can begin to look very much like a resident.
In the past, this situation was so uncommon it hardly made a blip on the FTB’s radar scope. It might involve a scenario where a husband took a long-term job out-of-state or overseas. Older cases are populated with merchant marines and oil-field workers in Saudi Arabia; more recent ones prominently feature professional athletes and corporate managers assigned to overseas offices. That’s changed. Separate-residency marriages are now more about a lifestyle choice involving a global economy and the scenario of remote work that can allow some people to live and work anywhere. Continue reading
The Issue
Can COVID-19 orders make you a resident? Since the COVID-19 emergency struck, tens of thousands of nonresidents have found themselves marooned in California due to coronavirus travel restrictions. The typical situation involves a seasonal visitor forced to remain in a vacation home longer than intended. But it runs the gamut, involving temporary visits to California prolonged by stay-at-home orders, or by the increased risk of contracting the coronavirus posed by traveling back home, particularly where the only feasible method of transportation is via commercial airline. Some nonresidents have even been formally quarantined due to a family member becoming infected. Unable to return home as planned, many nonresidents find they have already spent the majority of the year in state.
In those scenarios, it’s reasonable for out-of-state visitors to ask (as many contacting my office have) whether they will be deemed California residents due to the extra time spent in coronavirus lockdown. And the corollary question to that is, will the Franchise Tax Board, California’s tax enforcement agency, find out about the extended sojourn, and if it does, how will that affect the likelihood of being audited?
The Short Answer
The short answer is, remaining in California longer than planned for reasons not within your control is, in most cases, a temporary or transitory purpose. Therefore, unexpected delays in leaving California, beyond the power of the nonresident to mitigate, don’t usually confer residency status. The coronavirus pandemic is just such as case.
However, as usual with residency rules, it’s never that simple. Context may determine whether getting locked down in California jeopardizes nonresidency status. The good news is, the year is only half over, and that means even the worst-case scenarios can be managed in the remaining months of 2020. For nonresidents still stranded in California by the coronavirus emergency, what they do next may make all the difference.
And now the long answer. Continue reading
The Six-Month Mythos
You don’t have to be a tax lawyer to know that the way to avoid becoming a resident of California is to spend less than six months in the state during any calendar year. Right? Well, not exactly. The “six-month presumption,” as it’s called, which is mentioned in one form or another in almost every Google search result of California residency rules, isn’t all that it’s cracked up to be. That’s not to say the amount of time spent in California doesn’t play an important role in determining legal residency. Just the opposite. It’s critical. But the real rule is more complex and has to be understood in the context of how California determines residency. It isn’t by counting days. In fact, relying on the six-month figure as a magical way to avoid California residency can get a taxpayer into serious tax trouble.
What Is The Six-Month Presumption?
The six-month presumption is established by regulation. You would think it would say something simple like: if you spend no more than six months in California during any calendar year, you’re not a resident. That’s the popular online version. And frankly it’s the version many auditors for the Franchise Tax Board (California’s tax enforcement agency) seem to have in the back of their minds. But that’s not the legal rule.
Rather, the rule has various qualifiers: if a taxpayer spends an aggregate of six months or less in California during the tax year, and is domiciled in another state, and has a permanent abode in the domicile state, and does nothing while in California other than what a tourist, visitor, or guest would do, then there is a rebuttable presumption of nonresidency. What would a tourist, visitor or guest do? According to the regulation, nothing much more than owning a vacation home (or presumably renting one), having a local bank account for local personal expenses, and belonging to a “social club” (read “a country club”).
These qualifiers call for some parsing. Continue reading
California Residency Tax Planning