Residency And Taxing In California
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Originally Posted On: https://scltaxlaw.com/residency-and-taxing-in-california/
Residency And Taxing In California:
THE UNCERTAIN CERTAINTY OF THE LAW
by Samuel Landis, LL.M
The State of California taxes individuals based upon their residency in the State and, otherwise, on their income derived from the State. A full-time resident of California will be taxed upon all of his income, regardless of source, during a tax year (Revenue & Taxation Code § 17041(a)); a part-year resident of the State will be taxed on all of his income earned during that period of the tax year when he was residing in the State and, otherwise, taxed on income derived from a California-source during that part of the tax year when he was not a resident of the State (R&TC § 10741(b)(i)); and a nonresident will be taxed on income derived from a California-source during the tax year (R&TC § 10741(b)(i)).
Whether a person has resided in California during a tax year is determined under California’s Revenue & Taxation Code Section 17014(a), which states that a person becomes a resident of the state whenever she “is in the state for other than a temporary or transitory purpose;” or, alternatively, whenever she “is domiciled in this state [and] outside the state for a temporary or transitory purpose.”
Accordingly, any place a taxpayer lives “for other than a temporary or transitory purpose” is a residence (R&TC § 17014). Under this definition, a taxpayer can have more than one residence during any one tax year. The place of primary residence, the place which a taxpayer effectively calls their home, is designated to be their “domicile” (See Whittell v. Franchise Tax Bd., (1964) 231 Cal.App.2d 278, 284).
Given the two alternative methods to determine residency under R&TC § 17014, three general categories of residency exist. A person is a resident of California if:
Domiciled in California
- A person who is domiciled and who is living in California is “in the state for other than a temporary or transitory purpose” and, so, is a resident of California;
- A person who is domiciled in California but who is living outside of California “for a temporary or transitory purpose” remains a resident of California, even though living outside of the State.
Not Domiciled in California
- A person who is not domiciled in California but who is living in California “for other than a temporary or transitory purpose” is a resident of California, even though domiciled in another state.
Any person who does not fall into one of these three categories is a nonresident (R&TC § 17015). This means, amongst other things, that a person who is domiciled in California but who is living in another state for other than a temporary or transitory purpose is a nonresident during that part of the tax year during which she is living in that other state.
Any person who qualifies as a resident of California for part of the tax year and as a nonresident for the remainder of the tax year is a “part-year resident” (R&TC § 17015.5).
The issue as to exactly what is meant by a ‘temporary or transitory purpose’ will be taken up below; but first I will briefly cover how the residency issue affects taxation.
A resident of California is taxed on all income received during the tax year, regardless of source [R&TC § 17041].
Wages and salaries have a source where the services are per-formed. Neither the location of the employer, where the payment is issued, nor the taxpayer’s location when she receives payment affect the source of this income [FTB Pub. 1031].
Interest and dividends generally have a source where the taxpayer is a resident [FTB Pub. 1031]. The exception to this general rule is that, regardless of the taxpayer’s state of residence, interest and dividends payable to the taxpayer over an account or security which is used in a trade or business or pledged as security for a loan, the proceeds of which are used in a trade or business in California, will gain having a source in California and, therefore, such gain is taxable in this State [FTB Pub. 1031; R&TC § 17955].
Distributions from employer-sponsored and self-employment (Keogh) pension, profit-sharing, stock bonus plans, or other deferred compensation arrangements are taxable by California regardless of where the services were performed [FTB Pub. 1031].
Income from the sale of stocks or bonds, generally, has a source in the taxpayer’s state of residence [R&TC § 17952; Miller v. McColgan (1941) 17 Cal. 2d 432]. Accordingly, since the gain or loss from the sale has a source where the taxpayer is a resident at the time of the sale, when a California resident sales his stocks, the gain is taxable in California even when the stock was for an out-of-state business entity [FTB Pub. 1031].
Lump-sum distributions are taxable by California. Because residents of California are taxed on all income, regardless of source, the distribution is taxable even if it is attributable to services performed outside of California and accrued prior to the taxpayer becoming a California resident [FTB Pub. 1031].
The gain or loss from the sale of real estate has a source where the property is located. If a taxpayer sells his California real estate and move out of state, it remains true that the source of the gain arose in California and, therefore, the gain is taxable by California. [FTB Pub. 1031].
Whether spousal income is community property and, therefore, taxable income, is determined by the laws of the state where the spouse earning the income resides [See Family Code § 760; Thomasset v. Thomasset (1953) 122 Cal.App. 2d 116; Schecter v. Superior Court (1957) 49 Cal.2d 3; Appeal of Misskelley 84-SBE-077 (1984)]. If a California resident has a spouse who is not a resident of California but the spouse resides in a state which also has community property laws, then the California resident taxpayer must report one-half of the nonresident spouse’s income as the taxpayer’s income (Appeal of Herrman 62-SBE-041 (1962)). Similarly, if a California resident has a spouse who is domiciled in California but is a nonresident of the State during the tax year, then the California resident taxpayer must report one-half of the spouse’s income as the taxpayer’s income (Appeal of Bailey 76-SBE-016 (1976)).
The following are community property states and U.S. territories (countries not listed): Arizona, California, Guam, Idaho, Louisiana, Nevada, New Mexico, Northern Mariana Islands, Puerto Rico, Texas, Washington, Wisconsin [FTB Pub. 1031].
NB: Withholding may be required on income with a California source. This includes, sales of California real estate, income allocations or distributions from S corporations and partnerships, and other payments of California source income paid to nonresidents [FTB Pub. 1031].
The source of reimbursed moving expenses is the state to which the taxpayer moved, regardless of his residency at the time the reimbursement is made [FTB Pub. 1031].
NB: A taxpayer who became a resident of California during the tax year must restate carryover items, deferred income, suspended losses, and suspended deductions as if the taxpayer had been a resident for the entire tax year [R&TC § 17041; FTB Pub. 1100].
A nonresident is taxed on income from California sources arising out of a business, trade, or profession carried on in California [R&TC § 17951; CCR § 19751-2]. The critical factor in determining the source of income arising out of the taxpayer’s provision of personal services is the place where the services were actually performed [Appeal of Janice Rule 76-SBE-099 (1976); Appeal of Perelle 58-SBE-057 (1958)].
If the nonresident taxpayer’s business, trade, or profession is carried on both within and outside California, the income sourced to California may be based only on the business conducted within California, or may be determined by using the apportionment formula for corporations engaged in multistate businesses [R&TC § 17954; CCR § 19751-5].
If the nonresident taxpayer is receiving income from sales or services sourced to California, then he may have California sourced income (or apportionable business income) [FTB Pub. 1031; CCR § 17951-4; R&TC § 25136; CCR § 25136-2]. Sales from services are considered sourced in California to the extent the purchaser of the service received the benefit of the services in California; similarly, sales from intangible property are considered sourced in California to the extent the property is used in California [R&TC § 25136].
Distributions to a nonresident from employer-sponsored and self-employment (Keogh) pension, profit-sharing, stock bonus plans, or other deferred compensation arrangements are not taxable by California if received after December 31, 1995. Similarly, IRA, Roth IRA, SIMPLE IRA, SEP, and Keogh distributions received after becoming a nonresident are not taxable by California if received after December 31, 1995 [FTB Pub. 1031; FTB Pub. 1005].
The gain or loss from the sale of stocks or bonds has a source where the taxpayer is a resident at the time of the sale. Accordingly, when a nonresident sales such a personal investment, the gain is not taxable in California even when the stocks or bonds were for a California business entity [FTB Pub. 1031].
If the taxpayer exercises a stock option when he does not reside in California but the the taxpayer provides services in California while he was a resident of that State and those services were provided between the grant date and the exercise date of the option, then he will be taxed by California [CCR § 17952].
Lump-sum distributions from a qualified plan or annuity after December 31, 1995, are not taxable by California. However, lump-sum distributions, derived from a California source, received from a nonqualified plans after December 31, 1995, are taxable by California [FTB Pub. 1031; FTB Pub. 1005].
The gain or loss from the sale of real estate has a source where the property is located. If the taxpayer sells her California real estate, the gain is taxable by California even if the real estate is sold when the taxpayer is a nonresident [FTB Pub. 1031].
If the nonresident taxpayer has a spouse who is a resident of California and the spouses are filing separately, the taxpayer must claim one-half of the spouse’s income as her own.
Gains from the sale of a partnership interest are not taxed [Appeal of Amyas Ames, 87-SBE-042 (1987)].
A part-year resident uses the Resident rules to compute taxes owed during the portion of the year in which she was a resident of California and uses the Nonresident rules to compute taxes owed during the portion of the year in which she was a nonresident.
TEMPORARY OR TRANSITORY PURPOSE
As noted above, whether domiciled in California or domiciled in another state, a person will be considered a resident of the State depending upon their “temporary or transitory purpose” respectively for living outside the State or living in the State. However, even though the issue of residency for taxation purpose is entirely dependent on its meaning, what entails “a temporary or transitory purpose” is not specifically stated or, otherwise, defined within California’s tax code.
California Code of Regulation, Title 18, Section 17014 (CCR § 17014), does provide some guidance. It states that the purpose in using the “temporary or transitory” language was “to assure that all individuals who are physically present in this State enjoying the benefit and protection of its laws and government, except individuals who are here temporarily,” will be considered residents and, therefore, taxed on all of their income regardless of source. This regulation further affirms that “if an individual acquires the status of a resident by virtue of being physically present in [California] for other than temporary or transitory purposes, he remains a resident even though temporarily absent from the State;” that “whether or not the purpose for which an individual is in this State will be considered temporary or transitory in character will depend to a large extent upon the facts and circumstances of each particular case;” and that “the underlying theory of Sections 17014-17016 [of the Revenue & Taxation Code] is that the state with which a person has the closest connection during the taxable year is the state of his residence.”
CCR § 17014(b) discusses how the FTB should go about interpret-ing “temporary or transitory purpose” when reviewing a taxpayer’s return. This discussion have led to the development of two general tests to assist in determining this issue: the Identifiable Purpose Test and the Closest Connection Test.
Identifiable Purpose Test
CCR § 17014(b) states that “generally, … if an individual is simply passing through this State on his way to another state or country, or is here for a brief rest or vacation, or to complete a particular transaction, or perform a particular contract, or fulfill a particular engagement, which will require his presence in this State for but a short period, he is in this State for temporary or transitory purposes, and will not be a resident by virtue of his presence here.”
In other words, the Identifiable Purpose Test suggests that any person who is not “simply passing through” California while on his way somewhere else but remains in California for a prolonged period will likely be considered a resident – unless his stay arose out of a need to carry out a specific purpose in the State and that stay was only for a “short period”, or his stay was for a rest or a vacation lasting a “short period.”
How “particular” the contracted performance or engagement must be is unstated and, so, subject to the aforementioned factual analysis. Be that as it may, subdivision b mentions a time limit, that the taxpayer is expected to be just “passing through” California if he wishes to remain a nonresident; accordingly, the shorter his stay and the more specific and limited his activity while in California, the less likely that California’s Franchise Taxation Board (FTB) will allege that the taxpayer is a resident of this State.
Given the above, it is easy for the FTB to rule that a person living in California while domiciled outside of the state is a “resident” of California. For example, CCR § 17014(b) notes that if person is domiciled in another state but has come to California for the specific purpose of “improv[ing] his health and his illness” but doing so will “require a relatively long or indefinite period to recuperate,” then this person is a resident of California during his stay in the State – even though he has come to California for a specific purpose and, otherwise, intends to immediately leave the State once he has recuperated.
Similarly, if a person comes to California for “business purposes” and concluding that business will require a “long or indefinite period to accomplish,” or the person is employed in a position which requires he move to California “indefinitely” to fulfill the purpose of his employment, or the person has moved to California after retiring from his work with “no definite intention of leaving shortly thereafter;” then he will be considered a resident of California in each of these scenarios.
Accordingly, the question under the Identifiable Purpose Test is whether the non-domiciliary taxpayer has come to live in California for a specific, limited purpose and, assuming he has, whether his stay in the State will not be for a “long or indefinite” period of time.
Unfortunately, the phrase “long or indefinite period” of time is not defined. So, while the regulation sets out to clarify what is meant by “temporary or transitory purpose,” it does so by using yet another undefined phrase.
Be that as it may, the examples in CCR § 17014(b) make a point of affirming that, if the facts were reversed, the same determination would be made for a California-domiciled taxpayer who now lives in another state. Accordingly, the question under the Identifiable Purpose Test is also whether a California-domiciled taxpayer has gone to live in another state for a specific, limited purpose and her stay in that state will not be for a “long or indefinite” period of time.
Closest Connection Test
As noted above, CCR § 17014(b) states that “[t]he underlying theory of Sections 17014-17016 is that the state with which a person has the closest connection during the taxable year is the state of his residence.” Accordingly, the determination of residency will often require a detailed analysis of the facts and circumstances to determine which state has the “closest connection” with the taxpayer. This determination cannot be based solely on the individual’s subjective intent, but must instead be based on objective facts (Appeal of Anthony V. and Beverly Zupanovich 76-SBE-002 (1976)).
The facts which will be considered relevant in making this determination, however, are not stated in CCR § 17014. Accordingly, in Appeal of Stephen Bragg, 2003-SBE-002 (2003), the Board of Equalization (BOE) attempted to remedy this silence by listing various objective factors to be considered in determining whether a taxpayer was in California during the tax year “for other than a temporary or transitory purpose.” These factors can be organized into three categories:
(1) Registrations and Filings Records
(such as a driver’s license, an address on tax returns, or voter registration address);
(2) Personal and Professional Associations Records
(such as where the taxpayer maintains business interests, where the taxpayer’s children attend school, or where the taxpayer maintains memberships in social, religious, and professional organizations); and
(3) Physical Presence and Property Records
(such as the location of real property owned or rented by taxpayer, taxpayer’s telephone records, or origination of checking account and credit card transactions.)
More clearly state, these factors are:
∙ The location of all of the taxpayer’s residential real property;
∙ The approximate sizes and market values of each residence owned by the taxpayer located in California;
∙ The approximate sizes and market values of each residence owned by the taxpayer which are not located in California;
∙ The state wherein the taxpayer’s spouse resides;
∙ The state wherein the taxpayer’s children reside;
∙ The state wherein the taxpayer’s children attend school;
∙ The state wherein the taxpayer claims the homeowner’s property tax exemption on a residence;
∙ The taxpayer’s telephone records, to determine the state from which his telephone calls originated;
∙ The number of days the taxpayer spent in California compared to the number of days she spent in another state;
∙ The purpose of the taxpayer’s stay in California compared to the purpose of his stay in another state, i.e. vacation, specific business need, etc.;
∙ The location where the taxpayer filed his taxes;
∙ The state which the taxpayer claimed to be his state of residency on her tax return;
∙ The location of the taxpayer’s bank accounts;
∙ The location stated by the taxpayer as his residence when setting up a checking account;
∙ The location stated by the taxpayer as his residence when setting up a credit card account;
∙ The state where the taxpayer is a member of a social organization;
∙ The state where the taxpayer is a member of a religious organization;
∙ The state where the taxpayer is a member of a professional organization;
∙ The state where the taxpayer has registered her automobile;
∙ The state where the taxpayer was issued a driver’s license;
∙ The state where the taxpayer is registered to vote;
∙ The state in which the taxpayer has a history of voting;
∙ The state where the taxpayer’s primary medical care provider is located;
∙ The state where the taxpayer’s dentist is located;
∙ The state where the taxpayer’s attorney is located;
∙ The state where the taxpayer’s accountant/tax preparer is located;
∙ The state where the taxpayer is employed;
∙ The state where the taxpayer owns a business/maintains a business interest;
∙ The state where the taxpayer holds a professional license;
∙ The state where the taxpayer holds a business license;
∙ The state where the taxpayer owns investment property;
∙ The state where the taxpayer owns real property;
∙ The state mentioned by the taxpayer or by knowledgeable third parties as the taxpayer’s residence
As to these specific factors listed in Bragg, it should be noted that CCR § 17014(d) states that the fact that “an individual votes in or files income tax returns as a resident of some other state or country, although relevant in determining one’s domicile, are otherwise of little value in determining one’s residence.” It also affirms that “[n]o weight shall be given to the fact that charitable contributions are made to charities either within or without the State.”
Fundamental Uncertainty of the Tax Code
The straight-forward manner in which it is used in R&TC § 17014 implies that the phrase “temporary or transitory purpose” is uniformly used both for a California-domiciled taxpayer living in another state and for a taxpayer domiciled out-of-state living in California.
This impartial use of “temporary or transitory purpose” is further implied by the many examples given in CCR § 17014(b), each of which concludes that “[i]f, in the foregoing example, the facts are reversed” so that the hypothetical facts referencing an out-of-state-domiciled taxpayer were applied to a California-domiciled taxpayer or visa versa, then the opposite determination would be made. So, if the example alleges the hypothetical facts indicate the out-of-state domiciled taxpayer living in California is a California resident, then the reversed facts would mean applying the hypothetical facts to a California-domiciled taxpayer living outside the state necessarily must mean that this taxpayer is not a California resident.
So, reading R&TC § 17014 and its use of “temporary or transitory purpose” for both California-domiciled and otherwise-domiciled taxpayers and, thereafter, reading the examples applying this phrase, found in CCR § 17014, gives the impression that the FTB will carry out an impartial weighing of factors regardless of the taxpayer’s original place of domicile and a determination in favor of residency of a non-domiciled taxpayer will necessarily mean a determination against residency of a domiciled taxpayer under the same fact pattern.
In reality, this is hardily the case; and given that the FTB’s determination of residency is presumptively correct and, therefore, the taxpayer bears the burden of showing error in the FTB’s residency determinations, (Appeal of Mazer, 2020-OTA-263P), it does appear these ‘impartial’ rules and regulations are biased toward finding a taxpayer to be a resident of California and, therefore, taxable on all of her income regardless of source.
In example, R&TC § 17016 states that a person who “spends in the aggregate more than nine months of the taxable year” within California will be presumed to be a resident. This presumption can be rebutted. See Appeal of Woolley, 1951-SBE-005 (1951)).
Given the language of Section 17016, it might be assumed that spending less than nine months in California means that the taxpayer’s stay is “for a temporary or transitory purpose,” and, therefore, a stay of less than nine months will not make the taxpayer into a resident of California. However, this assumption is incorrect. In fact, as noted in CCR § 17016, a taxpayer may spend no time in California during a tax year and still be found to be a resident.
Still, given Section 17016, it might further be assumed that when applying the Identifiable Purpose Test that the undefined term “long or indefinite” period of time means a stay in California exceeding nine months. This assumption, however, also is incorrect. CCR § 17014(b) states that:
An individual whose presence in California does not exceed an aggregate of six months within the taxable year and who is domiciled without the state and maintains a permanent abode at the place of his domicile, will be considered as being in this state for temporary or transitory purposes providing he does not engage in any activity or conduct within this State other than that of a seasonal visitor, tourist or guest.
An individual may be a seasonal visitor, tourist or guest even though he owns or maintains an abode in California or has a bank account here for the purpose of paying personal expenses or joins local social clubs. (See also, Klemp v. Franchise Tax Bd. (1975) 45 Cal.App.3d 870.)
So, despite the nine-month period set down in R&TC § 17016, the regulation sets the time limit at six months and, even then, it is expressly limited to persons who are not engaging in business activity in California, but only in the State as a “seasonal visitor, tourist or guest.”
Now, it has been argued that the only real test is the Closest Connection Test because CCR § 17014(b) expressly states that “[t]he underlying theory … is that the state with which a person has the closest connection during the taxable year is the state of his residence.” Given this, is the Identifiable Purpose Test even valid?
I would have to say that it is. The example regarding the annual California vacationer found in CCR § 17014(b) was cited in the Klemp decision and that example states the only connections the taxpayer has with California is that she vacationed here for less than six months and, in so doing, either rented or purchased a California abode and opened a bank account. By its terms, she did “not engage in any activity or conduct within this State other than that of a seasonal visitor, tourist or guest.”
Under this scenario, the out-of-state visitor must have an out-of-state abode and, as her contacts with California are limited, she must vote in that other state, register her vehicles in that other state, carry out her work in that other state, receive medical care and other professional services in that other state. Simply put, under the Closest Connection Test, she would be a resident of the other state.
Yet, if she remains in California for over six months, the example indicates she will be considered a resident of California despite the fact that she has closer connections to the other state. So, while the closer connection test is the one more often discussed in opinions by the OTA, it does seem that the Identifiable Purpose Test does play a part in determining residency.
Given the aforementioned “equivalency” in how “temporary or transitory purpose” is applied whether the taxpayer is domiciled in California or elsewhere, can it be presumed that a taxpayer who is domiciled in California will no longer be considered a resident of the State if he vacations in another state for more than the six month period outlined in CCR § 17014(b)?; or if he is living in another state for whatever reason for more than the nine month period outlined in R&TC § 17016?
The answer is, no.
Despite clear language in Section 17016 setting nine months in the State of California as the benchmark to presume residency, that benchmark does not apply to a taxpayer domiciled in California who has moved to another state. In fact, the benchmark for a California-domiciled taxpayer living is another state is two years (See, for example, Appeal of Crozier, (92-SBE-005) (1992); Appeal of Mazer, 2020-OTA-263P (2020)). Accordingly, a taxpayer domiciled in California who has not lived in that State for over a year, in fact who has not lived in California for up to nearly two years, will still be presumptively considered a California resident and, therefore, required to pay taxes over all of his income, regardless of source.
So, once again, whereas the language of the statute and of the regulation defining that controlling statute does strongly imply an impartial equivalency between the treatment of out-of-state domiciled persons coming to live for California for a limited time and the treatment of California-domiciled persons going to live in another state for a limited time; this is far from the case. The fact is that the manner in which the language is interpreted and the very open-ended nature of that language, which is more suggestive than authoritative, makes it fairly easy for the FTB to argue the facts prove an out-of-state domiciled person living in California is a residence of California and, contrarily, to argue the same general facts prove a California-domiciled person living outside of California remains a resident of California.
This conclusion is also somewhat confirmed by the application of the two tests. The Identifiable Purpose Test is clearly aimed primarily at persons coming to California, as it expressly references determining residency if and when a person remains in California for anything other than a “short period” or for other than a “particular” reason and, thereby, that person benefits from staying in California.
While the regulatory language in CCR § 17014(b) states the Identifiable Purpose Test is equally applicable to Californians who decided to live outside of the State, that does not seem particularly true. In fact, the Closest Connection Test seems to be the test most often used in analyzing whether a California-domiciled taxpayer remains a resident while he is living in another state (See, for example, Appeal of Mazer 2020–OTA–263P (2020)). A review of the Bragg factors should convince you that the Closest Connection Test favors finding residency in the state of domicile since the several Bragg factors favor finding residency at the place where the taxpayer has generally “set up” his life.
To be fair, before I concluded this screed against the “impartiality” of California’s residency tax laws, it should be noted that the situation for a California-domiciled person is not so dire as the above suggests. There is a ‘safe harbor’ provision set down in R&TC § 17014(d) which states that “any individual domiciled in [California] who is absent from the state for an uninterrupted period of at least 546 consecutive days under an employment- related contract shall be considered outside this state for other than a temporary or transitory purpose.”
For this “safe harbor” provision to apply, the following conditions must be met: 1. The taxpayer may not return to California for more than 45 days in any one tax year during his absence; 2. The taxpayer must not earn in excess of $200,000 from stocks, bonds, notes, or other intangible personal property in any one tax year during his absence; and 3. The principal purpose for the taxpayer’s absence from California must not be that he wants to avoid paying income tax to California. (If the taxpayer’s spouse accompanies him while he lives outside of California, she will also be considered a nonresident if she also complies with the aforementioned three conditions.)
As can be noted, this “safe harbor” provision is contrary to the two-year general rule mentioned above. So, whereas generally a California-domiciled taxpayer must live continually in another state for over two years before he will no longer be considered a resident of California, if he lives continually in another state for over eighteen months in furtherance of an employment contract and does not have excessive investment income and does not visit California too often, then he can cut six months off of the general rule under the ‘safe harbor’ provision set down in R&TC § 17014(d).
It goes without saying, however, that this “safe harbor” eighteen-months period applicable to a California-domiciled taxpayer is twice as long as the Section 17016 nine-month period which will lead to a presumption of residency in California for an out-of-state domiciled taxpayer living in California.
In summary, all California tax statutes and other regulatory language referencing the residency issue, despite their specific language, are often conditional and, therefore, should be seen as guidance rather than an instruction as to how residency must be determined.
Until recently, deciding administrative appeals for income taxes and business taxes was carried out by the California State Board of Equalization (BOE).
The Office of Tax Appeals (OTA) was created by the Taxpayer Transparency and Fairness Act of 2017 to take over this duty from the BOE. The OTA publishes a written opinion for each case in which it makes a determination; however, only a few of them are designated by the OTA as precedential.
Most residency cases arise out of the FTB’s review of taxpayers’ Form 540NR attached to their returns. Claims for refund also will often bring the attention of the FTB.
No matter the reason for the FTB’s interest, once its curiosity is peaked, the FTB will begin “scoping the return.” This process commences with a close scrutiny of the tax return to determine, amongst other things: responses to the residency questions found in Schedule CA (Form 540NR); the taxpayer’s address stated on the return; the address stated on the W-2s and 1099s issued to the taxpayer; other addresses disclosed on the tax return; location of assets that were sold or exchanged; location of rental or other investment property; location of banks and financial institutions; taxpayer’s occupation; moving expense information; income, expenses and deductions which may indicate a connection within California; income, expenses and deductions which may indicate a connection outside of California; Schedule C activity and address; investment activity; location of any closely held corporation.
The scoping process will usually include skip tracing and review of prior tax returns filed by the taxpayer. The skip tracing will generally seek evidence of property owned by the taxpayer and that property’s location and will include review of DMV records, a general internet search, a Lexis/Nexis search, and a Zillow real property search.
If a full audit is deemed necessary. The FTB will investigate to determine taxpayer information regarding:
purchase price; date of purchase; assessed value; homeowner’s or renter’s insurance coverage; furnishing of residence; homeowner’s property tax exemption information; dates of occupancy;
make/model of vehicle(s); dates of ownership; states of registration; vehicle expense and location where services on the vehicle were provided;
type of pet; where pet housed; pet expense and location where those expenses were incurred;
address; type of business; nature of taxpayer’s involvement in running business;
address; type of business; nature of taxpayer’s duties; compensation received; location where taxpayer performed his employment duties;
date registered to vote; voting history; present voting status;
registration period; residence address on license; status of license;
account number; type of account; branch location; date opened/closed account; authorized signatories; transaction activity location;
name on card; account number; date opened/closed;
authorized signatories; transaction activity location;
name/relationship to taxpayer; age, if minor children; location of family member(s) during audit tax year(s);
name/address of club; type of club; dates of membership;
name/address of organization; type of organization; dates of membership; nature of taxpayer’s involvement;
professional services used by taxpayer; address of each professional service; payment dates to professional service(s);
date the taxpayer reported the residency had changed;
calendar reflecting the days the taxpayer was physical present in any state/country during the tax year; an interpretation of the calendar in support of any analyses thereof;
California tax codes; regulations; case law supporting
After complying this information related to the taxpayer, the FTB agent is required to analyze each of the aforementioned fact sections separately and to objectively evaluate how each fact section affects the taxpayer’s residency status. It is the FTB’s position that none of these factors are decisive in and of themselves.
Be that as it may, some of these factors appear more telling than others. For instance, where a taxpayer has claimed a homeowner’s property tax exemption is highly suggestive that he believes he resides at that property. Further, spending extensively more time in one state rather than another implies the more traveled-to state is where the taxpayer feels most at home and, therefore, where he likely resides.
Giving Up the Taxpayer’s California Domicile
CCR § 17016(c) defines “domicile” to be “the place in which a man has voluntarily fixed the habitation of himself and family, not for a mere special or limited purpose, but with the present intention of making a permanent home, until some unexpected event shall occur to induce him to adopt some other permanent home.” A taxpayer can at any one time have but one domicile. If an individual has acquired a domicile at one place, he retains that domicile until he acquires another elsewhere.
A domicile once acquired is presumed to continue until it is shown to have been changed. (Appeal of Bailey 76-SBE-016 (1976)). The burden of proof as to a change of domicile is on the party asserting such change. (Appeal of Bragg 2003-SBE-002 (2003)). If there is doubt on the question of domicile after presentation of the facts and circumstances, then domicile must be found to have not changed (Appeal of Bragg).
To establish a new domicile, two things are necessary:
(1) the taking up of a physical or actual residence in a particular place,
(2) the intent to make it a permanent abode; such intention is to be gathered from one’s acts.
Union of act and intent is essential; and until such union occurs one retains his former domicile. The taxpayer’s intent is not determined merely from his unsubstantiated statements; the taxpayer’s acts and third party declarations will also be considered. Accordingly, a taxpayer does not lose a former domicile by going to and stopping at another place for a limited time with no intention to reside there permanently, though the absence may continue for a number of years.(Chapman v. Superior Court (1958) 162 Cal.App.2d 421, 426; see also Noble v. Franchise Tax Bd., (2004) 118 Cal.App.4th 560).
While moving to a new abode in another state with the intention of making that new residence permanent are the two elements generally stated by case law to change a state of domicile, the FTB’s reading of this legal authority is more severe; its Publication 1031 states three elements required for a change of domicile. These elements are:
∙ Abandonment of your prior domicile.
∙ Physically moving to and residing in the new locality.
∙ Intent to remain in the new locality permanently or indefinitely as demonstrated by your actions.
Accordingly, the FTB had made it clear that its interpretation of case law is that proof of the taxpayer’s intention to remain at the new location effectively means proof that the taxpayer has abandoned her past domicile.
A taxpayer should look to the Closest Connection Test to determine what steps are needed to “abandon” his old domicile. Any element in the test which presumably suggest a connect with the old domicile should be resolved. In particular, it is recommended that the taxpayer:
∙ Sell his California residence
It is strongly advised that the taxpayer sell his residence. The legal assumption is that a taxpayer retains his state of domicile unless he proves otherwise. Retaining his residence strongly implies the taxpayer continues to benefit from living in California and, otherwise, has an intention to eventually return to the State;
If the taxpayer decides not to sell his California residence, then it should be leased out to a tenant to prove it is investment property;
If the taxpayer’s California residence is not sold and it is not leased out, then the taxpayer should not use the residence at anytime when returning to California;
∙ Stay at a hotel or with friends/relatives whenever returning to California
The taxpayer should keep receipts, invoices, etc. and otherwise contemporaneously document each such stay in a travel journal if staying with friends/relatives;
∙ Leave his California employment
If the taxpayer retains his employment, he should have his employer declare or the taxpayer himself should document how he works off-site and in another state;
If his employment requires the taxpayer to regularly return to California, he should document his travel itinerary, document his stay at hotel, document his sole purpose traveling to California was for employment and, as such, he left the state as soon as his employment requirement was met;
It is not advised that the taxpayer rent an abode in California to be used when returning to the state for work-related activities or, otherwise, do any related act which indicates the taxpayer is retaining a permanent address in California. As noted before, it is much wiser to stay in a hotel or stay with friends/relatives. The presumption is that a person domiciled in California remains domiciled in California even when the taxpayer moves to another state; therefore, simply moving from one California residence to another California residence will be seen as proof that the taxpayer still hopes to benefit from living in California and, as such, remains domiciled in the State;
If the taxpayer decides to risk it by renting an abode in California, then he should rent a small apartment with just the basics so he can prove the California abode is not retained as a home but to serve utilitarian needs. In short, the closer the apartment resembles a hotel room, the more clearly will be the evidence that it is used by the taxpayer for a “temporary or transitory purpose.”
The taxpayer should always be aware that even if he can prove he has changed his domicile, if his employment requires him to spend extensive time in California, then he may still be a resident of the State and, therefore, fully taxed by the State despite his change of domicile. Again, the presumption is that spending cumulatively nine months of a tax year in California will make the taxpayer into a resident; however, under the Identifiable Purpose Test, the FTB will likely allege the taxpayer is a resident even when the taxpayer spends less than nine months in California if any one of the visits by the taxpayer is not of a short duration or the visit does not appear to be carried out for a particular purpose. Again, the exact nature of a “short” stay is not defined, so the more it can be characterized as “passing through” the State, the better for the taxpayer.
∙ Close down/sell of California business
The best practice is for a taxpayer to cut ties with any
business he owns in California and, if he wishes to
continue int business, to open similar business in the new state.
∙ Discontinue business and social ties in California
The taxpayer must remembers he is “abandoning” California to seek a new permanent home. In other words, he is permanently leaving California behind. Again, the presumption is that the original domicile remains until proof than that domicile has been “left behind.” Because of this, any acts which imply the taxpayer still looks to California for his living, financial, social, emotional needs will be considered proof that he is not permanently leaving California.
∙ Track communications (telephone calls, emails, etc.) with California to prove taxpayer has attempted to resolve any personal business with a California service provider from his new abode outside of California
∙ Use registered/certified mail or express mail services whenever sending documents to California to prove once again that the taxpayer resolved issue arising with a California provider from outside of that state.
∙ Purchase an abode in the new state which is comparable in size to the abode vacated in California
The taxpayer should have this abode when she moves. Moving into an apartment in the new state while the taxpayer searches out a new abode to purchase will generally be viewed as the taxpayer hoping to move to the new state if the right home can be found rather than intending to do so.
If the taxpayer moves into an apartment permanently in the new state while he had a residential home in California, then he should expected that he will have to provide a sensible reason why he has not replaced his California abode with a like-in-kind abode in the new state.
Again, anything which remotely suggests the taxpayer is not replacing his lifestyle in California with an equivalent lifestyle in the new state will be viewed as indicating the move to the new state is not intended to be a permanent move.
∙ Move the entire family, including pets, to the new abode
If the taxpayer’s family remains domiciled in California, the FTB will certainly believe the taxpayer’s move is temporary and that the taxpayer will eventually move back to California.
Leaving a pet behind in California, particularly if the pet is still owed by the taxpayer, implies the taxpayer intends to return to California; otherwise, why would he leave the pet behind in that state?
∙ Enroll any minor children in schools located in the new state
∙ Terminate services of professionals (doctors, accountants, lawyers, etc.) in California and promptly replace them with other professionals located in the new state
If a professional used in California is with a firm or office with a branch in the new state, have a professional at the local branch in the new state be assigned as the primary lead on the taxpayer’s matters.
∙ Register to vote and, thereafter, do vote in the new state
∙ Register all vehicles, including boats, in the new state
All vehicles should be housed in the new state. Leaving a boat in a harbor in California will be seen as the taxpayer continuing to benefit from that state and, therefore, will suggest he has not abandoned the state.
∙ Obtain driver’s license and other licenses in the new state
∙ Close out bank and other financial accounts in California and, otherwise, open similar accounts in the new state
∙ Transfer all credit cards from California to the new state
∙ If religious, the taxpayer should stop attending religious services in California and begin doing so in the new state. Any donations should, thereafter, be to religious organiza-tions in the new state.
∙ Close out any post office boxes in California and, otherwise, have all mail forwarded to new state
∙ Limit visits to friends, family, vacating in California
Each visit to California, for whatever reason, should be
documented to show purpose of visit.
∙ If the taxpayer owns investment property in California, she should consider purchasing similar investment property in the new state or, otherwise, divest a portion of her California property portfolio. Extensive disproportionate investment in California will imply a strong emotional tie to the state and, therefore, suggest any move away from the state is not permanent. If neither option is viable, the taxpayer should expect that he will have to explain why he continues to retain investment in a state he alleges he has ‘abandoned.’
∙ Obtain declaration from third parties who can testify to the taxpayer’s sincere intention to permanently move away from California.
OTHER STATE TAX CREDIT
A person domiciled in California who is employed in another state for less than 18 months consecutively will generally remain a resident of California. He will earn income in the other state, yet as a resident of California his entire income will be taxed in California. Realizing its tax laws may lead to double taxation, California has provided for a tax credit whenever a taxpayer’s income is taxed in another state [R&TC §§ 18001, 18002].
The taxpayer should use Schedule S to report this tax credit.
The following information is taken from the FTB’s Schedule S Instructions.
Taxpayers may qualify for a credit for income taxes paid to another state when the same income that is taxed by the other state is also taxed by California. Other state income taxes which are paid to the other state do not necessarily have to be in the same year, as long as the taxes relate to the same transaction.
The credit is applied against California net tax, less other credits. The credit cannot be applied against California alternative minimum tax. When a joint tax return is filed in California, the entire amount of tax paid to the other state may be used in figuring the credit, regardless of which spouse/ registered domestic partner (RDP) paid the other state tax or whether a joint or separate tax return is filed in the other state. When a joint tax return is filed in the other state and separate California tax returns are filed, the credit is allowed in proportion to the income reported on each California tax return.
If, after paying tax to the other state, the taxpayer gets a refund or credit due to an amended tax return, computation error, audit, etc., he must report the refund or credit immediately to the Franchise Tax Board (FTB).
Residents of California may claim a credit only if the income taxed by the other state has a source within the other state under California law. No credit is allowed if the other state allows California residents a credit for net income taxes paid to California.
California residents that derived income from sources within any of the following states or U.S. possessions and paid a net income tax to that state or U.S. possession on income that is also taxed by California may claim the other state tax credit:
Alabama (AL), American Samoa (AS), Arkansas (AR), Colorado (CO), Connecticut (CT), Delaware (DE), District of Columbia (DC) (unincorporated business tax and income tax, the latter for dual residents only), Georgia (GA), Hawaii (HI), Idaho (ID), Illinois (IL), Indiana (IN), Iowa (IA), Kansas (KS), Kentucky (KY), Louisiana (LA), Maine (ME), Maryland (MD), Massachusetts (MA), Michigan (MI), Minnesota (MN), Mississippi (MS), Missouri (MO), Montana (MT), Nebraska (NE), New Hampshire (NH) (business profits tax), New Jersey (NJ), New Mexico (NM), New York (NY), North Carolina (NC), North Dakota (ND), Ohio (OH), Oklahoma (OK), Pennsylvania (PA), Puerto Rico (PR), Rhode Island (RI), South Carolina (SC), Tennessee (TN) (excise tax only), Utah (UT), Vermont (VT), Virgin Islands (VI),Virginia (VA) (dual residents*), West Virginia (WV), and Wisconsin (WI).
Nonresidents of California may claim a credit only for net income taxes imposed by and paid to their states of residence and only if such states do not allow their residents a credit for net income taxes paid to California.
California nonresidents that are residents of one of the following states or U.S. possessions and paid a net income tax to that state or U.S. possession on income that is also taxed by California may claim the other state tax credit:
Arizona (AZ), Guam (GU), Oregon (OR), and Virginia (VA).
California nonresidents who are residents of any state or U.S. possession not listed may not claim this credit. This credit is not allowed on a California group nonresident tax return.
If I have to leave you with one thought, it is that the California tax laws are fair – to a point.
If a person domiciled outside of California comes to the state, the FTB looks to see if he is gaining benefit from his stay in California, generally which it believes to be true whenever the person comes to California with no particular purpose or for a prolonged stay; if so, it will find he is a resident of the state.
If a person domiciled in California moves away from the state, the FTB looks to see if he still has closer connections to California than to the new state, generally requiring that he (and his family, if he has one) effectively “abandon” California during his time living in the new state or stay away from California for over two years; if he has not, it will find he remains a resident of the state.
A person who wants to give up their domicile status in California must effectively cut all ties with the state. A person’s original domicile is presumed to remain his domicile even when he leaves it for extensive periods of time. Accordingly, as evidence that a person who was domiciled in California continues to seek benefit or maintain ties to the state will be considered as still domiciled in California.
This paper has covered a lot of ground and, despite my best efforts, it likely wandered about a bit. Still, I hope it was cogent and, otherwise, helpful.
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