With personal income tax representing 61% of California’s total general fund revenue sources, it is no surprise that the California Franchise Tax Board in the last few years has become more aggressive in its enforcement and interpretation of California residency law, using residency audits to do so.
What is California Residency Audit?
According to California’s residency laws, residents must pay state tax on their worldwide income, no matter the source of the income. Meanwhile, part-year residents are only required to pay taxes on income received while a resident of the state. Therefore, a person’s “residence” under California law is the key to understanding their state income tax liability. For this reason, the FTB conducts residency audits that will determine a person’s residency.
The 3 Types of “Residency” According to California Residence Law
When the FTB conducts a residency audit, the outcomes are generally broken down into three different categories. These are resident, nonresident, or part-year resident. The audit is simply meant to help determine which category taxpayers fall into.
- Resident: A taxpayer may be found to be a resident of California, in which case they are taxed on income from all sources, including income from sources outside of California.
- Nonresident: A taxpayer may be found to be a nonresident of California, in which case, they are taxed only on income from California sources.
- Part-year resident: A taxpayer may be found to be a part-year resident, and taxed on all income received while a resident and only from California sources while a nonresident.
According to California residency is defined as an individual who is in the state for anything else other than a temporary or transitory purpose or domiciled in California but physically outside the state for a temporary or transitory purpose. While the above definition might seem very straightforward, in reality the law is broadly written and leaves room for interpretation. As a result, if the FTB says you are a state resident, the burden now lies with you to prove them wrong.
How the FTB Determines Residency Status
California residency law defines the class of persons that are expected to contribute tax revenue to the state. California’s Revenue and Tax Code (R&TC) § 17014 includes every person in the state of California except for those in California for “a temporary or transitory purpose.”
It is important to note that this definition of residency is very broad, and includes everyone currently in the state except for those remaining in the state for a temporary or transitory purpose. It also includes those people domiciled in the state of California but currently outside the state for a temporary or transitory purpose.
Much of the residency determination depends upon the definition of “a temporary or transitory purpose.” California Code of Regulations (CCR) § 17014(b) defines in great detail what “temporary or transitory purpose” means. It states that those domiciled in the state who leave for a short period of time for both business and pleasure are outside the state for “a temporary or transitory purpose,” and as such are to be taxed as California residents.
Those domiciled outside the state, but staying within the state for business, medical or retirement purposes that are long-term and indefinite in time will not be considered in the state for “a temporary or transitory purpose,” and will be subject to the state tax.
- As you can see, there is a lot of room for the FTB to interpret your movement as they like. But in general, listed below are the factors that the FTB uses to determine an individual’s residence status:
- The amount of time the individual spent in California versus the amount of time spent outside of the state.
- The location of the individual’s spouse and children.
- The state where the individual’s principal residence is located.
- The state that issued the individual’s driver’s license.
- The state the individual’s vehicles are registered in.
- The state the individual’s professional licenses are maintained in.
- The state the individual is registered to vote in.
- The location of the individual’s bank accounts.
- The origination points of the individual’s financial transactions.
- The location of the individual’s medical professionals, as well as accountants and attorneys.
- The location of the individual’s social ties such as worship, country clubs and professional associations.
- The location of the individual’s real estate property and investments.
- The permanence of the individual’s work assignments in California.