by: Ashley Quinn, CPAs and Consultants, Ltd.
California imposes a significant income tax burden on its residents. In fact, California's income tax rates are among the highest of all states in the Union. Nevada is one of only a handful of states which impose no personal income tax at all.
Nonresident individuals (as well as estates and trusts) are taxed only upon their taxable income from California sources, if any. So, in the right circumstances, a move to Nevada just might save you a substantial amount of tax.
Who is a "nonresident"?
So, just what constitutes nonresident individual tax status when it comes to the application of the California rules? Technically, the California law says that a resident is an individual who is (1) domiciled in the state, and who may be outside the state, periodically, for a temporary or transitory purpose, or one who is (2) in the state for other than a temporary or transitory purpose.
In general terms, therefore, one can become a nonresident simply by acquiring a "domicile" (primary residence) in Nevada, begin living there on a regular basis, and limiting time spent in California thereafter for any reason.
The underlying theory of residency is that one is a resident of the place where one has the closest connections. It is also important to note that the strength of those connections, and not just the number of connections, is of considerable importance in determining the state of residency.
Among the more important connections are these:
1. Amount of time spent in California versus amount of time spent elsewhere, including time spent by spouses and children;
2. Location of one's principal residence;
3. State which issued one's driver's license;
4. State in which one's vehicles are registered;
5. State in which one maintains professional licenses;
6. State in which one is registered to vote;
7. Location of banks where accounts are maintained;
8. Origination point of financial transactions;
9. Location of one's medical and other professionals, including accountant and attorney;
10. Location of one's social ties, such as place of worship, professional associations, or social and country clubs;
11. Location of real property and investments;
12. Permanence of work assignments in California and elsewhere.
How is a "nonresident" taxed by California, if at all?
After establishing residency outside of California, depending on the circumstances, an individual may totally eliminate further California taxation, or at the very least, just might substantially reduce his California tax burden. Generally speaking, after making a change, only income items which have a source in California would continue to be taxed by the state. Among the more common forms of income which may have a California source are:
1. Income from personal services actually performed in California;
2. Income from "pass through" entities (such as partnerships, LLCs, or 'S' corporations) conducting business in California;
3. Income from rents or royalties arising from property located in California;
4. Gains from sales of real estate (i.e. - "tangible" property) physically located in California;
5. Some forms of deferred compensation (such as income arising from stock option transactions, proportionate to the underlying personal services actually performed in California).
So, to the extent that a nonresident may have income items of these sorts, a move to
Nevada will not completely eliminate California taxation, but would likely still enable him to reduce the California bite.
And here's where it gets better - the typical wealthy nonresident will likely have, now or in the future, the expectation of a significant amount of "intangible" income. Included within the "intangible" category are interest income, dividend income, and significantly - capital gain income.
Let's say you have lived in California for a long time, during which you started a business which grew and became very successful and valuable. Commonly, these days, the value of such a business is largely the result of some intellectual property which, for example, might be of great interest to one of the "big name," publicly traded companies dealing in the same realm.
So you are approached by "big name," and successfully orchestrate a merger of your company with "big name," upon the conclusion of which you end up with a significant quantity of "big name" stock. Such a transaction can often be orchestrated in a manner which does not give rise to a taxable event at the time of the merger.
Subsequently, the value of your "big name" stock increases even further, and you are now, on paper at least, among the super rich. But remember - at such time as you may liquidate some or all of your "big name" stock, as long as you reside in California, the state will clip you for about 10% to 13% of your gain.
But say you first take up residency in Nevada, and subsequently liquidate that stock. Assuming you have planned and executed your residency change appropriately, the realization of that intangible gain gives rise to NO California taxation - even though the original genesis of the wealth may have had its roots there!
So it's easy to see how a savings of about 10% to 13% of any amount of gain might very well go a long way toward covering some (maybe even all!) of the cost of that Nevada residence which you previously purchased as your new Nevada home!
The narrative set forth above is necessarily general in nature. In evaluating the overall personal economic implications of any change in residency, including specific Federal and state income tax consequences, the reader should first consult with qualified financial and income tax advisors in order to assist in the assessment of the specific financial and income tax consequences which would apply to the reader's specific situation.
Ashley Quinn, Certified Public Accountants and Consultants, Ltd., is an independent Nevada firm originally established in Incline Village, Nevada in 1979. The firm has grown with the success of its clients, and has evolved into a highly regarded regional Nevada Certified Public Accountants firm with offices in Incline Village (Lake Tahoe) and Reno, Nevada. Further information regarding the firm is available at www.ashleyquinncpas.com, or by calling our Incline Village office at 775-831-7288.