We saw a lot of people and businesses move this year. Leaving the city behind. Waving good-bye to the high cost of living. Bidding adieu to high state taxes.
One of the states that saw a radical net decline was California. For the first time in over 100 years, there was a decline in the number of people moving to CA. And, at the same time, people were moving out. One of the most popular destinations for businesses and their owners was Texas. From a state with some of the highest state taxes to a state with no income tax.
But that’s not all. I have clients in more rural New England that saw rents shoot up as tenants move out of NYC to bigger places with yards for lower rent than what they were paying in NYC.
All of that leads to a question.
What happens to your taxes when you move out of a state? And what if you keep a home in your old state? When have you REALLY moved for state income tax purposes?
The answer differs depending on the state you move from, and to some extent, the state that you move to. One of the most aggressive states is California, so let’s use an example of a CA business that moves to TX. When is the move official? This is especially true for a business that exists solely online. If there is no bricks and mortar location, where does the business really exist? And when does an online business move?
California to Texas, What Happens to the Business Taxes?
The California exodus is real. Elon Musk (Tesla), Drew Houston (Dropbox), Venture Capitalist Joe Lonsdale and hundreds of thousands others are leaving CA for TX. The reasons are pretty simple. The cost of living is lower and state income taxes drop from the highest to zero. But the California Franchise Tax Board (FTB) is notoriously aggressive.
Just like a bad ex, they may not let you go that easily.
You Have to Prove Your Case Against CA in a CA Court
When you leave California, the FTB (CA taxing arm) may decide you really are still a CA resident and if you disagree, you’ll have to prove your case against the FTB in a CA court. If you louse the next step is to take your argument to the CA Office of Tax Appeals (OTA).
The OTA review starts by saying that determinations by FTB are presumed correct. The burden of proof is on you to prove they are wrong. The FTB doesn’t have to prove they’re right. You have to prove they are wrong.
Gulp. That’s not a good position to be in.
CA Wants to Prove You’re a California Resident
If the FTB determines you are a California resident, all of your income from every state is taxable in California. On the other hand, non-residents are taxed only on California sourced income. Part-time residents are taxed on all income earned while a CA resident and then the remainder is taxed in another state. All California-sourced income is still taxed in CA.
The first hurdle when you move from California is proving you’re no longer a California resident.
First You Must Prove the Out-of-State Move is NOT Temporary
One of the important factors for FTB regarding residency is whether the move by the former California resident is just temporary. If a resident is “temporarily absent” from California, he or she is still a resident.
California defines a home as “the most settled and permanent connection.” If a California resident still owns his or her California primary resident, California has taken the position that the taxpayer is still a resident. Otherwise, why would they keep a home in California?
Theoretically, if you have rented the property as a long-term rental with a lease, you could prove the home is a rental and not your full-time residence.
You Must Prove Your New State is the Closest Connection
Pretty much all states use “closest connection” as the test for determining where you live. If you have a house in two different states, where do you live? The home state will be determined based on where you had the closest connection.
In the case of California, our poster child for far-reaching state tax agencies, the “Bragg” factors are used. These come from a 2003 California decision. These factors are:
Membership in churches and/or social associations
Property (owned or rented)
Origin of bank account
Origin of credit card purchases
Cell phone records
You may be able to add a signed affidavit to supplement the records, as long as it is signed under the penalty of perjury.
Plan Your Move Carefully
California wants to pull you into their tax structure. I think this is a growing trend we’ll see more often in other states. Everyone wants your tax money. If you’re leaving a high tax state, be careful to follow the rules when you leave.