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.
The United States saw some of the most sweeping changes in
December 2017 with the passing of the Tax Cuts and Jobs Act (TCJA). Many of the amendments to the Internal
Revenue Code are temporary in nature, set to expire at the end of 2025. For
example, the basic exclusion amount (BEA), which doubled from $5 million to $10
million prior to being adjusted for inflation, will return to pre-2018 levels when
the TCJA is set to expire. One major concern, raised by public comments, is
what will happen to individuals taking advantage of the increased gift and
estate tax exclusion amounts when the exclusion amounts drop to pre-2018
levels? Will they be adversely impacted?
For example, what would happen if a taxpayer chose to gift
their entire $11.4 million (adjusted for inflation) lifetime exclusion amount
during the TCJA? Rather than using up their basic exclusion amount at their
time of death, a taxpayer may choose to use their basic exclusion amount during
their lifetime by making large gifts.
Any unused portion would be used to offset or possibly eliminate estate
taxes when a taxpayer perishes.
Those concerns were laid to rest last month when the Treasury Department and the Internal Revenue Service issued final regulations confirming that individuals who plan to take advantage of the TCJA-increased basic exclusion amount will not be adversely impacted after 2025 when the exclusion amount is scheduled to drop to pre-2018 levels. The final regulations also provide a special rule that allows the estate to compute its estate tax credit using the higher of the BEA applicable to gifts made during life or the BEA applicable on the date of death.
For 2019, the inflation-adjusted BEA is $11.4 million. If you
are considering making a large gift within the next few years it is important
to understand how these changes will impact your personal or business
operations. The professionals in our office can answer your questions, call us
Professional Services to Help You Stay Focused on Living
At Hamilton Tharp, we apply our expertise in estate and trust planning and administration to help ensure your wishes, or those of your loved ones, are carried out as efficiently as possible and with the least possible burden on survivors and successors.
The estate settlement and trust administration process is often lengthy, taking longer than many executors and trustees anticipate. Our trusted professional advisors help our clients get back to enjoying life more quickly by reducing administrative time and costs, safeguarding assets, facilitating efficient transfers, and minimizing tax liabilities.
Thinking about death and taxes is not how most people choose to spend their time. Putting some time and thought into your end-of-life issues now will minimize complications, confusion and conflict for your loved ones down the road. We help individuals, trustees and executors across the country plan for and navigate the financial circumstances surrounding times of death, divorce, health issues and aging. We also help business owners with transition and succession planning, and we work with valuation experts and appraisers to determine the most tax-advantageous business valuations and how to justify them.
Our estate and trust services include:
- Preparation of final individual income tax returns for decedents
- Preparation of estate tax returns (Form 706) and Form 8971
- Preparation of gift tax returns (Form 709)
- Preparation of trust and estate income tax returns (Form 1041)
- Trust funding
- Estate tax projections and tax planning
- IRS audit representation
Experts You Can Count on in Life or Death
Estate planning attorneys often refer trustees and executors to Hamilton Tharp due to our depth of experience in this area. Every client’s situation is unique, but having successfully guided clients through so many different scenarios has strengthened our expertise and broadened the base of knowledge from which we can pull as we work with you to reach your financial objectives.
With Hamilton Tharp, you’ll work with:
- Estate and trust specialists – With professionals who focus on this area and have extensive training, education and experience, we offer an unparalleled level of quality in our services.
- Accessible, long-term partners – We are committed to helping guide and support you every step of the way.
- Tax experts – Although your estate tax and income tax returns do not have to be prepared by a CPA, our perspective and depth of knowledge regarding the tax laws can result in significantly lower taxes.
Effective estate and trust planning can ensure financial security for loved ones and maintain a smooth succession of ownership for business owners. Contact us to learn more about how our services can help simplify estate and trust planning and administration and ease the burden on you and your loved ones.