Articles Tagged with Vacation home

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CA residency and coronavirus

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

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Manes Law graphic six-month presumption

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

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Factors to decide to change residency from California

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

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Lincoln on California resideny

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

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4600 Tax NoticeOur 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

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California Tax Traps for Nonresidents

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

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boomerang man residencyIt’s no trick to leave California to avoid its high income taxes – if that’s all you want to do. You can sell all your California assets, including your home, terminate all business contacts, never spend any time in the state after your move, close all your financial accounts, sever all your professional and social connections. And so forth. Taxpayers who leave California lock, stock, and barrel don’t really have to worry about residency issues (despite scary stories on the internet). But in fact, most people who change their legal residency from California have something else in mind. They also want to or have to retain contacts with the state. That might mean a vacation home or income properties; it might be managing a California business remotely, with operations in the state; it might involve working while in California, from meeting potential clients or investors to working at a branch of an employer for designated periods. The last situation, which is fairly common, requires planning, since changing residency may not be enough to avoid California income taxes if your work for an out-of-state or in-state employer brings you back to California.

When Changing Residency Isn’t Enough

A typical situation involves a business owner who changes legal residency and moves the business out of state. But it can also involve an executive who moves out of state, but still has to make business trips to California, because that’s where the company’s client base or operations are located. Well and good. Unless a taxpayer changes legal residency, everything else is moot from a tax perspective. But the fact is California is an economic powerhouse. Few businesses, especially those in high-tech and financial services, can succeed without participating in the California market. And that often means meeting with and cultivating potential clients or investors in Los Angeles or Silicon Valley, where the capital, expertise and demand resides, or spending time working at a California branch of the company.

If that’s the case, it’s important to understand the differences between personal residency versus doing business in California versus working while physically present in California. These are three separate tax circumstances, which require different approaches to manage. Continue reading

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moz1With 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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4600 notice from FTBCalifornia’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.

Continue reading

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3e3cc7a8-6972-4e93-b914-51a711755f0cManes 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

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