August 30, 2021
Breaking California Residency
Taxpayers have been leaving California in droves. California’s rising cost of living with increased ability to work remotely has resulted in an unprecedented exodus. In addition, California residents are taxed at one of the highest rates in the country. Many taxpayers are incentivized to leave the state for these reasons and others, but breaking residency in California can be a complex process that requires detailed tax planning. To break residency, taxpayers must do more than acquire an out-of-state address.
How does California determine residency?
California considers you a resident if you are present in the state for any purpose other than a temporary or transitory one. Residency is based on the concept of domicile, which determines where your closest financial and familial connections have been established. Factors such as the following are considered: the locations of your living accommodations, closest family members, prized possessions, professional services, and many other factors such as gym memberships, voting registration, and driver’s license.
Please click here for a comprehensive checklist for factors California is likely to review to determine residency.
What do I need to do to break CA residency?
You will need to have sufficient evidence that demonstrates the following:
Sufficient facts and circumstances that you are no longer domiciled in California.
Sufficient facts and circumstances that you have established domicile elsewhere.
Sufficient indicators that you have no intention of returning to California.
Residency is more likely to be broken if your new facts and circumstances mirror those of your life as it had been while you were living in California.
Continuing to have too many personal connections to California could give the Franchise Tax Board sufficient evidence to continue to declare you a resident. It is important to examine your remaining connections to California as you are establishing residency elsewhere. For example, if you wish to keep your former personal residence in California, you could consider repurposing the property as a rental property.
The determination of sufficient facts and circumstances is a complex one. We recommend consulting with us so that we can personally evaluate your personal facts and circumstances to ensure that they are sufficient.
What will the State of California continue to tax?
If you still have California sourced income (from rental properties based in state, K-1 income, ordinary income earned while working in CA etc.), that income will still be taxable to California and you will be required to file a non-resident return. Another consideration is if you have unexercised shares in a company. For your option income, California takes the position that your residency at the time of exercise does not matter; the taxation of option income depends on the days worked in California from the grant date to the exercise date since the income was “earned” during that duration of time.
If you are successful in breaking California residency, your normal investment income (interest, dividends, and capital gains) will be taxable to the new state of residency, not to California.
Will breaking California residency trigger an audit?
Residency is a hot issue with the California Franchise Tax Board. Upon exiting the state, the FTB may enquire about your move via questionnaire. California requires you to disclose the date of your exit on your final state return.
Additionally, if you have a substantial income event closely after your residency change, the chances of a residency audit increase substantially. California examines each taxpayer’s circumstances on a case-by-case basis to determine residency.
If you are considering leaving California, it is important to check in with us to make sure you have everything you need to substantiate your exit. Please contact us to schedule an appointment to discuss your options for moving out of state.