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The Function-Time Resident Tax Trap

Sunny Taxxy California

Most of the world knows the Palm Springs area for its picturesque golf game courses, glory homes and halcyon weather. Amongst the taxing government in Sacramento, however, the words "Palm Springs" conjure up less carefree images. Spurred past the land's ambition for revenue enhancement revenues, the Franchise Taxation Board, California's primary revenue enhancement enforcement agency, has tapped into a new revenue source: taxing seasonal visitors to popular holiday spots in California, where residents often have second home. Palm Springs is ane such surface area. But so is Santa Barbara, Sonoma County, San Diego.

Seasonal Visitors As Tax Targets

This is how information technology works. California taxes residents based on their worldwide income, from whatever source, no matter how far-flung. In dissimilarity, California taxes nonresidents only on their income derived from California sources. For instance, these might include a express partnership operating in California or rent from an investment belongings. Since California has the highest income tax rate in the land, visitors who suddenly find themselves defined as "residents" may face a large and unexpected tax liability.

Plainly, the FTB  would like to claim everybody who sets pes on California soil every bit a resident and subject their income to California tax. That'southward their job, after all. As many seasonal visitors take discovered, the FTB's policies sometimes seem not to autumn too far short of that mark.

A special segmentation of the FTB has for years systematically targeted seasonal "part-fourth dimension" residents for audit (I use the term "part-time" loosely, since we are talking most nonresidents who spend part of the year here, not part-timelegal residents per se; merely 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 equally 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 ordinarily involve Midwesterners who own wintertime 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 organisation interests or long visits to the state), it can lead to the launch of a total-blown residency audit.

In some ways, these audits are the equivalent of the old-fashioned speed trap, with the departure that a speed trap unremarkably nets the country nearly $500, while these residency audits can often fill the state's coffers with tens of thousands of dollars in back taxes. And for the taxpayer this may besides hateful years of legal wrangling.

Instance in betoken: Gilbert Hyatt, inventor of microchip technology that ultimately resulted in the modernistic consumer reckoner industry, institute himself audited in 1993 on the issue of whether he was a resident of California or Nevada – states where he owned homes – for a tax year when his invention earned him about $90 million.  Hyatt won (mostly). But the case took over 25 years to resolve.  See the Appeal of Gilbert P. Hyatt hearing summary for all the gory details.

Unfortunately for many nonresidents, "residency" is a legal term of art, ane that may take nothing to do with a person's honest belief that his or her real dwelling house lies outside California

The Intrusive Unintuitive Resident Audit

A resident audit isn't like a typical tax audit (see California Residency Audits: Three Twelvemonth-End Tasks To Reduce Gamble for Nonresidents for a discussion of the distinctions). If a large enough taxation liability is at pale, to establish legal residency, FTB auditors may announced out of nowhere to interview neighbors. They can amendment a taxpayer's utility bills, credit card statements and check register. They solicit affidavits from friends (and enemies).  In general, they pry into a taxpayer's private diplomacy.

Unfortunately for many nonresidents, "residency" is a legal term of art, i that may have nothing to practice with a person's honest belief that his or her real home lies outside California. Equally a result, the effect of a residency audit often turns on seemingly petty facts with no legal significance for a non-lawyer.

For example, our business firm handled a instance in which the FTB auditor concluded that a Texas woman was a California resident despite the fact that all of her meaning business organization, social and family ties were in Texas and her California contacts were limited to a 2nd home in the desert and a country club membership. One of the factors in the auditor's conclusion focused on the fact that the woman put her local subscription to The Los Angeles Timeson hold when she left the land and returned to Texas. TheTimes, it so happens, calls that a "vacation concord." There were other bad facts, but in the accountant'southward mind, vacation holds loomed big. It meant that my client's Texas trips must exist vacations, which made California her permanent home. Thankfully, we won the instance on entreatment.

Temporary Visits And The Closest Connection Test

Under California constabulary, a person who visits the state for other than a temporary or transitory purpose is a legal resident, bailiwick to California tax. Basically, brief vacations or transactions, such every bit signing a contract or giving a speech communication, establish temporary or transitory purposes that do not confer residency. Every other kind of visit can result in residency condition, including coming to California for an indefinite stay for health reasons, extended stays (usually over six months), retirement, or employment that requires a long or indefinite flow to accomplish.

How does the FTB make up one's mind whether a visit has a permanent purpose versus a temporary one? It applies the so-chosen "Closest Connectedness Test." This refers the comparing contacts a person has with various states during a taxable year: the one with the "closest contacts" is the state of legal residence. For the FTB, this literally means counting all the California contacts a person has and comparing that number with the non-California contacts. Of course, some contacts simply weigh more than than others. A job or real estate ownership obviously indicates a closer tie than only enjoying a round of golf at a country guild or attending a music festival. The weightiest factors for residency (based on statutes, regulations and inspect practices) are the following:

• Buying or lease of real estate.
• Business interests or employment.
• Financial accounts, such as banks and investments, prophylactic eolith boxes.
• A spouse's residency (they don't have to be the same)
• Schools children attend.
• Voter registration.
• Motorcar registration and license
• Employ of professional services such as main medico, dentists, accountants and lawyers.
• Professional licenses.
• Family ties and social life.
• Representations of residency in social media or websites (where does your Twitter account say yous're tweeting from?).
• Address used on various tax documents, such as a federal return (class 1040) or Due west-2s, 1099s, K-1s, etc.
• Location of of import personal belongings such as family heirlooms, art, or important documents.
• Membership in clubs and gyms.
• And of form, where y'all spend most of your time.

I hasten to add together, these are simply factors. Despite many internet myths about California residency, no 1 matter makes you lot a resident; and no i thing makes you a nonresident. California doesn't follow bright-line rules to determine residency, but rather employs a "facts and circumstances" standard. That means FTB auditors can be somewhat impressionistic in their application of the law and downplay the main factors in favor of quirky logic, as our Texas client discovered. In another instance our firm handled, the FTB argued that an elderly S Dakota couple with a 2nd abode in California were residents because during their seasonal stays hither, they would fly overseas or go along a cruise. Co-ordinate to the accountant, if the couple left California to go on a vacation, they could not be on vacation while in California. Again, the FTB somewhen lost. There are bodily rules about how the revenue enhancement authorities can weigh contacts. But the rules often only come into play at the appellate level, where attorneys get involved, after a residency audit has occurred and the taxpayers already incurred tens of thousands of dollars in legal and accounting fees.

Warning Signs of a Residency Audit

Here are ten warning signs of a possible FTB inspect to keep in heed and to avoid, if possible:

1. Six Months. You spend more than six months in California during the agenda year, and especially if you spend more than nine. Spending more than than ix months creates a legal presumption of residency, though it is rebuttable. But notation, the 6 months is not a "rule"; information technology's always more of import why you're spending time in California than the length of fourth dimension spent (see The Six-Calendar month Presumption in California Residency Law, at our blog). Y'all can spend no time in California and still be a resident; and you tin spend the whole year here and remain a nonresident – nether the right conditions (but I wouldn't recommend information technology).
2. Second Home. You live out-of-state but own a second home in California and regularly visit or holiday there, especially if your stays here total more than 6 months during any year (or at least y'all spent more time in California than your dwelling state).
3. Property Storage. In anticipation of moving to or retiring in California in the future, you begin to send personal property ahead of your move for storage here (an of import consideration if you want to sell stock or a business in a low-revenue enhancement state while still a nonresident earlier moving to California).
4. Keeping Contacts. You programme to move abroad from California, but yous retain business organisation interests, a vacation home or other pregnant contacts.
5. Point of Departure for Vacations. You come to your vacation dwelling house in California, and go on to other holiday spots from here, and return from holiday to California.
6. Multiple Land Contacts. Yous have contacts with multiple states, including California.  This is peculiarly true if you spend more time in California than whatever other land, even if the total is under six months.
7. Low-Revenue enhancement State. You're selling stock or other intangible property in a state with a depression or zip income tax rate, while having meaning California ties.
8. Selling Out-Of-State Residence. You ain a second habitation in California, and you sell your out-of-state principal residence.
9. Employment. Your house sends you to California to work for an extended period of fourth dimension, or you work as an contained contractor working on a project in California requiring spending significant fourth dimension in-state.
10. FTB Discover. Y'all receive an FTB detect asking information about why you didn't file a tax render for income reported to the FTB from a California bank, banker or mortgage lender (the dreaded "4600 Notice, Demand for Tax Return"). This can be a prelude to a full-diddled audit.

The primal to winning a residency inspect is to avoid one in the kickoff place. If whatsoever cherry flags are fluttering over your California vacation paradise, you may want to minimize your exposure by carefully examining the rules of residency and applying them to your situation.

[This commodity is updated from a piece I wrote over five years ago, which has had hundreds of thousands of hits, many of them, I presume, from FTB agents]

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Manes Law is the premier police force house focusing exclusively on comprehensive California residency taxation planning, on a stock-still-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. Nosotros 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 alive and work anywhere. Learn more at our website: www.calresidencytaxattorney.com.

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No information contained in this post should be construed as legal advice from Justia Inc. or the individual writer, nor is it intended to be a substitute for legal counsel on any subject matter. No reader of this post should act or refrain from acting on the basis of whatever information included in, or accessible through, this post without seeking the advisable legal or other professional advice on the particular facts and circumstances at issue from a lawyer licensed in the recipient's state, country or other appropriate licensing jurisdiction.

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Source: https://www.palmspringstaxandtrustlawyers.com/the-part-time-resident-tax-trap/

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