An Overview of California Tax Residency
An Overview of California Tax Residency
With the personal income tax rate topping out at a nation-high 13.3% for the highest earners, many California residents are contemplating a move to save on their tax bill. Some California residents look to change residencies to avoid a lavish tax bill before selling real estate, receiving a litigation or settlement payout, or selling shares in a public offering or private stock sale. For this group, changing residencies is even more tempting as California does not have a separate (lower) rate for capital gains. Capital gains are taxed as ordinary income.
However, relinquishing your California residency status is not as simple as packing up and leaving to a lower or no income tax state. It is possible that even after you have packed your belongings, purchased a new home in another state, and moved your family across state lines, you may face an ominous unwelcomed reality: An incoming residency audit and a corresponding tax bill (along with penalties and interests) from the California Franchise Tax Board ("FTB"). So how does one avoid this unfortunate fate? Careful planning before one decides to move may help insulate against these risks and avoid common blunders.
California Residency Determination
To plan a successful move from California, one must understand the concept of California tax residency. A California resident (for tax purposes) is an individual who is: (i) in California for other than a temporary or transitory purpose or (ii) "domiciled" in California, but who is outside of California for a temporary or transitory purpose. "Domicile" for California tax purposes, has a special legal definition that is not the same as residence.
Domicile is defined as the place where an individual voluntarily establishes their true, fixed, permanent home and principle establishment, and to which place they have, whenever absent, the intention of returning. It is the place where an individual has voluntarily fixed the habitation of self and family. An individual can only have one domicile at any one time. If an individual has acquired a domicile at one place, that domicile is retained until another domicile is acquired. A change in domicile requires: (i) abandonment of the prior domicile; (ii) physically moving to and residing in a new locality; and (iii) intent to remain in the new state permanently or indefinitely. Importantly, mere intent to change domicile is insufficient to change domicile. The intent must be manifested in acts and declarations.
While many states consider domicile and residence to be the same, California makes a distinction and views them as two separate concepts, even though often they may overlap. The FTB indicates that one may be domiciled in California but not be a California resident. Conversely, one may be domiciled in another state, but be a California resident for income tax purposes.
Application of California Residency Taxation
A California resident is subject to California state income tax on all income regardless of where it is earned. In contrast, non-residents are only subject to California state income tax on income that is California sourced. Examples of California sourced income include, but are not limited to, income derived from services performed in California, rent from real property located in California, the sale or transfer of California real property, or income from a California business, trade, or profession. Note that part-year residents pay tax on all worldwide income while they were a resident of California.
So what are the factors the FTB considers when determining whether one is a California resident? Fortunately, the FTB has provided some published guidance. The FTB looks to objective factors to determine residency and connections with California. Such factors include, but are not limited to, the amount of time spent in California versus time spent outside California, location(s) of a person's spouse and children, location of a person's principal residence, where their driver’s license was issued, where they maintain their professional licenses, where the origination points of their financial transactions, and location of their social ties. This list is not exhaustive, and the FTB even cautions against relying on these and other published factors alone.
In fact, case law reveals additional factors for consideration. For example, in the Appeal of Stephen D. Bragg, 2003-SBE-002 (May 28, 2003), the California State Board of Equalization ("SBE") held that the following factors are also relevant in determining residency: (i) the approximate size and value of all residential real property; (ii) where the taxpayers' children attend school; (iii) where the taxpayers claim the homeowner’s property tax exemption; (iv) telephone records showing the origination of their phone calls; (v) where they file their state and federal tax returns, and the state of residence claimed on those returns; and (vi) the state where they are employed.
Additionally, many residency and domicile cases turn on an overall comparative analysis. In the Appeal of Raymond H. and Margaret R. Berner, 2001-SBE-006-A (August 1, 2022), the SBE explained that when an individual has contacts with more than one state, the state in which the individual maintains the closest connections during the taxable year is the state of residence. The contacts maintained by a taxpayer in other states are important objective indicators of whether an individual's presence in California was for a "temporary or transitory purpose."
When it comes to properly severing ties with California, it is critical to check the correct boxes, dot your i's, and cross your t's. To help insulate against potential risks, it is best practice to work with a legal professional to help document your move and sever California residency status. For questions on California residency issues or help with a California residency audit, contact Wilson Feng and the Hanson Bridgett Tax Group for assistance.