(4 minute read)
Written by: David A. Paddock, CPA, M. TAX.
Have you ever considered moving to Nevada to escape California’s high income tax? Gilbert Hyatt not only considered it—he did it!
In the early 1990’s, Gilbert Hyatt invented a computer chip that hit gold. He patented the chip and fled to Nevada to escape California’s income tax. (California’s tax rate is one of the highest in the nation. Nevada does not have an income tax.) In 1993, a state tax auditor read about his lucrative patent in the newspaper and decided to review his 1991 income tax return. The return showed no income from the patent. So the auditor initiated an audit. Let the games begin!
What did the auditor do?
1. The auditor sent over 100 letters and demands for information to third parties. Auditors can contact third parties such as banks, utility companies, newspapers, medical providers, attorneys, your neighbors, and other individuals and entities during the audit process. But they don’t have the right to disclose confidential information. The auditor disclosed the taxpayer’s Social Security number and home address to third parties.
2. Disclosure of confidential information can cause collateral damage. The auditor sent demands for information to two Japanese companies that held licenses to the taxpayer’s patent. Included with the letters were copies of the licensing agreements which made the companies aware of the investigation. The taxpayer had no patent-licensing income after these companies received the demand letters.
So what acts of fraud were committed?
1. We will protect your confidential information (not really!). The taxpayer relied on the auditor’s guarantee of confidentiality. The auditor told the taxpayer that any personal and financial information provided to the state would be held in confidence. But the auditor didn’t mean it. The auditor disclosed the taxpayer’s Social Security number and home address to a lot of individuals and businesses. The auditor also sent demand letters to several doctors with the same last name requesting information about the taxpayer without first trying to determine which doctor was his.
Verdict: GUILTY in favor of the taxpayer!
Why would someone want to disown California?
California taxes its residents on world-wide income (universe-wide income may be more appropriate). And in certain cases, California takes the position that you are a resident even though you do not live in the state! WHAT!?! It might help to explain some of the terms.
Who is a California resident?
1. Individuals who spend more than nine months in the state. You are presumed to be a resident of California if you live in the state more than nine months. The presumption can be overcome, but I wouldn’t take any chances.
2. Temporary out of state job transfer. You are still a resident of California unless you are absent from the state for at least 546 days under an employment-related contract. (This exception does not apply to individuals who have more than $200,000 of income from stocks or bonds.) This is an example of where you think you are a resident of another state, but you have fallen into the vortex of being considered a resident of more than one state at the same time.
3. Temporary sent abroad by your employer. You are still a California resident if your employer sends you abroad with the expectation that your assignment will last for at least two years or less; the transfer is not forever; and your employment contract was for only one year. In this case, you are a resident of multiple countries (the “country” of California and the country to which you are sent).
Who is a non-resident?
1. Anyone who is a not a resident. Duh! But that’s how it’s worded in the law.
2. Individuals who spend less than six months in the state. If you are in California to visit Disneyland, don’t move into Cinderella’s castle.
What factors indicate you are a resident?
• Registering to vote in California
• Claiming the homeowner’s property tax exemption on a residence in California
• Credit card transactions and your social connections in California can indicate you spend more time in the state than in another state.
• Professional athletes are residents if they choose to live in California in the off-season.
• Carrying a California driver’s license
• If you own a home in California, there should be some attempt to rent the house to prove you aren’t using it as a residence.
California aggressively pursues taxpayers who claim they are non-residents (especially if there is a lot of money at stake). They have a department that solely focuses on residency audits. It’s a big money raiser for the state because reclassification of a taxpayer as a resident allows them to charge tax on the taxpayer’s world-wide income.