My previous California residency articles have discussed how simply applying mechanical factors (such as where your driver’s license is, where you’re registered to vote, and using an out of state mailing address) can still result in you being found a California resident. One overlooked aspect of the California residency test is where one maintains their “domicile”.
Domicile is the place where an individual has his true, fixed, permanent home and principal establishment, and to which place they have, whenever they are absent, the intention of returning. An individual can only have one domicile at a time.
This means that you can be completely absent from California for a certain period of time (say a year), but the Franchise Tax Board can still claim that California was your “domicile” because you always intended to return here. The domicile test is essentially a test of your intent.
Of course, intent is very difficult to prove and can always change. When you consider how aggressive the Franchise Tax Board is in trying to claim people are California residents, you can see that the whole issue of “domicile” is a potential trap.
In my August 20th, 2012 blog article, I included a list of 29 California residency factors which are “objective” indicia of intent. The problem with these factors is that they do not always apply in every case, and there is no specific weight attached to any particular California residency factor. For example, consider the factor of where a taxpayer was born or married. The fact that someone was born and married in California really has no bearing if they legitimately move to Texas. And in the case of someone born and married in Texas, that factor really is irrelevant once they move to California and live here.
How then do you plan when a very aggressive tax agency will try to claim that notwithstanding various objective factors, you are a California domiciliary? The answer is that you manage whatever objective factors you possibly can, along with (here is the difficult part) really and truly staying out of California as much as you possibly can. Ultimately you want to show you left California for other than a temporary or transitory purpose.
As an example, one question I frequently get is, “Can we keep our family home in California if we’re moving out of state”? The answer is that, as a single factor, keeping your home shouldn’t matter very much if the other factors indicate non-residency. But you can expect the state to focus on the family home very clearly, looking at the following:
Was it actually used by the family? If so, how much?
Did the owners come back and stay in the home while conducting business in California?
What is the size and value of the home as compared to the out of state home? (This is a big disadvantage, since California real estate prices tend to be much, much higher than most other states. A $500,000 home in Houston, Texas might be a $2,000,000 home in Orange County).
Most critically, you can expect the state to point to the retention of the family home as a factor which indicates the taxpayers “intended” to return to California.
Sometimes I tell clients that, theoretically, and assuming the right transaction structure is used (a stock sale which is treated for federal tax purposes as such), they can move shortly before a substantial stock sale of their business and exclude the entire gain from California taxes. California would be very skeptical of this timing, of course, but assuming that Mr. and Mrs. Smith move several months before there’s a binding agreement to sell the Smiths’ business, and the sale occurs while the Smiths are completely out of California and happily living somewhere else, they can win if, in addition to being out of California, they can prove their domicile changed.
Assume the Smiths stay out of California for two years—they don’t even return to spend a weekend at Disneyland with their children. Is the Smiths’ sale safe? Not if the Franchise Tax Board finds evidence that the Smiths always intended to return to California at the time of the sale. It does not matter if they actually return in the future if, at the time of the sale, they had no intent to return.
How might the Franchise Tax Board make the argument the Smiths intended to return? Well, if the Smiths retained their California home, and the Franchise Tax Board talks to neighbors who tell them that “the Smiths said they would move back to the neighborhood in a few years”, the Smiths may have gone through a lot of trouble for nothing.
The one huge advantage that people who are planning to terminate their California residency have is that they can control the facts, the evidence, and how the evidence is documented. It sometimes requires hard choices—like selling the family home—to clearly show that domicile has shifted. But in significant enough cases, such as a major liquidity event, the taxpayer has the advantage of knowing well ahead of time what needs to be documented before the Franchise Tax Board is even aware there’s an issue.
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