Nonresident Challenge Irks California FTB

Leave it to the Franchise Tax Board to throw the U.S. Constitution under the bus, when it comes to taxation of folks who have fled the state – in many cases because they simply can’t stand the taxation there anymore.

And perhaps such was the case with taxpayer Hughes, who had moved to Tennessee, but continued his employment in California – putting up with a sizeable commute.  He properly filed his nonresident California tax return, alright, but got a little bent out of shape when he eventually understood that the California tax rate applicable to his out of state income was a function of his worldwide income, even though his California salary was just a portion of the total.  Specifically, he argued that while his other (retirement) income had no California source characteristic to a Tennessee resident, the fact that it was taken into account in establishing his California tax rate was just downright – unconstitutional, violating the “privileges and immunities” clause.

This guy must have been around for a while, because back in the first Jerry Brown era, nonresident source income was taxed in just the manner which Hughes deemed to be fair and reasonable.  Before Brown got the idea (in the early 80s) that he could jack up the state revenues by changing the methodology, a nonresident’s income from sources outside California had nothing whatsoever to do with the determination of the rate applicable to the measly sum which was actually earned there.  And when Brown pushed the issue, the constitutional arguments failed then, just like they have again in Hughes’ case!

Who said life (particularly in California) ain’t fair?

And while we’re on the subject of the Golden State Revenooers, another troubling development recently emanated from FTB in their “Tax News” publication, which revealed the fact that one of their main audit target issues these days will be 1031 exchanges – notably those orchestrated by – you got it:  nonresidents!

Strange to us that they haven’t caught up with this potential issue until now – in any case, recall that if a bloke exchanges real estate located inside California for replacement property located elsewhere (say, Nevada), and the numbers work out right, California gets no tax when the exchange occurs.  However, it has always been the case that if/when the replacement property is later sold, any deferred gain hanging around from the California days is then taxable by California.  And it’s not surprising that there probably has been a 1031 exchange or two (and subsequent taxable sale) fitting this fact pattern that never found its way on to a Form 540NR filed by the taxpayer who, by then, was long gone from California and whose priority list probably didn’t include running right down to the nearest FTB office and paying the tax bill.

Folks in this situation need to mind their P’s and Q’s, now that FTB is going to get a little more aggressive in uncovering these sorts of transactions.

CONSULT YOUR TAX ADVISOR – This article contains general information about various tax matters.  You should consult your CPA regarding the implications to your own particular situation.

Jeff Quinn, the author of this article, is a shareholder in Ashley Quinn, CPAs and Consultants, Ltd., with offices in Incline Village and Reno.  He may be reached at 831-7288, welcomes comments at jquinn@ashleyquinncpas.com, and invites readers to consider his other commentary at http://blog.nolo.com/taxes.

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