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When Does a Resident Become a Nonresident?

According to a recent SFGate poll, 53% of Bay Area residents interviewed want to leave California.(1) We have been hearing similar comments from seminar attendees across the state, and we know many of you have clients who are attempting to “move out of California.”

Keep in mind, one of the FTB’s longest running, and most active, audit programs is the residency audit program. The FTB looks closely at a taxpayer who moves from California, and often they are high income taxpayers who have large amounts of income after they change their residency to another state. However, lower income taxpayers can also be caught in this trap.

Recently, we heard of two examples of clients who want to leave California — but not completely.

Case study #1: High-income taxpayer who is expecting a large capital gain from the sale of very appreciated stock will move out of state. However, he will keep the California home that has been in his family for generations.

Case study #2: Woman moves to a non-tax state, buys a home there, and keeps her California home to which she returns periodically to oversee care of her mother. She has income from both California and the other state.

Each of these taxpayers is in the danger zone. Let’s look at the rules for residence and domicile and apply them to these case studies, as this is the key to being a nonresident.

Residence and domicile

A “resident” is an individual who is:

  • In California for other than a temporary or transitory purpose; or
  • Domiciled in California, but who is outside California for a temporary or transitory
    purpose.

A domicile is the place where an individual has his or her true, fixed, permanent home and principal establishment, and to which place he or she has, whenever absent,the intention of returning. It is the place in which an individual has voluntarily fixed the habitation of self and family, not for a mere special or limited purpose, but with the present intention of making a permanent home, until some unexpected event shall occur to induce an adoption of some other permanent home.(2)

If a person has not changed their domicile, they continue to be California residents for income tax purposes, even if they are outside of California for most or all of the year.

Don’t keep the house

The key to these case studies is domicile. In order to be a nonresident of California for tax purposes, the taxpayer must show that their domicile is in another state. The FTB will assume any taxpayer that left the state but kept a home in California has retained their California domicile (because they “intend to return”). So, that is one big step against the taxpayer.

In case study #1, the taxpayer must dispose of the property or they will have trouble proving they ended the residency. This is going to be a particularly difficult situation because the taxpayer has significant income from the sale of his appreciated stock, and the FTB will argue that he is only trying to change his residence to avoid the California tax on that income. We would typically recommend that the taxpayer sell their California residence and purchase a residence in their new home state. However, the taxpayer does not want to sell his home because it has been in the family for generations.

Simply having the children rent the family home will make it hard to prevail, as the FTB may argue that the taxpayer can return to the home at any time. One suggestion might be to gift the home to the children or put the home in an irrevocable trust for the children.

In case study #2, the taxpayer has relatively low income, but the FTB is still likely to find that she continues to be a California resident. Keeping the home here indicates that she intends to return to California, especially if she is periodically using it and working occasionally in California. If the FTB audits her, she will surely lose. The best way for her to end her residency is to sell the home and not work in California when she comes to care for her mother. She can stay with friends or in a hotel, but not in her home.

Cases where taxpayers won and lost

A good way to understand factors that will help or hurt taxpayers in these situations is to review cases where taxpayers have lost on residency issues.

Losers

In the Appeal of Murray, the taxpayers were domiciled in California prior to the husband signing with the Cleveland Cavaliers.(3) The Board ruled in favor of the FTB, and found that the taxpayer maintained a domicile in California because the taxpayer and his family resided in Ohio only during the seven-month basketball season. They maintained two homes in California — one occupied by his mother-in-law and the other presumably vacant — and continued to use financial advisors, doctors, and had business registrations in California.

In Appeal of Cummings, the taxpayers had moved to Nevada — or so they thought.(4) However, they retained two homes in California and one in Reno, Nevada. Credit card transactions and amounts and locations of expenses for each spouse demonstrated an overwhelming presence in California. Following all trips, the Cummings always returned to their California location. The Board found that the taxpayers were still California residents.

In Appeal of Norton, the taxpayers, contemplating retirement, began construction of a residence in California and listed their Connecticut homes for sale.(5) In February 1990, they rented a small apartment in California and lived in it until their new home was finished. The Board determined that residency began on April 10, 1990, when the taxpayers moved much of their furniture, including a piano that had been kept in storage, and brought one of their vehicles to California.

Winners

In Appeal of Lau,(6) which was dismissed by the FTB before the BOE made a decision, the Board was posed to rule in favor of taxpayers who had retired from running their California business and had moved to Nevada. Due to the poor housing market, they had retained their California home along with its custom made furnishings, kept their Kaiser health plan, their golf membership (which they were unable to sell), and cars in California to use while they were visiting family and checking in on their business interests. The Board indicated that they felt that the taxpayers had demonstrated their intent to establish a Nevada domicile.

In Appeal of Bills,(7) taxpayers allowed their adult daughter to stay in their California home and purchased another home in Washington to move into when the husband retired from his investment company. The BOE ruled that the taxpayers had established a Washington domicile in only one week, even though they made frequent and extended stays in California immediately thereafter. The Board emphasized the subjective intent test rather than a quantitative objective test in establishing domicile.

1. www.sfgate.com/expensive-san-francisco/article/move-out-of-bay-area-california-where-to-go-cost-13614119.php
2 18 Cal. Code Regs. §17014(c)
3 May 22, 2013, Cal. St. Bd. of Equal., Case No. 469418
4 Appeal of Nicholas and Dorothy Cummings (October 7, 1999) Cal. St. Bd. of Equal., Case No. 98A-1239
5 Thomas H. Paine and Teresa A. Norton (October 7, 1999) Cal. St. Bd. of Equal., Case No. 98A-0741
6 Appeal of Lau, Cal. St. Bd. of Equal., No. 739838, heard March 25, 2015, dismissed May 7, 2015
7 Appeal of Bills (April 28, 2016) Cal. St. Bd. of Equal., Case Nos. 610028, 782397

This article is reprinted with permission of Spidell Publishing, Inc.® ©2019

New Partnership Audit Rules for 2018 Tax Filing Year

For the 2018 tax filing year, there are new Internal Revenue Service (IRS) partnership audit rules [also adopted by the California Franchise Tax Board (FTB)] in which the partnership, not its members, will now be responsible for tax adjustments under audit.

There is a very narrowly defined opt-out provision that many partnerships do not qualify for.  Please consider amending the partnership operating agreement to designate a “partnership representative” to represent the company in disputes with the IRS or the FTB.  Also, you should consider including language regarding the responsibility of tax audit adjustments pursuant to the three allowable methods: “amend”, “pull in”, and “push out.”

Below is a chart which discusses the advantages and disadvantages of each method.

MethodProsCons
Election OutPartnership out of CPARLimited to small partnerships with limited kinds of partners
Must elect on annual basis
AmendSimple to implementPartnership can’t compel partners to amend

Partnership can’t monitor who amends and who doesn’t

Pull InSimple to implement

Partnership can act as clearing house for convenience of partners (allows partnership to monitor which partners have pulled in)

Partnership can’t compel partners to pull in
Push OutPartnership can compel reviewed-year partners to pay tax on their share of imputed underpaymentShort time frame to elect and comply

Large administrative burdern on partnership

Partners pay additional 2% penalty

To discuss your situation under the new partnership audit rules, please contact a WFY tax expert at (949) 910-2727 or info@cpa-wfy.com

© Copyright 2019. All rights reserved.

Rental Real Estate Owners-Guidance Related to the 20% Pass-through Deduction

On January 18, 2019, the IRS issued a notice providing “safe harbor” conditions under which rental real estate activities will be treated as a trade or business for purposes of the IRC Section 199A deduction.

To qualify for the safe harbor:

  1. Separate Books and records must be maintained for each rental real estate enterprise.
  2. At least 250 hours of rental services must be performed by the taxpayer and/or workers for the taxpayer during the tax year for each rental real estate enterprise. To clarify, a real estate enterprise may be one rental or multiple rentals.  Commercial and residential rentals cannot be combined in the same real estate enterprise.  Qualifying rental services counting toward the 250 hour requirement include advertising, negotiating and executing leases, verifying tenant applications, collecting rent, daily operation, maintenance and repair of the property, management, purchase of materials for repairs and supervision of employees and independent contractors.  The services can be performed by owners, employees, agents and/or independent contractors working for the owners.  We recommend filing 1099s by January of the following year for any services performed by non-owners.
  3. The taxpayer must maintain contemporaneous records including time reports, logs or similar support to document the hours of services performed, a description of the services performed, dates on which the services were performed and who performed the services. This will require tracking everything, your personal time and the time of those you employ.  A log book and a file for all invoices from others should be maintained.

Further clarification in the notice:

Triple Net Leases are not eligible for the safe harbor.

Vacation rentals (residences used by the owners) are not eligible for the safe harbor.

A statement is required to be attached to the taxpayer’s tax return and be signed by the taxpayer declaring that all the safe harbor requirements have been met and must include the following language:  “Under penalties of perjury, I declare that I have examined the statement and to the best of my knowledge and belief, the statement contains all the relevant facts relating to the revenue procedure and such facts are true, correct and complete.”

Lastly, an enterprise that fails the safe harbor requirements may still qualify as a trade or business under the regulations for purposes of the 199A deduction.  If you are unsure about your rental real estate enterprise, consult with a WFY tax advisor.

© Copyright 2019. All rights reserved.

wfy grows

WFY Grows Tax Department Before 2018 Tax Season

WFY grows their firm with eight new hires: Michael Montgomery, Jennifer Nguyen, Karla Young, Alice Wang, Jeff Hwang, Linh Trinh, and Farheen Kolsy.  All these new hires are joining WFY’s tax department as tax staff or tax interns.  WFY is pleased to welcome these new hires to the WFY team.

Michael Montgomery

Joining the WFY tax staff is Michael Montgomery. Michael graduated from CSU Fullerton in 2015 and has a Bachelor’s degree in Business Administration, with a concentration on Accounting.  With his experience in accounting, he has mainly worked in offices that specialize in small businesses and individuals.  During the off season, Michael and his wife, Katie, enjoy traveling and attending Anaheim Ducks and Anaheim Angels games.

Jennifer Nguyen

Jennifer Nguyen graduated from CSU Fullerton last fall after interning with WFY last year. We welcomed Jennifer back to WFY as an addition to our tax staff. Jennifer plans to start studying for her CPA exams this year, and continues to foster kittens from WAGS Animal Shelter and Animal Services in Westminster.

Karla Young

Our third tax staff addition to WFY is Karla Young. She graduated from University of the Philippines with a degree in Development Studies. Karla is well versed in IT and Marketing, but switched to developing her career in accounting once she moved to Orange County. Other than developing her skills in accounting, she also likes to send out typewritten letters to friends and family.

Alice Wang

Alice Wang joins the WFY team as one of our newest tax staff.  She received her Master’s degree in Accounting from CSU Fullerton, and has worked in accounting for four years.  Outside of the office, Alice loves to read and travel.

Jeff Hwang

For the 2018 tax season, Jeff Hwang joins the WFY team as a tax intern. Jeff is currently attending CSU Fullerton and working on his Master’s degree in Taxation.  Other than practicing taxation, Jeff enjoys watching sports games and attending comedy shows.

Linh Trinh

Linh Trinh is starting with WFY as a tax intern in our tax department.  She’s currently attending CSU Fullerton and plans to graduate in the Spring of 2020 with her Bachelor’s degree in Accounting.  Other than working towards her degree, Linh is also an active member of Accounting Society at CSU Fullerton.

Farheen Kolsy

Our fourth tax intern to join our WFY tax department is Farheen Kolsy. She’s a senior on the road to graduating from CSU Fullerton in May of 2019 with a degree in Business Administration concentrating in Accounting. On her down time, Farheen likes to hang out with friends and hike.

We are always looking to grow our firm. If you would like to see our open positions in audit, tax, and estates and trusts, please head to our Careers page.

Making Large Gifts Now Won’t Harm Estates After 2025

On November 20th, the IRS announced individuals taking advantage of the increased gift and estate tax exclusion amounts in effect from 2018 to 2025 will not be adversely impacted after 2025 when the exclusion amount is scheduled to drop to levels before 2018.

The Treasury Department and the IRS issued proposed regulations which implement changes made by the 2017 Tax Cuts and Jobs Act (TCJA).  As a result, individuals planning to make large gifts between 2018 and 2025 can do so without concern that they will lose the tax benefit of the higher exclusion level once it decreases after 2025.

In general, gift and estate taxes are calculated, using a unified rate schedule, on taxable transfers of money, property and other assets. Any tax due is determined after applying a credit – formerly known as the unified credit – based on an applicable exclusion amount.

The applicable exclusion amount is the sum of the basic exclusion amount (BEA) established in the statute, and other elements (if applicable) described in the proposed regulations. The credit is first used during life to offset gift tax and any remaining credit is available to reduce or eliminate estate tax.

The TCJA temporarily increased the BEA from $5 million to $10 million for tax years 2018 through 2025, with both dollar amounts adjusted for inflation. For 2018, the inflation-adjusted BEA is $11.18 million. In 2026, the BEA will revert to the 2017 level of $5 million as adjusted for inflation.

To address concerns that an estate tax could apply to gifts exempt from gift tax by the increased BEA, the proposed regulations 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.

To discuss more about your gift and estate tax situation, contact WFY’s Estates and Trusts Partners, Marisa Alvarado and Kevin Wiest, at info@cpa-wfy.com or (949) 910-2727.

© Copyright 2018. All rights reserved.

Tax Saving Moves to Improve Your Tax Situation

Since 2018 is coming to a close now is the time to take action to proactively reduce your tax liability before the new year.  Included are a few strategies that may help with your tax situation:

  1. Harvest stock losses while substantially preserving one’s investment position. This can be accomplished by selling the shares and buying other shares in the same company or another company in the same industry to replace them, or by selling the original shares, then buying back the same securities at least 31 days later.
  2. Apply a bunching strategy to deductible contributions and/or payments of medical expenses. Beginning in 2018 the standard deduction has been increased and the itemized deduction of state and local taxes limited to $10,000 which will cause many taxpayers to lose the benefit of their itemized deductions. By bunching multiple years of charitable contributions and medical expenses into one year a taxpayer may create a taxable benefit that would not otherwise exist.  For example, a taxpayer who expects to itemize deductions in 2018 and usually contributes a total of $10,000 to charities each year, should consider refunding 2019 and 2020 charitable contributions by contributing a total of $30,000 into a donor advised charitable fund and then distribute the funds to the charities over the following two years.
  3. Take required minimum distributions (RMDs). Taxpayers who have reached age 70-½ should be sure to take their 2018 RMD from their IRAs or 401(k) plans (or other employer-sponsored retired plans). Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Those who turned age 70-½ in 2018 can delay the first required distribution to 2019, however, this can result in taking a double distribution in 2019 (the required amount for 2018 and 2019).
  4. Use IRAs to make charitable gifts. Taxpayers who have reached age 70-½, own IRAs, and are thinking of making a charitable gift should consider arranging for the gift to be made by way of a qualified charitable contribution, or QCD—a direct transfer from the IRA trustee to the charitable organization. Such a transfer (not to exceed $100,000) will neither be included in gross income nor allowed as a deduction on the taxpayer’s return. A qualified charitable contribution before year end is a particularly good idea for retired taxpayers who don’t need all of their as-yet undistributed RMD for living expenses.
  5. Make year-end gifts. A person can give any other person up to $15,000 for 2018 without incurring any gift tax. The annual exclusion amount increases to $30,000 per donee if the donor’s spouse consents to gift-splitting. Anyone who expects eventually to have estate tax liability and who can afford to make gifts to family members should do so.

These are broad suggestions that will benefit some but not all taxpayers.  To discuss and create a personalized tax strategy be sure to contact a WFY tax specialist at info@cpa-wfy.com or (949) 910-2727.

© Copyright 2018. All rights reserved.

Landmark SCOTUS Decision on Sales Tax Collection Requirements

The U.S. Supreme Court recently issued a ruling that could have a dramatic impact on American retailers, and not only those who primarily operate on the Internet.  In what has been called the Wayfair sales tax case, the court on June 21, 2 018 said that states can impose sales taxes on businesses even if they do not have a physical presence in the state.

The ruling effectively overturns Quill Corp. v. North Dakota, which was a Supreme Court decision handed down in 1992.  In that case, the court said that the Commerce Clause in the U.S. Constitution forbids states from imposing sales tax on companies without a physical presence.  The court said that states could only impose sales tax on a company if it had an actual location in the state, or if it had another bright-line physical presence, such as in-state employees, inventory, or sales representative in the state.

South Dakota, in the Wayfair sales tax case, bypassed interstate commerce restrictions in a law that it enacted back in 2016, called S. B. 106. Justice Anthony Kennedy, who wrote the majority decision for the court in this case, said that the South Dakota law was constitutional because of the following reasons:

  • The law allows out-of-state companies to be exempt from sales taxes if they only do limited business in the state. That is, if they have less than $100,000 in sales revenue and less than 200 transactions in a calendar year;
  • The law does not try to collect sales tax retroactively; and
  • South Dakota abides by the Streamlined Sales and Use Tax Agreement, which reduces compliance and administrative costs associated with collecting sales tax.

Essentially, the court allowed South Dakota to collect sales taxes from Internet retailers because its law did not place a significant burden on interstate commerce.  Currently, 31 states have laws that impose sales taxes based on economic, as opposed to physical presence nexus standards. While it is possible that not all these laws pass the standard set by Wayfair, the court has now given them guidance toward making their laws constitutional.  Furthermore, it can be expected that other states will impose similar laws in the future.

On the federal level, there are two bills currently making their way through congress that will let states impose sales taxes on out-of-state entities.  Both the Marketplace Fairness Act (MFA) and the Remote Transactions Parity Act (RTPA) allow states to collect sales taxes if they keep the process of paying the taxes simple.

Because of the court’s decision, it is important for retailers selling into multiple states to understand in which states it has sales tax obligations, which will require it to both register and file taxes in these states.  Fortunately, if your business operates in multiple states, you do not have to figure all this out by yourself.

If you have questions regarding your sales tax filing requirements, please call 949-910-2727 or email info@cpa-wfy.com.

© Copyright 2018. All rights reserved.