California Residency Tax Planning
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.
4.Q. How long a vacation can I take in California before I am deemed a resident?
A. Technically, you could spend the entire year vacationing in California, if you had the means to do so, and not become a resident, though it is not something to be recommended from a residency perspective. If your time in California is truly for vacation purposes, then it is temporary and transitory, and hence not a permanent move. The purpose of a visit to California determines how it affects your residency status, not the time per se. That said, the longer a vacation last, the less it looks like a vacation and the more it looks like a permanent move. From a residency perspective it is hard to justify a “vacation” in California that lasts longer than the time spent in your home state during the same tax year, except in unusual circumstances (a rock star who takes time off to party for an entire year in a rented Malibu beach house?). Also note the nine-month presumption, discussed above, which is extremely difficult to overcome.
5.Q. What does a “temporary or transitory” stay mean in California residency law?
A. “Temporary or transitory” are terms of art in California residency law. Basically, brief vacations or transactions, such as signing a contract or giving a speech, constitute temporary or transitory purposes that do not confer residency. But you can also work in California for a temporary period, and that period can be quite lengthy, as long as the agreement makes clear that the work will terminate and isn’t permanent (though again the length of the employment is relevant to whether it is truly temporary or not). Every other kind of visit can confer residency status, including coming to California for health reasons, extended stays, retirement, or employment that requires a long or indefinite period to accomplish.
6.Q. What if I’m a California resident, and I leave California to work in another state or overseas, but plan to return after a period of time?
A. The “temporary and transitory” rule applies in reverse in this situation. If you are a resident of California, you remain a resident unless you leave permanently or for an indefinite period. If you leave for temporary or transitory purposes, you are still taxed as a resident. Whether taking a job out of state is only a temporary move is determined by many factors. There is one “safe harbor” rule involving working out of state for 546 consecutive days (18 months). However, it has many qualifiers.
7.Q. How does California determine whether a stay is temporary or permanent?
A. A taxpayer’s residency status is initially determined by one of California’s taxing authorities, the Franchise Tax Board. The FTB determines whether a visit has a temporary or permanent purpose by applying the “Closest Connection Test.” This refers to the state with which a person has the closest connection during the tax year in question. For the FTB, this literally means counting all the California contacts a person has and comparing them with the non-California contacts. Of course, some contacts weigh more than others. A job or real estate ownership tends to indicate a closer tie than merely enjoying a few weeks at a beach house. The weightiest factors for residency are as follows:
• Ownership or lease of real estate.
• Business interests or employment.
• Schools used by children.
• Membership in clubs or professional organizations.
• Bank accounts or safety deposit boxes.
• Use of professional services such as accountants, doctors, dentists and lawyers.
• Automobile registration and license.
• Family ties and social life.
• Appearance in telephone or social directories.
• Address used on federal tax returns and other tax documents.
• Social media and website identification of residency.
• Claims of homestead or principal residence tax benefits.
• Local resident discounts taken from business or municipal programs.
• Location of personal belongings such as clothing, family photo albums, fine art, “the good china”.
• Jury duty.
8.Q. How does California apply the Closest Connection Test?
A. The FTB undertakes a “fact and circumstances” analysis. That is, it looks at all the facts in context, not just one factor in isolation (or at least it’s supposed to). From a residency audit perspective, that can be bad news, since the FTB requires a taxpayer to provide not only financial information (as in a typical audit), but detailed information about where you spend your time, what you buy, the professionals you hire, the friends and family you socialize with, the kind of plane tickets you buy (one way or round trip), etc. A residency audit essentially pries into your entire lifestyle.
9.Q. I own a vacation home in California. Can I have my broker and other financial professionals send statements to my vacation home while I’m in California for convenience sake?
A. You shouldn’t have any financial statements sent to your vacation home at all. Any documents related to income or any tax incidents (such as mortgage interest), whether a bank statement, a brokerage statement, or a mortgage bill, should be sent to your principal residence out of state. Otherwise, the documents may be used against you in a residency audit. Indeed, using a vacation home address for tax-related documents (such as 1098 or a K-1) is the number one reason residency audits are triggered.
10.Q. Can I keep my car at my vacation home year-round? It’s convenient to use it when I come to California on vacation.
A. You can, but you will have to register it in California. In fact, the rule is if your vehicle is in California for a plurality of the time during any tax year, it should be registered here. Additionally, this will require you to insure the vehicle using a California insurance company (unless you have an umbrella policy). This won’t make you a resident of California by itself, but it involves two significant contacts that can be used against you in an audit. Vehicle registration looms large in residency case law. You may want to consider the option of renting a car while on vacation, or having the car shipped in and out of the state if it has particular importance to you and it can’t driven here.
11.Q. I want to retire to my California vacation home after my out-of-state business sells. Can I sell my principal residence before then and store my belongings in California until the move?
A. Definitely not. Case law is clear that nonresidents who try to delay the date they move permanently to California by putting their furniture and furnishings in storage in California are in jeopardy of being deemed residents. If the point is to delay the move to California until the sale of a business or other asset in a low-tax state, this can be a costly mistake, since California will claim the transaction is taxable because you became a resident before the sale.
12.Q. When I vacation in California, I often check in with my out-of-state business by phone or email and carry out management or other duties. Is that a problem?
A. It can be. W-2 wages for work performed while in California produces “California-source” income, which is taxed by California whether you are a resident or nonresident. There is no “de minimis” rule exempting work performed while on vacation in California. The real question is whether your communications with your business while on vacation really constitute work: the duties an owner or employee undertake for compensation. That requires some detailed analysis. And there are ways to work around the problem with careful planning and drafting of agreements. See our article, “Working While Vacationing: The Perils Of California Source Rules For Nonresidents“.
13.Q. I’m a nonresident of California, but the corporation I work for has a division here that they want me to manage. Does that make me a resident?
A. Not necessarily. It depends on whether the work to be performed in California is temporary or permanent, as determined by law. For instance, many nonresident executives are tasked with setting up a division in California (especially in the tech sector), or making it profitable, after which they return to their home state. While the W-2 wage income from working in California is taxable by the state, the executive’s other income may not be, if the terms of the project are planned carefully to preserve nonresidency. See our article, “Nonresidents Working Temporarily In California“.
14.Q. I’m a professional actor who was hired to work in California for an extended period, does that make me a resident?
A. If you plan carefully, you should not be deemed a California resident. You will be taxed on the W-2 income related to your work in California (and most actors use a loan-out corporation that involves W-2 wages), but your income from sources outside of California should not be taxed by the state. However, to avoid being audited, it’s important to have a plan for working temporarily in California.
15.Q. I’m a professional actor who wants to look for work in California, but I do not want to move here permanently. Will I become a resident while seeking employment?
A. A stay in California for an indefinite period generally results in California residency status. For that reason, professional actors who do not want to become California residents but do want to look for work in California’s entertainment industry, should plan carefully so that the period for auditioning or otherwise seeking work is not indefinite, but subject to a business plan with a specific time period in mind.
16.Q. I’m a professional athlete who plays for a California team but my home is in another state. Am I a resident of California?
A. Like the professional actor or executive, with careful planning you can avoid being deemed a resident. Your income for working while in California will be taxed by California, but income earned in other states will not. To get this result requires that you maintain your out-of-state contacts and don’t take actions that will otherwise confer residency status.
17.Q. Can my spouse become a resident of California, while I retain my nonresident status?
A. Yes. Spouses can have separate residency status. However, it takes careful planning, since in most cases you will be spending significant time in California with your spouse. It is important to limit all other contacts since having a spouse in California carries a lot of weight in determining residency status. Moreover, a careful tax analysis is required if you live in a community property state or if you have a prenuptial agreement converting separate income to community property. If you do, under California law, your spouse will have to report half your income on his or her California resident tax return (Form 540) and you will have to report half of your spouse’s income on a California nonresident tax return (Form 540NR), which will likely be California-source income. This means the tax savings of having separate residency can be limited. See our article, “Married with Residents: Nonresidents with California Spouses“.
18.Q. If I have a pension from working as a resident of California and I retire out of state, can California tax my pension distributions?
A. No, if the plan is a “qualified plan” (that is, it is under Federal ERISA rules). If it is some other company retirement plan involving deferred compensation, nonqualified stock options, RSUs etc., then California can tax all or part of the distributions under various complex vesting rules.
19.Q. I received a notice from the FTB entitled “Demand for Tax Return.” What is it and how should I respond?
A. The “Demand for Tax Return” or 4600 Notice is sent by the FTB for a number of reasons, but often it involves a nonresident with a vacation home in California who had some income or tax incident that resulted in an “information return” (such as a 1098, 1099 or K-1) being sent to Sacramento. This happens, for instance, when a nonresident has interest income from a local bank account or mortgage interest from the loan on his vacation home. When the FTB gets such an information return without the nonresident filing a California return, the 4600 Notice is sent out. It should be treated seriously. The 4600 Notice asks for a variety of information about the taxpayer’s income and residency status. If not answered properly, it can be a prelude to a full residency audit. Nonresidents should consider consulting a tax attorney experienced in California residency law before trying to complete the 4600 Notice response.
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Manes Law is the premier law firm focusing exclusively on comprehensive California residency tax planning, on a fixed-fee basis. We have over 25 years of experience in successfully assisting Californians to change their legal residency, businesses relocating to other states, and nonresidents purchasing vacation homes or investment property in California. We serve a clientele of successful innovators and investors, including founders exiting startups through a sale or IPO, Bitcoin traders and investors, professional actors and athletes, and global citizens able to live and work anywhere. Learn more at our website: www.calresidencytaxattorney.com.
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