A recent study by the California Policy Lab has shown that far fewer people have been moving to California from other states, and more have been leaving. According to the study, exits out of California to other U.S. states are up 12% since the start of the pandemic.
While the number of taxpayers leaving the state may be attributable to steep housing costs and flexible remote-work policies, others are leaving California to reside in low-tax jurisdictions like Florida, Nevada, and Texas. This begs the question, is the Franchise Tax Board (the “FTB”) poised to increase residency audits to try and collect tax from those fleeing the state during the pandemic? While there has been no specific policy directive promulgated by the FTB, it appears likely.
What is a FTB Residency Audit?
A residency audit is distinct from an audit of the tax return that you file with the FTB. In a residency audit, the FTB analyzes your connections to California to discern whether you are a resident, part-year resident, or nonresident. California residents are taxed upon their entire taxable income (regardless of source). See R&TC § 17041(a). On the other hand, part-year residents and nonresidents are only taxed on income earned while residents of California and from California sources. See R&TC § 17041(a), (b), & (i). This means that, even if you move out of state, you may still be required to pay tax to the state of California. As noted above, the FTB will examine your connections to the state after moving and may propose additional tax and/or penalties if you have sufficient connections to California. The FTB has a non-exclusive list of factors it considers when making this determination.
These audits can be very intrusive because personal information is sought by the FTB to analyze these connections. The FTB may review your phone logs to pinpoint the origination of your calls, ask for financial statements to trace the location of your bank accounts, and review informational returns (such as Form 1099) and billing statements to see what address is used by the taxpayer. There are many actions on the part of the taxpayer that can trigger a residency audit.
The Office of Tax Appeals – In the Matter of the Appeal of J. Bracamonte and J. BracamonteA recent decision from the California Office of Tax Appeals (the “OTA”) has shown the lengths the FTB will go to collect the tax they believe is owed. In the Matter of the Appeal of J. Bracamonte and J. Bracamonte, taxpayers that moved out of the state were found to be California residents during the period at issue despite taking several steps to establish a new domicile in Nevada. Ultimately, the OTA found their connections to California to be so substantial during the period at issue that they were required to pay income tax on the net gain from the sale of their
The OTA noted that the taxpayers retained ownership of their large California home, had numerous vehicles registered in the state, had a financial interest in several bank accounts located in California, and met with professional advisors licensed in the state during the period at issue. Lastly, and most importantly, during the period at issue, the taxpayers spent more days in California than in Nevada.
While these connections may be instructive, they are not meant to be dispositive of other taxpayers’ residency status.
What Can You Do to Mitigate Your Risk of Audit?
A taxpayer that has recently moved out of California should closely examine their ties to the state and take affirmative steps to establish a new domicile in their new state of residence. Further, it is prudent to engage a professional advisor to assess your ties to California to help mitigate your risk of a residency audit.
Benjamin Wohlford is an attorney in the corporate and tax department at Berliner Cohen, LLP. He can be reached by telephone 408.286.5800 and via email email@example.com.
 In the Matter of the Appeal of J. Bracamonte and J. Bracamonte, 2021-OTA-156P