Moving out of California changes how the state taxes a person, but it does not end California’s ability to tax income that comes from California sources. Knowing which income stays taxable, and which generally does not, helps in planning a move and in filing correctly afterward. This article summarizes the sourcing rules the Franchise Tax Board (FTB) applies, based on FTB Publications 1031 and 1100.
Residents, Nonresidents, and Part-Year Residents
According to the FTB, California residents are taxed on all income, regardless of source. Nonresidents are taxed only on taxable income from California sources. Part-year residents are taxed on all income received while a resident plus California-source income received while a nonresident. Nonresidents and part-year residents generally file Form 540NR.
California computes a nonresident’s tax in two steps. It first calculates the tax on total taxable income from all sources, then prorates that tax by the ratio of California taxable income to total taxable income. As a result, the effective rate applied to California-source income reflects the taxpayer’s total income, not just the California portion.
Income That Remains California-Source
Wages for work performed in California. FTB Publication 1031 states: “Wages and salaries have a source where the services are performed.” A nonresident who travels to California to work is generally taxable on the wages for that work.
Business income. A nonresident’s California-source income includes income from a business, trade, or profession carried on in California. When a business operates both inside and outside California, determining the California portion can involve the state’s allocation and apportionment rules.
Real property. Rent from California real property is California-source income, and gain or loss from the sale of real estate has a source where the property is located.
Pass-through entities. Nonresident partners, LLC members, and S corporation shareholders are taxed on their share of the entity’s California-source income.
Installment sales. According to Publication 1100, California taxes installment proceeds received by a nonresident to the extent the income from the sale was from a California source, such as installment payments from a sale of California real estate.
Employee stock options. California taxes the wage income a nonresident receives from employee stock options on a source basis, so income connected with work performed in California can remain taxable after a move.
Income Generally Not California-Source for a Nonresident
Interest and dividends. Under Publication 1031, interest and dividends generally have a source where the taxpayer is a resident. The exception is when the account or security is used in a trade or business in California or pledged as security for a loan.
Sales of stocks and bonds. Gain or loss from selling stocks or bonds generally has a source where the taxpayer resides at the time of the sale. Installment gains from selling intangible property are generally sourced to the seller’s state of residence at the time of the sale.
Retirement income. According to the FTB, California does not tax nonresidents on IRA distributions or on distributions from qualified pension, profit-sharing, and stock bonus plans.
Wages for work performed elsewhere. Compensation for services performed outside California after a change of residence is generally not California-source income.
Whether income from services provided remotely to California customers is California-source depends on the facts, including how and where the business is conducted. This area deserves individual review rather than assumptions in either direction.
Withholding on Payments to Nonresidents
California uses withholding to collect tax on some California-source payments. The FTB requires withholding agents, such as partnerships, LLCs, and rental property managers, to withhold 7 percent on payments or distributions of California-source income to nonresident payees when the total for the calendar year exceeds $1,500. Sales of California real estate can also be subject to real estate withholding.
Practical Considerations
Keep a record of the date residency changed and of any days worked in California afterward. Review the timing of sales and other income events relative to the move, since the source of some income depends on where the taxpayer resided on the date of the transaction. Items such as stock options, deferred compensation, bonuses, and installment sales are governed by special rules and should be reviewed individually. Finally, keeping California real estate or a California business after a move can mean continuing California filing obligations.
Moving out of California?
Tax attorney Cassra Minai, Esq. can review which of your income items California may continue to tax in a confidential consultation.