California is one of the most sought-after places to live. However, the Golden State’s highest individual income tax rate is 13.3%. I receive a lot of phone calls from individuals who are about to sell their business or a large asset and they don’t want to pay California income tax on that sale. Unfortunately, if you are a California resident, there is not much you can do to avoid this tax. While I don’t provide tax planning advice, I do handle California residency audits. Let’s look at what a residency audit means and what you need to do to not pay taxes in California.
A residency audit is when the state determines that you are a resident of the state and, as such, subject to the state’s income tax. The state of California has three classifications for an individual: you’re a resident, you’re a non-resident, or you’re a partial-year resident. According to the Franchise Tax Board (FTB), you are a California resident if you meet any of the following criteria: present in California for other than a temporary or transitory purpose; or domiciled in California, but located outside California for a temporary or transitory purpose. A non-resident is any individual who is not a California resident, and a part-year resident is any individual who is a California resident for part of the year and a non-resident for part of the year (e.g., someone who lives in both California and Nevada).
If you are a resident of California, the state taxes your worldwide income (e.g. income you make inside and outside the state). If you are not a resident, California will only tax the income you make within the state. This may include salary and wages, and money earned from assets within California, such as property. Part-year residents are taxed on all income they earned while being a resident, and only on income from California sources while being a nonresident.
If you continue to have rental income from a property in California, if you continue to have 1099, or bank statements or information with California addresses on it, the state of California is going to assume that you are still living in the state of California. So it’s very important to understand, if you want to avoid a residency audit, that you are actually moved to and reside in another state to avoid a residency audit.
If you want to become a resident of Nevada, New York, Texas or Arizona — and avoid paying any California income tax — you need to move to that state and sever all ties with California. You need to make sure your intent to reside in those states is documented and the less contact you have with California, the better. If you’re going to move to Florida, you need to move your family, your house, your driver’s license, your car registration, and you must actually reside in the state of Florida.
California does not mess around with residency audits. Additionally, the audit does not always always happen the first or second year you are gone. Typically it happens during the second or third year after moving; that is when you receive a notice of audit and a demand for a tax return. So if you’ve moved out of the state, do not assume California is done collecting tax from you.
If you do not want to pay California taxes, I would advise you not to be in California and not to have any income or contacts in the state. That is the safest way to avoid a California residency audit liability. If you’re unsure whether you are a resident, non-resident or partial-year resident — or if you are selling a business and unsure about the tax liability — it’s best to speak with an experienced tax attorney.
Allison Soares is a partner and tax attorney at Vanst Law LLP. It doesn’t matter the issue: audits, collections, appeals, international disclosures, grumpy people— Allison enjoys fixing problems. In addition to her legal work, she has worked in accounting and utilizes that knowledge to her advantage while handling cases involving EDD audits from San Francisco to San Diego.
