In the past couple of weeks, I’ve gotten a flurry of questions about over-reaching by California. The questions generally come down to just a few situations. A CA resident has a business or investments outside the state of California. Can they avoid CA tax? A CA resident moves to another state or another country. How do they stop CA from taxing them?
Here are some specific questions.
I live in California. Can I set up a Wyoming LLC and avoid CA taxes?
Actually, that’s paraphrased. It wasn’t a question. It was more of a statement because they talked to someone who did it and said it was legal, so they wanted to do it too.
Let’s break it down.
An LLC, limited liability company, actually has no specific tax form. It’s a tax chameleon. You select how you want to be taxed, as an S Corp, a partnership, or a C Corp. If you don’t select, there is a default tax structure. A single member LLC for a business is taxed as a Schedule C, Sole Proprietorship. A multi member LLC is taxed as a partnership.
So, when someone says a “WY LLC”, I’m not sure what tax structure they actually mean. Let’s just assume it’s a pass-through entity. That would be a disregarded (aka default) tax structure or an S Corporation.
A pass-through entity passes income or loss through to the owner. If you set up a WY LLC, taxed as a pass-through entity, the income ends up on your personal tax return. And if you live in CA, that means you’ll have CA income or loss.
CA says that if you have greater than 25% ownership in an LLC, you have to pay the $800 annual minimum fee to CA as well.
Plus, if you set up a WY (or other state) LLC, you have to pay the fees in WY (or other state) as well.
I’ve seen variations of this plan for over 35 years. Californians try to avoid California tax and it just doesn’t work. CA has investigators, social media experts, and lawyers looking for residents who try to set up entities outside the state to avoid CA tax. Sooner or later, you’ll get caught and you will face civil and/or criminal penalties.
What if I move to Mexico? Can I stop paying CA taxes?
California has a weird relationship with residents who move out of the US. The federal government and most states allow you to get a foreign earned income exclusion. California does not. If you’re moving from CA to a foreign country, go to another state first. Establish residency there and then leave the US.
Otherwise, CA will follow you forever.
How do I move to another state and stop paying California taxes?
When you move from California (or any state) to another state, you need to establish residency in the new state.
Check out the details here:
Tax Residency
You will need to file a part-year return for two states, at a minimum. It will be for the state you left and the state you went to. Then, in the following year, you probably just have the one state to file in. It’s possible that you could get a note from your previous state, especially if it’s California.
Just respond that you’ve moved and provide the information to California that explains what you’ve done as part of the move. That would include things like a new driver’s license, registered your vehicles, bank account and investments in the new state, etc.
We’re bound to see more of these type of audits in the future. States are getting particular about their own state income tax. They want their money!
