by Kathleen Pender, San Francisco Chronicle, Sept 5, 2020
Business groups have been pushing Congress for a decade to simplify how states tax nonresidents. They hope the work-from-anywhere boom will spur lawmakers into action.
Californians who worked part of this year in another state — to save money, be closer to family or for a change of scenery during the pandemic — may be in for a surprise next year when they file their taxes.
Depending on where they moved and how long they stayed, they may need to file a tax return, and possibly pay taxes, in both states. Although most states give their residents a credit for taxes paid to another state, the credit does not always make the taxpayer whole. And the rules are beyond perplexing.
“Right now, different states have different rules for when a nonresident working in that state” will be subject to income tax filing and withholding, said Eileen Sherr, a senior manager in tax policy with the American Institute of Certified Public Accountants. “The problem is, there are different thresholds that a lot of people aren’t aware of.”
Twenty-four states require employers to withhold taxes the first day a nonresident employee works in that state, or requires the nonresident employee to file a tax return if they’ve worked at least one day in the state, even if there’s no withholding, according to a map published by the Mobile Workforce Coalition, a business group pushing for interstate tax simplification.
“New York is notorious for staking out business conferences, looking for CEOs” who earn a lot in one day, said Jared Walczak, vice president of state projects with the Tax Foundation.
In other states, the threshold could be 15, 30, 60 or more days, or after the worker has earned a certain amount of money in that state. California requires nonresidents and part-year residents to file a tax return if they have a certain dollar amount of California-source income based on their age, filing status and dependents. (For details see FTB Publication 1031.)
Business groups have been urging Congress for a decade to adopt a nationwide standard for the taxation of nonresidents, and exempt nonresidents working in a state for 30 days or less. They’re hoping the explosion in remote working during the pandemic will give it some urgency. A bill introduced by South Dakota Republican Sen. John Thune, S3995, would extend the exemption from 30 to 90 days for 2020 because of the public health emergency.
“In practice, even in normal years, compliance (with these rules) is not terribly high when we’re talking about a few days here or there,” Walczak said. “During the pandemic, when you have a diaspora of employees who have moved all over the country and employers may not even be aware because their home address has changed, it’s very unlikely that much withholding is taking place.”
Nevertheless, for workers on the move, it’s important to understand the rules.
California taxes its residents on all worldwide income, regardless of the source. This includes income earned while working in California and any other state, as well as investment and other income. If you are a California resident and work temporarily in another state, and the other state taxes your earnings, you may get a credit that offsets some or all of the taxes you owe California for the same income.
California taxes nonresidents on “California-source” income only. This includes income from services performed in California, rent or capital gains from real property located in California and income from a business or partnership based in California. (Merely owning stock in a publicly traded company based in California does not give rise to California-source income, unless you got the stock because you worked for the company, in which case it could.)
Determining the source of income for services performed in California is different if you are a nonresident employee or independent contractor. If you are a contractor, “the source of the income is determined by where the benefit of the service is received. When the benefit of the service is received in California,” it’s California-source income, said Franchise Tax board spokesperson Victoria Ramirez. It doesn’t matter where you were when you did the work.
If you are a nonresident employee, it depends on where you were when you performed the service, not where your employer is. If you performed the service in California, your income for those days is California-source income.
California previously taxed nonresidents on pensions they earned while working in California, but that ended after 1995.
If a California resident relocates permanently to another state, that person is considered a part-year resident. California taxes part-year residents on all worldwide income received while a California resident, and from California sources received while a nonresident.
Most states with an income tax follow this same general regime. So if you move from California to a new state, the new state generally will tax you on all worldwide income received while you were a resident of the new state. But you would still be liable for California tax on California-source income, such as rent on a home you left behind. (Seven states charge no personal income tax: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming.)
Determining who is a resident of which state is not always easy.
Most states presume you are a resident if you spend more than six months in that state (which does not have to be consecutive). If you are living in two places. it’s important to keep a log of where you have spent each day.
California has no such “bright line test,” Ramirez said. FTB Publication 1031 states, “You will be presumed to be a California resident for any taxable year in which you spend more than nine months in this state.” However, “there is no presumption of nonresidency,” Ramirez said.
In other words, spending more than six months or even nine months outside of California does not automatically make you a non-resident.
“The underlying theory of residency is that you are a resident of the place where you have the closest connections,” the FTB says. It looks at a multitude of factors including the amount of time you spend inside and outside of California, where your spouse and children live, the location of your principal residence, the state where your driver’s license is issued, where your vehicles are registered, where you maintain your professional licenses and voter registration, and where your bank, health care providers, accountants and attorneys are. The state considers not just the number of ties, but also their strength.
The Franchise Tax Board is famous for pursuing people who have moved out of state if they have significant California-source income.
“If you think you can move to another state and still have ties to California,” you are “likely to face an audit. Don’t go into that lightly,” said Clay Stevens, a tax lawyer with the wealth management firm Aspiriant.
Establishing residency in another state is not always easy.
Brendan Foley and his girlfriend moved in April from San Francisco to Boulder, Colo., because it had a lower cost of living and less traffic but a similar culture. He has always worked remotely for a French electric company. His girlfriend, who works for a major Bay Area tech company, is working from her new home until its Boulder office reopens.
The couple spent their first two months in an Airbnb, while they were looking to buy a house. “The first month we were not able to establish residency” in Colorado because they had no permanent address, Foley said. So they kept their residency in California, even though they were working and having taxes withheld in Colorado. “It was this weird limbo, we didn’t know what to do,” he said.
Once they closed on a home in Boulder, they were able to get a Colorado driver’s license and mail with their name on it, open a bank account and establish residency in Colorado.