The State of California - Can Expats Ever Leave (Tax-Wise)?
Ines Zemelman, EAJan-20-2016
In California, when Proposition 55 passed it extended the “temporary” tax of 13.3% on higher income earners through 2030. It is applicable to approximately 1.5 percent of people in California - single filers earning USD 263,000 and joint filers earning USD 526,000. This tax rate is higher than any others in the United States. The anticipated federal tax cuts coming in 2017 will make California’s taxes appear even higher by comparison. For many people, states like Washington, Florida, Nevada, and Texas that do not have income taxes will be appealing.
Can We Utilize the Foreign Earned Income Exclusion?
Former California residents living abroad do not have a privilege of the foreign earned income exclusion of income earned abroad. They must add back a special “ CA adjustment” of foreign income excluded on the federal return when they report their state taxable income.
Jeez - Is there Nothing We Can Do?
Fortunately, there is a workaround for people who leave California under an employment contract. The name of this legal workaround is Safe Harbor.
The Safe Harbor rule states that a person whose residence is in California, but who is not in California because of a contract related to their employment for 546 days (consecutively) or more, will be seen as a nonresident, except if:
1. They have intangible income (interest, capital gains, dividends, royalties, copyright) of over USD 200,000 during any of the tax years that the employment contract is effective; or,
2. The primary purpose of being outside California is avoidance of the tax.
The spouse of a person who qualifies for this safe harbor may also qualify. There are additional limitations for those who otherwise qualify for Safe Harbor residency exception status.
- Visits to the state should not exceed 45 days within a calendar. Shorter visits during the contract are allowed and seen as temporary.
- You may have rental property in California or just leave behind your house vacant - this does not preclude you from Safe Harbor qualification.
Are There Any Limitations? What About Ties To the state?
Factors such as CA driver license, bank accounts, voter registration, even house ownership do not matter. Those who qualify under the Safe Harbor non-residency status can have all of these ties to CA, yet still be treated as nonresidents until they return to CA. They do not need to prove that absence is “temporary or transient”.
What If You Don’t Qualify?
If you do not meet the qualifications for the Safe Harbor exception then getting nonresident status gets much more complicated. Those who do not qualify for Safe Harbor - most often retirees who move out of California forever but their move is unrelated to work contract - have their residency determined based on their particular circumstances and surrounding facts. This is where the common assumption of CA being a “difficult state for expats” come true.
California Franchise Board is Tough
It is the job of the Franchise Tax Board, or FTB, to police the line separating non-residents from residents. And they are tough. Be careful, even if your situation and the facts do not seem complicated or controversial. The board places the burden on the taxpayer to prove that they do not have status as a Californian.
- A resident is someone in California for a purpose other than transitory, and includes anyone who has a domicile in California, but is outside of California temporarily.
- There is also an assumption that if a taxpayer is in California over 9 months, then they are presumed a resident of California.
What Is My Domicile?
Domicile is defined as a person’s true, permanent, fixed home - the location you plan to return to even when you are away. But, innocent facts do not look innocent in the eyes of California tax collectors. Remember that when fighting your California tax bill, the procedure you follow counts.
A taxpayer can have just one domicile, which depends on what their intent is. But, the objective facts also demonstrate your intent. For example, where your home is, where your children and spouse live, and where your kids go to school. The number of days you spend in and out of the state get considered as well, along with the reason for your travels. Additional factors include where your bank accounts are, and where any professional, religious and social organizations you belong to are located. Of course, vehicle registration, driver’s licenses, and voter registration location are considered as well. If you are not under the Safe Harbor safety net, all those factors matter.
Audit Danger - California Never Forgets
The state of California has a very long memory. Even though the IRS is only allowed to go back up to 6 years, the state of California often can go back and audit forever. There are several reasons that the FTB can have an unlimited time period to audit a taxpayer, but one of the most common is failing to file a tax return. If you believe you are not a resident, thus are not required to file in California, but the FTB disagrees, they have unlimited time to audit you.
If you live abroad and do not qualify for Safe Harbor yet do not plan to return to California, then filing non-resident CA state tax return could be a wise move. Even if the FTB disagrees with your non-residency position, you have an opportunity to timely challenge their decision. Moreover, you establish the Statute of Limitations and protect yourself from tax assessment on alleged state taxable income unreported 10 years ago. Make sure to obtain professional advice and plan carefully, or you may find yourself being chased by the tax authorities from California.