Watch Our Webinar About California Tax Exit Planning: Key State Tax Issues and Shifting Residency to Maximize Tax Benefits

Streamed: Tuesday, March 9, 2021
Duration: 1 hour
Language: English

 


 

About This Webinar

Many individuals and businesses are seeking to establish domicile in states with little to no income tax to further estate planning and income tax goals. The panelists will discuss important steps in pre-domicile planning, along with best practices for maintaining the new domicile once it is established in light of challenges from the State of California.

Who is this for?

Individuals and Businesses who have moved or are considering moving out of California

Non-Residents working remotely with vacation homes or assets in California

What will you learn?

How domicile and situs impact tax planning?

What steps should an individual or business take to establish a domicile in a new state?

What are the critical factors in determining residency for state tax purposes?

 


 

Webinar Transcript

Elizabeth Prehn:
Okay. Welcome everybody. I’m your host Elizabeth Prehn. I’m a lawyer with Moskowitz LLP. During the day, you can find me trying to keep up with Steve and Cliff. Today, Steve and Cliff are presenting this webinar to discuss the tax implications and planning opportunities if you’re thinking about leaving California or if you have left California.

Elizabeth Prehn:
Steve Moskowitz with founded this firm because he saw a need to advocate for businesses and individuals by using the tax code. 30 plus years later, he’s still doing this alongside with his team of attorneys and tax professionals, including Cliff Capdevielle. Much like Steve, Cliff began his career with a big-four accounting firm and brings his years of tax law and accounting practice to Moskowitz LLP.

Elizabeth Prehn:
We hope you enjoy this presentation. We are taking Q&A and we’ll do our best to answer your questions during this webinar. Also, if you have any follow-up questions, feel free to reach out to us directly. Thank you. Steve?

Steve Moskowitz:
Welcome to California tax exit planning and goodbye to California. But wait a minute, do you say goodbye to the taxes? And therein lies the problem and the reason for our presentation. Sometimes California says even though you physically left, they can still tax you. We’re going to explore that. We’re also going to learn the difference between residency and domicile, where we understand one being physical. I’m living somewhere else now. I’m living in Texas, Florida, China, or the moon. But the other one, even if we’re physically someplace else, California maintains that if you’re leaving California temporarily and you intend to return to California as your permanent domicile, they can still tax you on worldwide income.

Steve Moskowitz:
Our firm has done cases where our clients went to mainland China, another one to England, and California still tried to tax them as well as a lot of other States.

Steve Moskowitz:
California publishes 19 different points, and we have them on our website if you’d like to review them. Basically what we need to do is take a look at what you’re doing, explore it point by point, and giving you a blueprint, a guide as to everything that you should do to minimize the chances that California is still going to try to tax you and maximize the chances, if they look at you anyway, that we would prevail in an audit. That is why it is so vitally important to understand these things.

Steve Moskowitz:
A lot of times California will look at things that they don’t seem like a lot, but they are. For example, we represented a professional baseball player who lived on the East Coast and he played for an East Coast baseball team and he paid taxes on all the games he paid in California. However, before he came to us, the state tried to tax his worldwide income. You know why? Because his parents lived in California and he talked to them on the phone.

Steve Moskowitz:
You’ll see, there’s a lot of cases where California will pick up some picky point. It doesn’t mean that they’re right, but you need to know these and obviously, what we want to do is avoid as many of these as we can with planning.

Steve Moskowitz:
Now I’d like to turn the floor over to my friend and colleague Cliff Capdevielle. Cliff, let’s begin our slides.

Cliff Capdevielle:
Thanks Steve. We begin with the question that you raised, which is what determines California tax residency? That is very different from the question of where you are physically. Domicile is a question of intent. Where do you intend to be, regardless of where you are now? Residency is totally different. This is not the case in many states. Many states treat domicile and residency exactly the same for tax purposes. California does not.

Cliff Capdevielle:
What’s the difference? California residency is determined whether or not the taxpayer is in California or other than a temporary or transitory purpose. Or are you out of California only for a temporary or transitory purpose? We’ll see some examples, but really, the difference is intent and whether or not the taxpayer is out of California temporarily, or are they out of California for a more permanent purpose?

Steve Moskowitz:
That’s why it’s so important to understand this difference. Because with domicile, it’s subjective. Residency is physical. I’m on some other soil. But domicile is subjective and nobody knows what you’re really thinking. That’s why it’s so important to follow these points to say, “My behavior shows what I’m thinking.” That’s how we prove it.

Cliff Capdevielle:
Exactly Steve. That’s what the battle’s about. In California, there’s a presumption of non-residence. It’s a rebuttable presumption, but if a taxpayer is in California for six months or less, and they have a permanent abode in another state, and they do nothing other than what a tourist would do, then there’s a presumption that the taxpayer is not a California resident.

Cliff Capdevielle:
We’ll see some cases where California aggressively goes after people who were in the state less than six months. That is what we wrestle with. But assuming that you’re here just as a tourist or visitor, you’re doing nothing else. In other words, you’re not establishing a business, your kids aren’t going to school in California, none of those permanent ties are happening, then California is going to presume that you’re a non-resident if you’re here for less than six months out of the year.

Cliff Capdevielle:
Flip side of that, if you’re here in California for more than nine months, there is a presumption that you are a resident. However, there are cases where that’s not true. We’ll talk a little bit later about the Woolley case, a traveling salesman who’s in California most of the year. He won that residency battle because he lived in an, a hotel and never put down any kind of permanent roots in California. That presumption, again, can be rebutted by evidence. That’s what we do in a defense of a residency audit.

Cliff Capdevielle:
So what are the issues that come up- [crosstalk 00:08:09]

Steve Moskowitz:
Sometimes there’s some special circumstances, like people [crosstalk 00:08:12].

Cliff Capdevielle:
We see people retiring. Exactly. You may be stuck in California all year long with COVID, but you have a home in another state and you have no intention of staying in California permanently. You don’t have a job here. You don’t have kids here. In that case, the presumption would be overcome by that evidence.

Cliff Capdevielle:
The common issues we see, we see people retiring and maybe they have a place in California and they have a place in Florida and they’re back and forth. How do we determine residency in that purpose? If people are changing jobs or divorcing, oftentimes they’re moving and we’ll see that the question comes up, in those cases, whether you’re in California for more than a temporary or transitory purpose. That, again, is going to be based on facts and circumstances.

Steve Moskowitz:
Also it’s important to look [crosstalk 00:09:28].

Cliff Capdevielle:
It’s an interesting area of law. Go ahead, Steve.

Steve Moskowitz:
Also, it’s important, a lot of times the state will take a look at family here, which is very unfair. For example, someone decides to retire to Florida, but their kids are still here. Maybe they’re in school or their elderly parents are still here. The state looks at that. These are things that we will have to say, “Look, the fact that the family is here doesn’t mean that I’m a domiciliary here.” These are all things we have to look at.

Cliff Capdevielle:
Exactly. Who does the franchise tax board target there? They often are looking … They pick up on their bread crumbs that exist. For example, often times we have snowbirds who are in California. They own a vacation home here. They may have mail delivered to California. Those sorts of ties the franchise tax board will look to as establishing a connection. But again, those can be rebutted if there are sufficient facts on the other side, but certainly a vacation home is a big anchor and oftentimes the franchise tax board will look to the vacation home context, and particularly mail.

Cliff Capdevielle:
Now, if, for example, a property tax bill that’s mailed to a California home would be evidence that the franchise tax board would use to say, “Well, that’s a sufficient contact with California to establish residency. You have to be careful there.

Cliff Capdevielle:
Very few of these cases ever end up in court. For the most part, we’re dealing with State Board of Equalization rulings, but occasionally a case gets to court. One such case, back in the 1970s, was the Klemp case. Husband and wife were in Illinois. They had a country club membership and a vacation home and a bank account in California. They prevailed. They convinced the court, it’s a California Appellate Court case. They were able to convince a court because they really had no business connections to California. In other words, they were in California for no other reason than vacationing, even though they were in California quite a bit. They were not able to use the six-month presumption, but because they didn’t have a business here, they didn’t have kids going to school here, they were able to convince a court that they were not California residents for tax purposes.

Cliff Capdevielle:
The Safe Harbor, the 546-day rule, which says that if you’re outside of California under an employment contract for at least 546 consecutive days, there’s a presumption that you’re not a California resident for tax purposes. You also have to have less than $200,000 in intangible income during that period and you have to establish the fact that you’re not outside of California for primarily a tax-avoidance purpose. This would be anybody who’s … So you have a two year contract in Saudi Arabia, but you have a home in California. There would be a presumption that you’re not a California resident for tax purposes.

Steve Moskowitz:
California would also pay attention for some people, or let’s say, we’re going to have a major sale, stock sale, for example. They say, “I think I’ll go outside of California for awhile and then I’ll come back.” That’s one of the things you really have to look at. That comes up quite a bit when somebody has a major cash out like that.

Cliff Capdevielle:
Sure. That’s right. If California is able to establish the fact that you were outside … If you’re in Vegas for two years to avoid California tax on your stock sale, then they’re going to bring you back into California the tax system and make you pay California tax on that capital gain. That’s right.

Elizabeth Prehn:
Cliff, how do you … Getting back to intent, intent is so nebulous sometimes and difficult to prove. If you knew you were going to be traveling, you were retired and traveling and where would you set up your post office box maybe, or I’m not sure if you have a house or residence in California, but you had been in California and now there’s a launching point. How would you go about doing that? Would you set one up out of states? Are you looking at [crosstalk 00:15:11] point?

Cliff Capdevielle:
Yeah, it’s a good point. Obviously it’s a facts and circumstances test. The domicile is very tricky because it is based on that intent. How do you get to the true purpose of a person’s move? That’s why California has come up with what they call the Closest Connection Test. This is an appeal of Bragg. It’s not case law, but this is a State Board of Equalization ruling. They came up with 19 factors to look at. Instead of looking at that subjective intent, they look at these 19 factors, which includes where you own real estate, where your kids go to school, where your doctors are, where you’re registered to vote, et cetera. All of these factors are considered to establish, essentially, intent. These aren’t conclusive, but if you add up enough of these factors, the Franchise Tax Board is going to consider you a California resident for tax purposes.

Steve Moskowitz:
I called them pebbles in the scale.

Elizabeth Prehn:
[crosstalk 00:16:28] Well I think [inaudible 00:16:31].

Steve Moskowitz:
Go ahead, Liz.

Elizabeth Prehn:
Go ahead, Steve.

Steve Moskowitz:
I call them pebbles in the scale.

Elizabeth Prehn:
Okay. I think you got it. You [inaudible 00:16:37] answer there was if you must move, basically, move from California. Right? You can’t just [crosstalk 00:16:49].

Steve Moskowitz:
That’s where the tricky part is, because-

Cliff Capdevielle:
Not necessarily. Yeah. That’s back to the Woolley case, Liz. This guy was in California for most of the year. He was able to prove that he wasn’t a California resident because he never put down any ties here, never bought a house, never had his kids enrolled in school. It is truly a facts and circumstances case. These presumptions are helpful, but they’re not conclusive.

Steve Moskowitz:
That’s why it’s so tricky because- [crosstalk 00:17:19].

Cliff Capdevielle:
It makes it such a tricky area.

Steve Moskowitz:
It’s subjective. Nobody knows what you’re really thinking. One of the ways I call it, I call it pebbles in the scale. Sometimes when we’re talking with a client, they say, “Well, I’d like to have a vacation home. I’d like to have my kid going to school here. I’d like this and I’d like that.” What I say is, “Well, each factor is a pebble in the scale. What’s going to tip it to get your taxed in California?” Those are things you want to consider before you do something that might get you taxed.

Cliff Capdevielle:
Right? So what is California source income? What will California tax regardless of your residency? That’s going to be any wages or services performed in California, whether or not you’re a California resident. If you have business income in California, that’s going to be taxed California. If you have any California real estate that’s sold during the year, California will tax that regardless of your residency.

Cliff Capdevielle:
Stocks and bonds are different. Intangibles, general rule is that you’re taxed in your state of residency. California is not going to tax the intangible sales of a non-resident.

Cliff Capdevielle:
Retirement income, generally, you’re going to be taxed in your state of residency, regardless of where you worked during your working career. If you worked your entire life in Nevada and you retire to California, California is going to tax your retirement income.

Cliff Capdevielle:
Who has to file a California tax return? Generally, if you’re a resident, even part of the year, or if you’re a non-resident with California source income, you’re generally going to be required to file an income tax return in California.

Cliff Capdevielle:
Again, what do we look at for gross income? If you’re a California resident, they’re going to pick up not only your wages, but all of your intangible income. That means interest, rents, royalties, dividends. Interesting issue comes up on interest, if you have an installment sale in another state, so let’s say you sell a property in Nevada, you move to California. That capital gains, of course, taxed in the state of the property. But that interest income on that installment sale, it’s going to be taxed where you’re a resident, so that will be taxed to California if you’re a California resident. Obviously, if you have an interest in an estate, that’s going to be taxed here too.

Cliff Capdevielle:
When are California resident’s subject to withholding and when are they not? You don’t have to withhold tax if the payments are 1500 or less, if you’re purchasing goods. And if you’re paying for services outside of California, if they’re performed outside of California, you don’t have to withhold. Otherwise, you’re going to withhold generally 7% of non-wage payment, if it’s more than $1,500 in any year. And then-

Cliff Capdevielle:
And then that is going to include payments for contract actors, payments to non-resident entertainers, actors, athletes, et cetera. We hear about the professional athletes, NBA player, one case went up on appeal. And the general rule is you’re only subject to withholding if the work was done in California. So non-resident, let’s say it’s an athlete, NBA player who’s playing in California, may be subject to California income tax withholding. One thing that’s missed off, and I see this [inaudible 00:21:56] some of our clients is that if you make payments to non-residents for rent, for example, property manager, managing a property in California for a California non-resident, they’re generally required to withhold California income tax on that income. Payments to shareholders and members of partnerships are also subject to withholding.

Elizabeth Prehn:
[Cliff 00:22:30], what if [inaudible 00:22:34] California, but you hold investment property in California real estate?

Cliff Capdevielle:
That’s an interesting question, [Liz 00:22:45]. So if it’s a California non-resident that owns a piece of, let’s say, residential rental property and that income is being collected, let’s say, by a property manager in California, that property manager is required to withhold and pay over to State of California income tax on that income. And that’s often missed.

Elizabeth Prehn:
[crosstalk 00:23:20].

Cliff Capdevielle:
Non-wage payments to non-residents are also subject… Pardon?

Elizabeth Prehn:
Almost like a [inaudible 00:23:29]?

Cliff Capdevielle:
Yeah. And so who is a non-resident? So business entities, partnerships, if they’re registered in the other state, non-residents for California with [inaudible 00:23:48]. And payments that are subject to withholding for non-residents, obviously, independent contractors. Often times this is missed as well. If you’ve hired somebody to work for you as an independent contractor providing services in California, you are required to withhold income tax on whatever you pay, that independent contractor. And talk a little bit about California deductions and credits and the nonconformity here.

Cliff Capdevielle:
So as most of you know, the tax cuts and jobs act limited the deduction of state income taxes on schedule A of the 1040 form. California does not conform that. It still allows you to deduct property taxes. California’s also keeps the old limit of $1 milliom of mortgage principle that is subject to that interest payment as opposed to the $750,000 limit for federal. California also keeps a charitable contribution of 50%. And of course the tax cut and jobs act severely limited itemized deductions. Subject to 2% for the miscellaneous, itemized deductions are essentially gone for your federal 1040, but those are preserved on your California income tax return. So check that to make sure that…

Steve Moskowitz:
For the people that are here in California and thinking of going, could you just give us a word about how California is treating the tax deductibility of PPP money? I think that’s important probably to know.

Cliff Capdevielle:
That’s a good point, Steve. So California often conforms to federal law with regard to PPP money expenditures. They intended to conform, but they didn’t. So what happened was, originally the federal government intended for all expenses paid with PPP loan money to be tax deductible. And the IRS came out last summer and said, “No, that’s double-dipping because you get this free money. You don’t have to repay, you don’t also get a tax deduction for the expenses paid with that money.” There was a big uproar. And at the end of 2020, the federal government fixed that.

Cliff Capdevielle:
So now those expenses are tax deductible. California was late in conforming. And so they attempted to conform, but that happened in September, conform with the original law. They have not yet caught up with the federal law. So those expenses that you pay with the PPP money currently are not deductible on your California State income tax return. We are recommending that if you’re in that situation, if you’ve taken money and used it to make payroll or other expenses, the PPP money, that you file an extension and wait for California to sort that out, if you can wait.

Steve Moskowitz:
And another thing the feds made some last minute changes at the very tail end of December. So whoever does your taxes, things that you were told, you can’t do this, or you can’t choose this benefit and that benefit, some of those have changed. So you want to get an update before you actually file your return.

Cliff Capdevielle:
Exactly. And so what… Go ahead, Liz.

Elizabeth Prehn:
I have a couple of questions having to do with telecommuting and how to treat that from a California residency or taxation perspective.

Cliff Capdevielle:
We’re going to get into that little detail in this next section, but the punchline is, it depends whether you’re a W2 employee or an independent contractor. So W2 employees, very simple. You’re taxed in the state in which you were working. So if you are working for a California firm and your physical location is in Nevada, you’re a W2 employee. You are not taxed on your wages by the state of California. If you were in California, working for a Nevada employer, then you are taxed in California on your W2 wages. It’s the exact opposite if you’re an independent contractor. So if you’re a true 1099 worker, and California is willing to let you be classified in that way, then you were taxed at the employer’s location. So in other words, if you’re a 1099 independent contractor in Nevada, working for a California business, you’ll be taxed in California. And that’s considered a California source.

Elizabeth Prehn:
Source? Okay. [inaudible 00:30:18] gets into whole [AB5 00:30:19] crossover, doesn’t it?

Elizabeth Prehn:
And you have also that threshold. So if you are treating yourself as a 1099, a worker, and California reclassifies you as a W2 worker, then you will be taxed accordingly. So its common issues we see in addition to wages. We see the remote working issues come up, that business source income, retirement plans, stock options. We’ve talked a little bit already about vacation homes, and we’ll talk about planning for real estate.

Elizabeth Prehn:
So short answer for wages. When you leave California, California only taxes those wages that were earned while you were a resident. So if like a lot of people, you were in California until March 18th, and then you moved, only those California wages earned in California, those W2 wages are taxed by California. If you’ve performed services outside of California, those are going to be taxed in the state where you perform those services.

Steve Moskowitz:
Cliff, what if what if an employee was working in California and the company said, “Here it is March, where we’ve decided to pay you a bonus.” The employee then moves to Nevada in April and receives the bonus in April, would that be taxed or not taxed in California?

Cliff Capdevielle:
California is going to try to tax that because it’s earned in California. So if the income is earned in California, it’s paid when the employee is outside of California, California we’ll still tax that money. And it’s going to re-tax the California source income regardless of the taxpayer’s residence. So take the example of Cliff who is now in Incline Village. He’s working as a W2 employee for a California employer. Is cliff going to be subject to California income taxes? I hope not. I already filed my return. We’ll find [crosstalk 00:32:54]. You’re going to find out a few months.

Cliff Capdevielle:
As I said, businesses are taxed differently. It’s going to be based on what’s called the more market source. So since 2013, taxpayers with income inside and outside of California must use the market-based sourcing. If the sales are in California, California is going to want their money. Work that’s done outside of California is going to be taxed by that state, wherever the benefit of the service is. So the benefit is in Nevada or Idaho, that will be the location for tax purposes. Take the example of Steve, the tax preparer. He performs accounting services and tax services in California and South Dakota. Steve lives and works only in California. He performs tax services for South Dakota client. Who’s going to tax those sir services that are performed for the South Dakota client?

Cliff Capdevielle:
Well, prior to the single factor test, Steve would compute his income and apportionate based on a formula that included his payroll, where his property was where the sales happened. This is all out the window as of 2013. And now those services performed for the South Dakota client are going to be taxed in South Dakota. Retirement plans for both federal and California purposes, qualified pension plan payments paid after 1/1/96 to former residents of California are not taxable. So again, if you work your entire career in California, you move to Nevada, your pension plan payments will not be taxed by California. We get a lot of questions about stock issues. There’s a lot of timing, especially in the Silicon Valley contacts. People want to know, do I have to pay California tax on my stock or stock options if I move out of California? So this again is, is determined by the stores and where the services were performed.

Cliff Capdevielle:
So for example, Steve asks the question, well, employee works for a Silicon Valley employer, and at the end of the year, they moved to Nevada just before a big bonus is paid, or stock is issued, is California going to want that money? Almost certainly they’re going to come after that. Typically that’s going to be reported on a W2 for non-qualified stock RSUs. Employee stock program payments are all included in W2. And typically the payroll department is going to allocate those on a day by day basis for on the W2.

Cliff Capdevielle:
So for example, if employee is splitting their time between California and New York, we see this with Google employees, they are back and forth. They’re going to get a W2. This can include California source income and New York source income with the respective withholdings. And they should also be allocating any stock compensation the same way. In other words, day by day. So if you’re in California for half the year and a half a year in New York, your stock options and your employee stock or issues are going to be divvied up [crosstalk 00:37:54].

Steve Moskowitz:
Cliff, would there be a planning opportunity in a situation like this? Suppose we have somebody that lived in and worked in California, and the company is considering giving him a bonus, but then he or she moves to Nevada, then the company pays the bonus when the recipient is in Nevada, if the company paid for the good deed that was done while the employee is working in Nevada, rather than the work they had done in California, would that be a way to legally escape the California taxes?

Cliff Capdevielle:
Yeah. So I think as long as you could establish that you’re being paid for work that was done outside of California, you could absolutely make that argument.

Steve Moskowitz:
So that should be a planning opportunity for people that are thinking about going?

Cliff Capdevielle:
California is going [inaudible 00:38:56]. Yeah, absolutely. With regard to vacation homes, there are many people who buy vacation homes in California. It’s one of those breadcrumbs that oftentimes triggers a residency audit. And that is the mortgage interest statement is mailed to the California address. And there’s information sharing that’s going on between the IRS and the Franchise Tax Board, same thing with the property tax payments. If those property tax bills are being mailed to a California address instead of an out-of-state address for those non-residents, oftentimes the state of California is going to send a 4,600 notice asking that non-resident why they haven’t filed California return because it looks like they’ve got contacts. So it’s recommended that non-residents who own second homes, if they’re rental properties or vacation homes, that you have this mortgage interest statements, property tax bills, et cetera, mailed to your non California address.

Steve Moskowitz:
And those mortgage statements also come up in a couple of other times. Sometimes the government will take a look at them and if you haven’t filed a tax return, they’re saying, “Well, how can you afford to pay the mortgage if you haven’t filed a tax return? Or if you have a tax return reporting a little bit of money and you have a big mortgage, how could you do that support in possibly the state alleged or the feds alleging unreported income?” So these mortgage statements from the bank to government, whether it’s California or feds love them, because they provide a lot of information, part of what we’re talking about in this seminar and in part for other things as well.

Cliff Capdevielle:
Absolutely. It’s those breadcrumbs that often trigger a residency audit. Sometimes it’s as simple as a car registration. If the DMV is mailing that registration or a bill to a California address, that information is going to be shared with the Franchise Tax Board. And even that can trigger a residency audit

Steve Moskowitz:
And, Cliff, before we conclude the seminar today, are we going to share information on gifting and trust?

Cliff Capdevielle:
Yeah. So we can talk a little bit about that. And obviously if you have family, children, who are going to be on title, or if a trust is going to be on title to a vacation home, same thing, you have to be careful that that’s…

Cliff Capdevielle:
… vacation home. Same thing, you have to be careful that the grantor is mailed any of those properties’ tax statements or anything else.

Elizabeth Prehn:
[inaudible 00:42:16]. How does the FTB decide, the Franchise Tax Board decide when and who to audit? Do we have any recon on that?

Cliff Capdevielle:
Yeah, I think it is often these little bits that are left behind and are exchanged with the other agencies, IRS, DMV, the counties, they all share information. So, if you have… oftentimes it’s a difficult… it’s a facts and circumstances task, but the state of California is aggressively trying to gather and analyze this information. And if they see a sufficient number of contacts like mail… the mailing address for a property tax statement or mortgage interest, or anything like that, being mailed to a California address, they assume there’s reasonable assumption that there’s somebody there picking up the mail. Who is that person? If it’s the owner of the property, then why are they at that property if it’s supposed to be a rental or a seldom-used vacation home? Why are they receiving their mail there?

Steve Moskowitz:
And there’s another big one too, the first year of change. So if somebody says, “You know what? On December 31st, I’m packing up and I’m moving to Las Vegas,” and then they don’t file a tax return the following year, California says, “Well, wait a minute. You’ve been filing all these years. What happened to you?” Or if the person changes and, say, they have a rental property from a part year, or they change to a non-resident, any type of change that’s a big one where California says, “Hey, wait a minute. What’s going on?”

Steve Moskowitz:
And that would almost always come up when somebody is taking a position of, “I’ve moved from California to Nevada or Florida or Texas or wherever, and I no longer have a filing requirement through California.” California files and says, “Wait a minute. Why aren’t you filing?” And the person says, “Oh, but I’m not subject to California taxes anymore.” Then the state says, “Well, wait a minute,” and then we can start going into all of these factors. And the state is very aggressive. Almost everybody in the tax profession agrees that California is way more aggressive than the IRS, and the IRS are not known for being sweethearts.

Cliff Capdevielle:
Exactly. They’re very aggressive, both in terms of audit and collection. So, you want to be very careful with your planning, here. So how do you plan for real estate sales? So, capital gains are taxed between the difference between the selling price and what you paid, plus any improvements. So if you buy a property for half a million dollars, you sell it 10 years later for 1.1 million, a $600,000 gain will be taxed in California, and California doesn’t have any preferential capital gains rate, so you’d be taxed just like any other income. If you’re a non-resident, you’re going to be subject to the withholding. Now, if your total California tax turns out to be less than three and a third percent of the sales price, you can file a California tax return and get that money back.

Cliff Capdevielle:
Like kind exchanges are tricky. So since 2014, California has really stepped up its enforcement here. So if you have California property and you exchange it for property outside of California, California now is going to require you to file an annual information return with regard to that property. So they’re not going to ask you to pay that tax, it’s still tax deferred, but they’re going to track you. So if you had, for example, a million dollars deferred gain, when you sell a piece of real estate in California, you’re now going to have to inform state of California every year, whether or not you sold that property, on an information return in the year in which you sell it. Guess what? California is going to want their tax on that million bucks.

Steve Moskowitz:
Cliff. I call this the new state flower, the forget-me-not.

Cliff Capdevielle:
Exactly right.

Steve Moskowitz:
A little tax humor there.

Cliff Capdevielle:
I think I mentioned the automobile issues. Where your car is registered is one of those 19 factors, the brag test. So California is going to… if you’re subject of residency audit, they’re going to ask for a copy of your driver’s license. They’re going to want to see where all of your vehicles are registered. So, if you’ve got one of your vehicles registered to a child who’s going to high school in California, that’s certainly going to weigh against you even if you never use that car.

Steve Moskowitz:
And folks, there’s another point you should be aware of. Everything we’re talking about are good legal tax planning to avoid California taxes, but sometimes people will try to trick the state, and the state is a lot smarter than what a lot of people think. For example, somebody might use their friend’s residence in Incline Village as their address and say to California, “Well, look, I’m living in Nevada now,” when really they’re not. One of the things California will look at is your credit card charges. And they’ll say, “Well, wait a minute. If you’re living in Incline Village, what are all these restaurant receipts here in San Francisco?”

Steve Moskowitz:
“And what are these dry cleaning bills in Sacramento? And what are these charges in this store?” That’s one of the things that amazes people. They’ll actually look at your credit card charges and if you have significant charges, then California’ll say, “Well, wait a minute, you must’ve been… you’re claiming you’re in Incline Village, but you’re not. You have all these charges in San Francisco.” And that just amazes a lot of people when they get caught that way. So again, we want to do everything legitimately and not try those tricks because they will just come back and haunt you. You want to avoid them with an 11 foot pole.

Cliff Capdevielle:
Exactly. Moving on to the community property issues. So, most people know California is a community property state. What does that mean? It means that if one spouse has income absent an agreement otherwise, half of that income belongs to the spouse. Comes up quite often. One spouse… let’s say it’s a one income earning family. The income earner is in Saudi Arabia for two or three years on contract. Spouse is with the kids in California. Guess what? That spouse in Saudi Arabia, may be a non-resident for tax purposes, but the resident spouse who’s in California will pay tax on half of that income.

Steve Moskowitz:
And Cliff, when we talk about people here in other states, how do we treat an Airbnb? Somebody’s living in Texas, but have an Airbnb in California?

Cliff Capdevielle:
Airbnb, it’s an interesting issue, Steve, especially this week with his new PPP issues. In general, Airbnb… well, let me say Airbnb income may be reported on a schedule E as essentially passive, or it may be reported on schedule C as actively earned income. That’s going to depend on the amount of ancillary services that are provided. So for example, let’s say someone’s renting out a room in their house and every day they change the sheets and they provide breakfast like a traditional bed and breakfast. That income’s going to be reported on a schedule C as self-employment income. On the other hand, if you rent out your place week to week, and you don’t provide any ancillary services like food or cleaning during the week, that is typically going to be reported on us on a schedule E as passive income.

Steve Moskowitz:
And also, that’s really important. It’s beyond the scope of this webinar, but whether something is passive income or active income is very important for deducting losses, and another area that people are interested in, how does California deal with crypto?

Cliff Capdevielle:
Yeah, so it’s intangible. So, it’s going to be dependent on a residency of the owner. If you make sales, even if you acquired crypto while you’re non-resident, you saw it during your period of California residency, California will expect you to pay tax on a hundred percent of that income even if the majority of the appreciation happened while you were a non-resident.

Steve Moskowitz:
And speaking of crypto, that’s a real hot topic with the IRS right now. The big focus on foreign for over a decade, and now they’re looking at crypto with a magnifying glass. Just to let you know.

Cliff Capdevielle:
Right. It comes up occasionally. We see planning for spouses that are living in different states. And how do you handle that on a tax return? Typically, we file a joint 540 in our non-resident, even though one of the spouses is in California. So, we allocate that California source income, plus one half of the community income that’s earned outside of the state of California to California.

Cliff Capdevielle:
Another common trigger, family. So as mean as this sounds, California will punish you, tax you if you visit your kids. So, they’re going to look at how often you’re in California, what the purpose is. If you have kids in high school or college, they’re going to boarding school or college in California, they’re going to look at the frequency of your visits. So you may be happily in Reno most of the year, but if you have frequent visits to California, if you buy a place that your kids are using while they’re living in California, those are additional ties. California is going to use that as one factor. It’s not determinative, but it is a factor.

Steve Moskowitz:
And to give you an idea of how strict California looks at this and overboard, and oftentimes overturned in court, that professional baseball player that I told you about, when he wasn’t playing baseball here, he visited his parents by telephone, and they brought that factor up. But he wasn’t physically here. By telephone, which was ridiculous. But again, you see that California goes to great lengths in this area. Just by telephone.

Cliff Capdevielle:
So, how do you survive an FTB audit? As we described, you certainly don’t want to be Gilbert Hyatt in this case, the 26 year long audit, but you got to be mindful of those 19 factors. You want to make sure that as many of those 19 factors are in your favor because you don’t want little things like property tax bills and car registration to trigger an audit, get you stuck in a multi-year battle with the franchise tax board.

Cliff Capdevielle:
What happens? So, the franchise tax board may come out to your residence. You can expect them, as Steve suggested earlier, to look at your credit card bills, canceled checks, bank charges, and any other connections to California. So the best way to win it is to avoid it entirely by following these recommendations.

Steve Moskowitz:
And don’t be surprised if the audits do what’s known as third-party contacts, and actually go to your neighbors and just simply say, “Hey, how often do you see John Smith?” “Oh, you know, we talk every night.” Uh-oh. They’re going to say, “Hey, wait a minute, John, what do you mean you’re living in Nevada? Seems like you’re living in California.” They really go to great lengths.

Cliff Capdevielle:
Yeah. So Liz, we’re exactly an hour in. Should we take some questions?

Elizabeth Prehn:
Yeah. We have quite a few questions. I think from a practitioner standpoint, if you’re going to be audited, you should try to get as much evidence in the audit as possible so that your team and your lawyers that you hire can… there’s grounds for appeal, and you preserve that evidence. I’ve seen that happen in a number of California residency audits, where people were just hoping it would go away and didn’t really take it seriously.

Elizabeth Prehn:
And then you’re somewhat limited later on, depending on the procedural aspects of the case. But as for questions, we have a ton of questions here. [crosstalk 00:57:23]

Cliff Capdevielle:
Do you want to read them for us? Or read them, and I’ll answer them? Yeah, go ahead.

Elizabeth Prehn:
Yeah. So, I’m just going to do a rapid fire to Steve and Cliff, what you do best here.

Steve Moskowitz:
All right.

Elizabeth Prehn:
There you go.

Steve Moskowitz:
We’ve been waiting for this, Liz.

Elizabeth Prehn:
Me too. Okay. What if you are now a non-resident living out of state, but receive income from consulting from a California business? Do you only have to file a California return on the income derived from that California income, or all of the income that you’ve received during the year?

Cliff Capdevielle:
Excellent question. The answer is if you’re a non-resident, then you only report and pay tax on the California source income. So if you’re an independent contractor and you’re doing work for a California business, you’ve prepared a 1099, that income is reported on your California income tax return, but your brokerage income, your interest income, all of that is not reported, and you do not pay that to California.

Elizabeth Prehn:
Okay. What if your employer is headquartered, and primary residence is located outside of California, but want to spend a significant portion of the year working with remotely from California? So employer and primary residence are out of California, but want to be working remotely in California.

Cliff Capdevielle:
So if you were working in California, so this is for somebody… let’s say the business is headquartered in Reno, but you want to work from your home office in San Francisco, and you’re a W2 employee, what’s supposed to happen is your employer is supposed to withhold California tax and file a W2 reporting that California source income, which if it’s 365 days out of the year, that’s going to be a hundred percent of your W2 income reported to California, and California income tax paid out a hundred percent of your income.

Steve Moskowitz:
And one of the things I would also say is that when we give advice to clients, part of the time, it’s to change behavior, because what I heard was the employer said they wanted the person to remotely work in California. If I were advising the employee, I’d say, “If you’re working remotely, what difference does it make if it’s California, Nevada, China, or the moon?”

Steve Moskowitz:
And that’s something where you may be able to renegotiate with the employer and save yourself 13.3%, or who knows, even 16.8% if California gets their way. Why does a person have to be here? And if it’s something like, “Oh, we want you to physically visit the Smith account and the Jones account.” Maybe that’s something that can be done with a very small amount of time rather than being here. So again, part of it is, what behavior can we modify to save the taxes? And a simple one could be like that.

Elizabeth Prehn:
And functionally, Cliff and Steve, how do you notify your employer of what your state… are employers asking what states you’re working in? How do you notify the payroll department?

Cliff Capdevielle:
Yeah, so it depends. If it’s a small business, they may not be tracking that. That may be something you have to fix at the end of the year or tax time. If it’s a major business, like Google, they’re very good. They have people working in multiple states. They track that day by day. So if you’re in New York for 35 days, then those 35 days, you’re going to be taxed by New York. And if you’re in California for the rest of the year, California’s going to tax-

Steve Moskowitz:
And the other thing that I would say is if you have somebody that’s living in California, working for a California employer, and the employer says… like so many of us have been working remotely for the past year, now, the first thing the employee should… that I would recommend the employee do, is notify the employer, “Hey, boss? Change of address. I’m now living in Reno,” and that’s good for a number of reasons.

Steve Moskowitz:
One is if the state says, “Hey, what are you trying to pull here? You backdated that. You’ve really been working in California.” “Look, I notified my employer on March 18th that I moved to Incline Village.” So, that’s good. And that’s still one more point. The other thing too is if you’re going to be moving around, you should keep a daily calendar, because sometimes that comes up in these audits or even trials where someone would say… you know, business records, “Every day, I travel for my job. So every day in my day-timer I recorded where I am. And on March 3rd, I was in New York, and March 4th, I was in New York, and on March 7th, I was in Nevada, and March 8th, I was in California, and the 10th through the 30th, I was in Washington.” That’s important.

Elizabeth Prehn:
Yeah. Journals come up often in our secondary evidence, don’t they?

Steve Moskowitz:
Yes, they do. Government loves journals.

Elizabeth Prehn:
Another question. The evidence loves them, too, so. [inaudible 01:02:53]

Steve Moskowitz:
Who doesn’t love a journal? Nothing like a good journal, I always say. Probably on the top of my Christmas list, whoever’s listening.

Elizabeth Prehn:
Okay. I Have a specific question-

Elizabeth Prehn:
I have a specific question. We’re not licensed as lawyers in Nevada, but perhaps you can speak generally as to this. And that is how does a Nevada incomplete gift non-grantor trust affect this tax regime, if at all?

Steve Moskowitz:
So, first, Cliff, I think we should define the terms because I bet a lot of the audience says, what’s that?

Cliff Capdevielle:
Yeah. So, one common income tax and estate planning tool is what’s called a defective grant or trust. And the reason [crosstalk 01:03:46].

Steve Moskowitz:
Intentional defective.

Cliff Capdevielle:
Why would you intentionally design something that’s defective? So the reason is for income tax purposes, it’s an incomplete gift. It’s defective the way that it’s drafted. So what that means is that the grantor, or the person making the gift, still pays income tax on that income. But for estate planning purposes, it’s a completed transfer to the beneficiaries.

Cliff Capdevielle:
So, this is an interesting question because it really depends on the source of the income. The source of the income is rents, that’s always going to be taxed at the source of the real estate. So if the real estate’s in California, California is going to want their money. If the grantor is in Nevada and the real estate’s in Nevada, then even if the beneficiary is in California, California is not going to be able to touch that income, even though eventually California beneficiary is going to own that income.

Elizabeth Prehn:
Okay, great. Thank you. Over my head, but that’s okay. I have you guys.

Steve Moskowitz:
But so many things are.

Elizabeth Prehn:
If you have a vacation home that is purchased outright in cash, is it best to use a trust or a company to buy [inaudible 01:05:35] to trust or a company to buy a vacation home in California from an out-of-state resident?

Cliff Capdevielle:
Well, you sound like a drug dealer, so you might have some other problems. Steve’s happy to represent you for an additional fee. No, but if you’re lucky enough to have cash to buy real estate, it sounds like the question is not really tax but more of a privacy issue. So oftentimes, we recommend real estate investors that you do use a separate entity. It’s typically going to be a limited liability company. There are some tax advantages to holding real estate in a partnership type entity like an LLC. We also commonly see the structure where there’s a trust that owns the LLC. And there’s some advantages there, in terms of estate planning and gifting, and also maintaining the privacy of the ultimate owners.

Steve Moskowitz:
And a couple other reasons too. If we’re talking about rental property, we’d do that for asset protection because if something happens and the tenant gets rip-roaring drunk, falls down, breaks his back and then sues you, if the jury gives away an amount in excess of your insurance, you don’t want them reaching your other assets. Worst case, you only want to lose that asset.

Steve Moskowitz:
And another thing, for privacy, we might choose a jurisdiction where the actual name of the person is in public, which is good if someone is doing an asset search to find out what you have. You want to make it all the more difficult for them.

Elizabeth Prehn:
Okay. Let’s get back to basics here. What is a domicile? Does having a lock box in a bank branch qualify as a domicile?

Steve Moskowitz:
Domicile, and that’s we have to be so careful. Domicile is… And it’s subjective. Where do you intend to return as your permanent home? So basically what California is looking for is, is there any tie that you have there?

Steve Moskowitz:
Many, many years ago, when I moved to San Francisco from New York city, I packed all my worldly belongings in my four cardboard boxes and came out here. I left nothing in New York. There was no tie in New York. Can’t say, well, we know you’re coming back. On the other hand, just think about a personal friend. If you left stuff in their house, the more you leave there, the more likely it is you’re coming back. And California is looking for any excuse, any straw, any pebble to say, “Oh, well, it’s your subjective intent to come back to California.” So while you’re in Nevada, California gets to tax your worldwide income.

Steve Moskowitz:
So the bottom line is, I would ask, why are you doing it? That’s one of the things too, with when we advise people, it’s not just, well, here’s what the law is. We ask them why. Why do you have that lockbox in California? Could you achieve the same thing by having a lockbox in Nevada? Why are you doing it? What reason? And a lot of times, what I’ll find in practice is people say, “Well, I always did it that way.” Well, yeah, when you lived here, but now you want to change or some other reason. And a lot of times what we do is a simple change in behavior can result in a big tax savings.

Elizabeth Prehn:
Okay. Cliff, do you have anything to add to that domicile question at all?

Cliff Capdevielle:
Yeah. So, domicile’s important for California law for a number of reasons. It often comes up in the context of dividing community property, but in the tax world, it’s not really what’s the determinative. So as we’ve said, it’s really a matter of residency, and the residency under the current scheme with the [FTB 01:09:51] is they’re going to look at those 19 factors and add them up, weigh them, and if you have a closer connection to California than another state, California is going to assess tax on all of your income.

Steve Moskowitz:
And remember when California does that, they’re not weighing it like a judge or an academic. They’re weighing it, looking what possible straw can they take to put a hook in you and get the taxes. They’re looking at it from their most favorable point of view. So when we advise people, we tell them, “Look, if you have this, here’s a potential problem. So watch out for this.”

Cliff Capdevielle:
These cases very rarely get to court. There’s one California Supreme Court case, and that’s the [Woodall 01:10:44] case. And that is a family that second generation Woodall moved from Woodside to Incline Village, and was the heir to a real estate railroad fortune. Used his money to buy 50,000 acres south of Incline Village and intended probably to develop it, but never did. And the family continued to generate real estate brokerage fees in California, and the family continued to own a 50 acre residence in Woodside, California. And franchise tax board fought that all the way up to California Supreme Court and determined that George Woodall Jr. was a California resident. Even though he spent vast majority of his time in his Nevada residence, he continued to draw a salary from his California business and maintained a large home and in Woodside and an apartment in San Francisco. And ultimately, California Supreme Court determined that those contacts created California tax residency. So it is [crosstalk 01:12:54]

Elizabeth Prehn:
Fortunately, I think the case law that’s been developed by the taxpayer [inaudible 01:13:01] like a lot of tax law is not taxpayer friendly. I think there’s cases where people have gotten divorced, and there was a spouse in California. They come back to visit their family, even for custody reasons, go back and forth. And then there’s cases that have people moving out of the state, having a serendipitous stock transaction, and then moving back in the state. It does seem like we get back to this intent issue, is how do you establish intent? What are the real factors? And coming from… I always am advocating just to keep it simple. What do you want to do? Accomplish that, and then let’s move on. Rather than trying to hide the ball, that sort of thing.

Cliff Capdevielle:
Yeah. It’s very frustrating for taxpayers because their intent may be solid in their own mind that they intend to reside in Nevada. They never intend to move back to California, but California says, wait, you still have a business interest here. Your kids are going to school here. You’ve got a vacation home or rental property here. And they will add those things up and may determine that you are a California resident for tax purpose, regardless of your intention.

Elizabeth Prehn:
A couple more questions. I live in another state, but use [Moscowitz 01:14:37] LLP to file our tax returns. Will this trigger a tax audit? Excellent [crosstalk 01:14:43]

Cliff Capdevielle:
Interesting question. So, that gets to professional services. It is one of the factors that franchise tax board will look at, but it’s not determinative. So for example, they’re going to look at where your doctors are, where your dentists are, where your country club is. All of these things are taken into account. None of them are determinative. And as we saw in the [Climp 01:15:15] case, one of those rare cases that actually got in front of a judge, the court determined that they were in fact not California residents, even though they spent a great deal of time here, they had a country club membership, and the wife was the president of the country club. That was not enough to make them California tax [crosstalk 01:15:47].

Steve Moskowitz:
Sometimes people will ask us to do their California return because obviously, we’re familiar with California taxes, and if they’re living somewhere else, and even if… A lot of times what will happen is that the state’s a throw on, where the main thing is the federal return, and then the preparer will do the state return. But sometimes, especially in a state like California that’s so aggressive and there’s so much involved, that sometimes people from outside of California say, “Okay, well, you guys just do the California return.” Which again, you’re specifically dealing with California law. And that could be another reason why.

Elizabeth Prehn:
I think it’s just also, I would… We do tax returns for individuals and companies worldwide. So I can’t imagine that we’re on some blacklist, although the having your vendors is a factor [crosstalk 01:16:36]

Cliff Capdevielle:
I’ve not seen that trigger in audit. Professional services is just one of those 19 factors that the state will consider.

Elizabeth Prehn:
Okay. So this has received a lot of media attention. We spent a year and a half of media attention about people moving out of California. I think there was just a couple of articles that came out this week about people giving the numbers for their… There hasn’t been a big outflow of people moving. Predictions. Do you think California franchise tax board will put some teeth in this residency type audit and their audit department?

Steve Moskowitz:
I forgot my Swami hat today, but I’m going to go ahead and give you my best guesses. I think so. And California, I believe, will open more offices in the other states. And the reason for that is with the working from home, there’s so many people in California that said, “Hey, wait a minute. If I’m no longer going to go the office, why don’t I go to another state where my money will go way further, and I’ll pay reduced or even no tax.”

Steve Moskowitz:
So there’s a tremendous amount of money not coming into California because of that, not to mention people not working, not to mention California paying out benefits. So my guess is… and California has always been aggressive, but I think even more so, because much like a hunter that has to follow the game, they’re going to follow the game. That’s my guess.

Steve Moskowitz:
Cliff, how about you?

Cliff Capdevielle:
Yeah, almost certainly. The dollars spent to pay additional auditors is recovered many times over in these audits, according to the FTB statistics. So we can expect these audits to continue. And as California rolls out more aggressive taxes and tax enforcement, we certainly expect to see a lot more of these audits happening.

Elizabeth Prehn:
Okay. I think that’s a nice place to end it. If you have any other questions, feel free to contact us. We’ll do our best to answer the specific questions that were raised during this webinar, if we haven’t already. And a recording of this will be sent to all attendees. If you have any questions or concerns, feel free to contact me at the same contact information here that Steve has.

Cliff Capdevielle:
Is that Steve’s real phone, Liz?

Elizabeth Prehn:
[inaudible 01:19:38] he’s also in the [inaudible 01:19:42] Steve.

Steve Moskowitz:
We love to Zoom with our clients.

Elizabeth Prehn:
Okay, well, thank you.

Cliff Capdevielle:
Thanks, Liz [crosstalk 01:19:58] thanks, everyone.

Elizabeth Prehn:
Thanks, Steve. Thanks, Cliff.

Steve Moskowitz:
Bye-bye. [crosstalk 01:20:02].

Elizabeth Prehn:
Bye-bye.