In all but the most rudimentary cases, determining California residency for personal income tax purposes is not an easy task. Upon first impression, one might be puzzled by this statement because the California statutory scheme is not complex on its face. Indeed, for purposes of California’s personal income tax, the legal standard for residency is defined in a mere 32 words in a single section of the California Revenue and Taxation Code.1 However, bright-line standards and formal guidelines are next to nonexistent. Instead, the residency analysis has grown in practice to involve a nearly limitless number of variables, all of which are potentially relevant and none of which are controlling. Truly, “the devil is in the details” when it comes to determining California residency for personal income tax purposes.

Taxpayers seeking clarity in changing from resident to nonresident, from nonresident to resident or from resident to part-year resident status will find little comfort in this lack of certainty. The California personal income tax is imposed on the entire taxable income of residents of the state.2 Thus, a residency determination often involves substantial amounts of money and significant tax consequences for the taxpayer, especially when a significant gain (e.g., sale of a business) is involved.

It is our experience that careful due diligence, interpretation and analysis allow the taxpayer to manage the seemingly unmanageable body of California residency law. In this article, we will summarize the major principles of residency law in California, including the statutory scheme and administrative and judicial tests used to determine residency for purposes of personal income tax. We will also explore possible reasons, based on current laws and trends, which may contribute to the increasing challenges involving California residency.

California’s current economic crisis arguably exacerbates the California Franchise Tax Board’s (“FTB”) already aggressive enforcement and interpretation of California residency law. Personal income tax represents 61% of total California general fund revenue sources, compared to 21% from sales tax and only 10.6% from corporate taxes.3 Over the past four decades, personal income tax revenues to the general fund have also increased dramatically, rising from 27% to 51% of general fund revenues.4 Moreover, the top 1% of income earners pay up to 50% of all California personal income taxes.5 Thus, it should come as no surprise that California’s overall tax burden (combined state and local taxes) is higher than all neighboring states and, of major states, only New York’s tax burden is considerably higher.6

State tax reform, potentially generating even higher personal income tax rates, also has emerged as a key issue in the upcoming November 2012 California election. Currently, the top graduated California personal income tax rate is 9.3%, plus an additional 1% tax on taxable income over $1 million.7 With a top marginal rate of 10.3%, California currently has the second highest marginal tax rate in the United States.8 Despite California’s already aggressive taxation scheme, California Governor Brown and the California Federation of Teachers have qualified an initiative for the November ballot which would “temporarily” increase the personal income tax rate by 1% for single filers with taxable income over $250,000; by 2% for taxable income above $350,000; and by 3% for taxable income above $500,000.9 The amounts for joint filers would be double the amounts for single filers.10 Activist Molly Munger has also qualified a separate initiative for the November ballot which would add an income tax surcharge to the existing personal income tax and the 1% “millionaire’s tax,” including an increase of 2.2% for taxpayers earning over $2.5 million.11 Even the magnitude of recent Silicon Valley IPOs, such as Facebook’s $16 billion IPO in May 2012, are seen as offering California a glimmer of hope for much needed revenue – and cause for worry for some taxpayers.12 Governor Brown’s office has estimated sales of Facebook stock will generate $1.9 billion of additional revenue, spread over two fiscal years, from the capital gains of Facebook’s newly-minted millionaires.13 As California seeks to balance its budget, the complex and challenging factual inquiry of California residency will move to the forefront of more taxpayers’ minds.

Ignoring for the moment the intensely factual aspect of residency, there is a single overriding statutory legal standard under which those facts are to be evaluated. The legal analysis of residency always must begin with Section 17014(a), which defines “resident” to include (1) “Every individual who is in California for other than a temporary or transitory purpose”; and (2) “Every individual who is domiciled in California who is outside the state for a temporary or transitory purpose.” Conversely, any individual who is not a California resident is a “nonresident.”14

Regulations promulgated by the FTB echo the language of Section 17014 to define residency: “[t]he term resident, as defined in the law, includes (1) every individual who is in the State for other than a temporary or transitory purpose, and (2) every individual who is domiciled in the State who is outside the State for a temporary or transitory purpose.”15 Again, note the absence of any statutory bright-line rule or specified metric for determining residency. The closest to a bright-line rule in the entire body of California residency law, by statute or regulation, is a rebuttable presumption of California residency when an individual is present within California for more than nine months of a taxable year.16 However, no presumption of nonresidency arises when a taxpayer spends less than nine months of the year in California.17 Indeed, FTB’s regulation states, It does not follow, however, that a person is not a resident simply because he does not spend nine months of a particular taxable year in this State. On the contrary, a person may be a resident even though not in the State during any portion of the year.”18

Unfortunately, there is a lack of judicial case law addressing the general question of California residency or interpreting either Section 17014 (or its counterpart in FTB’s regulations). In 2004, for the first time in decades, a California Court of Appeal issued a published decision interpreting Section 17014 in Noble v. Franchise Tax Board.19 Prior to Noble, the most significant and most cited judicial residency case was the 1964 Court of Appeal decision in Whittell v. Franchise Tax Board.20 There have been no published Courts of Appeal residency decisions subsequent to Noble in 2004. As such, both cases carry significant weight in the history of California residency law.

The definition of residency under Section 17014 is closely linked to the concept of domicile. The Court of Appeal in Whittell defined “domicile” as the “one location with which for legal purposes a person is considered to have the most settled and permanent connection, the place where he intends to remain and to which, whenever he is absent, he has the intention of returning.”21 Similarly, FTB Regulation 17014(c) defines domicile as “the place where an individual has his true, fixed, permanent home and principal establishment, and to which place he has whenever he is absent, the intention of returning,” as well as “the place where an individual has fixed his habitation and has permanent residence without any present intention of permanently removing therefrom.”

“Residence” and “domicile” are nonetheless separate and distinct concepts for California tax purposes. “Domicile” denotes the one location with which a person has the most settled and permanent connections and where the person intends to remain. “Residence” denotes any factual place of abode of some permanency, that is, “more than a mere temporary sojourn.”22 A taxpayer may have several residences simultaneously, but a taxpayer will have only one domicile at any given time.23 Once acquired, a domicile is presumed to continue until it is shown to have changed.24

In order to change one’s domicile, the California State Board of Equalization (“SBE”)25 has required a showing that a taxpayer: (1) left the state without any intention of returning; and (2) was located elsewhere with the intention of remaining there indefinitely.26 In determining the taxpayer’s intent, “the acts and declarations of the party must be taken into consideration.”27 In Noble, the court confirmed the significance of the taxpayer’s physical acts in determining intent, holding: “To the extent residence and domicile depend upon intent, ‘that intention is to be gathered from one’s acts.’”28 The Noble court further clarified the two indispensable elements to accomplish a change of domicile: (1) actual residence in the new locality; and (2) the intent to remain there for an indefinite period of time.29 Consistent with Noble, the SBE cautions that the determination of residency “cannot be based solely on the individual’s subjective intent, but must instead be based on objective facts.”30

When domicile is an issue in a residency case – the typical scenario – domicile is always decided first.31 For California domiciliaries, the focus of the inquiry is upon whether the taxpayer is absent from California for a temporary or transitory purpose. If so, the taxpayer is a California resident.32 For non-California domiciliaries, the inquiry is whether the taxpayer is in California for other than a temporary or transitory purpose.33 Whether a purpose is temporary or transitory in character “will depend to a large extent upon the facts and circumstances of each particular case.”34 The analysis under California tax law should be the same regardless of the taxpayer’s state of domicile. As discussed above, the case law on California residency is scarce.35 Accordingly, much of the body of law regarding the determination of California residency is found at the administrative level.

One might discern two independent tests from administrative and judicial decisions to address the residency question. The first test, and the most widely known and used, is commonly referred to as the “Closest Connections Test.”36 This test compares the taxpayer’s contacts with his or her new place of abode to the contacts with his or her former place of abode. A number of factors traditionally have been included in the “closest connections” analysis, and as usual, are considered with the facts and circumstances peculiar to each case. Neither FTB’s publications nor FTB’s regulations attempt or purport to provide a complete list of such factors.37 To its credit, in 2003, the SBE, in Appeals of Stephen D. Bragg, recognized the complexity of the residency question in light of the diverse factual contexts in which the issue could arise.38 Confronted with the near impossibility of creating a universal test, the SBE set forth a list of 19 items, now commonly referred to as the Bragg factors, to help determine a taxpayer’s closest connections:

  1. The location of all of the taxpayer’s residential real property and the approximate sizes and values of each of the residences; 
  2. The state wherein the taxpayer’s spouse and children reside;
  3. The state wherein the taxpayer’s children attend school; 
  4. The state wherein the taxpayer claims the homeowner’s property tax exemption on a residence;
  5. The taxpayer’s telephone records (i.e.1, the origination point of taxpayer’s telephone calls);
  6. The number of days the taxpayer spends in California versus the number of days the taxpayer spends in other states and the general purpose of such days (i.e., vacation, business, etc.);
  7. The location where the taxpayer files his tax returns, both federal and state, and the state of residence claimed by the taxpayer on such returns; 
  8. The location of the taxpayer’s bank and savings accounts;
  9. The origination point of the taxpayer’s checking account transactions and credit card transactions; 
  10. The state wherein the taxpayer maintains memberships in social, religious and professional organizations;
  11. The state wherein the taxpayer registers his automobiles; 
  12. The state wherein the taxpayer maintains a driver’s license; 
  13. The state wherein the taxpayer maintains voter registration and the taxpayer’s voting participation history;
  14. The state wherein the taxpayer obtains professional services, such as doctors, dentists, accountants and attorneys; 
  15. The state wherein the taxpayer is employed; 
  16. The state wherein the taxpayer maintains or owns business interests; 
  17. The state wherein the taxpayer holds a professional license or licenses;
  18. The state wherein the taxpayer owns investment real property; and 
  19. The indications in affidavits from various individuals discussing the taxpayer’s residency. 39

Although not codified in the statutory scheme of residency or set forth in any judicial case law, the Bragg factors are utilized by the SBE as a benchmark for determining residency.40 However, lest one think Bragg provides certainty, the SBE freely admits this 19-factor list is not “exhaustive” or exclusive and that these factors “serve merely as a guide” in determining residency.41 The focus of the Bragg examination is “to determine where an individual is present for other than a temporary or transitory purpose” and satisfaction of a majority or a significant number of the factors is not necessarily dispositive.42 According to Bragg, the weight given to any particular factor also depends on the totality of the circumstances.43

The second approach to residency is referred to as the “Identifiable Purpose Test.” In order to determine whether a taxpayer is in or out of California for other than a temporary or transitory purpose, the SBE examines if the taxpayer is in a location for an identifiable purpose and the length of time necessary to fulfill that purpose. “[W]here an individual expects to be out of California for an indefinite period of time which is expected to last more than two years, such individual will be expected to be out of the state for an indefinite period of substantial duration” and, therefore, is no longer considered a resident of California.44 While Section 17014 makes no distinction with respect to employment, the SBE has suggested that when a Californian is employed outside California, his absence will be considered for other than a temporary or transitory purpose if the position is expected to last a long, permanent or indefinite time.45

The SBE’s attempts to clarify California residency standards with an “Identifiable Purpose Test” or a “Closest Connections Test” are admirable. However, a dearth of formal guidance or direction in the form of agency materials contributes to the difficulties facing taxpayers confronted with FTB residency audits or who are attempting to plan their arrival into or departure from California for personal income tax purposes. As discussed above, the California Courts of Appeal have issued only two published California residency decisions since 1964.46 Even with the Bragg factors, a taxpayer’s ability to grasp the details of California residency is further limited because of insufficient written precedential SBE decisions interpreting California residency law.

Without written precedential decisions from the SBE to offer further and consistent insight as to its interpretation of the Bragg factors in varying factual contexts, the factors provide only limited guidance. That is because not only are the Bragg factors nonexclusive, they are too easily and often conditioned on subjective interpretations. Some factors now seem to be anachronisms. For example, one Bragg factor looks to the “location” of the taxpayer’s bank and savings accounts. In today’s modern society of interstate banking, where ATMs and bank branches are available on nearly every street corner and accessible from almost everywhere, is it necessary or even logical for a taxpayer to need to physically close an account at one “location” and open another in a new location? Some factors are overly subjective. For example, one Bragg factor addresses the number of days the taxpayer “spends” in California versus the number of days the taxpayer “spends” in other states. Further, all factors present issues involving comparative value. For example, should a taxpayer’s state of employment carry the same weight in the Bragg analysis as the state in which a vehicle is registered? Should the location of a taxpayer’s residence carry the same weight as where his doctors, dentists, accountants and attorneys are located? Such questions abound.

Thus, while at first glance appearing objective, Bragg’s application in practice is a subjective calculation in a sea of ambiguity. Further written and precedential guidance from the SBE (or, ideally, from the courts) in terms of explaining and weighting the Bragg factors would prove extremely beneficial – both to taxpayers and the FTB. Unfortunately, the number of published opinions issued by the SBE has plummeted in recent years. During the 1980s, the SBE published an average of 161.5 formal opinions each year, while during the period 2000 to 2010, the SBE only published an average of 3.2 formal opinions each year.47

To make matters worse, there is a plethora of procedural issues accompanying a typical FTB residency audit. For example, tax cases are to be decided, year by year, on their own merits and their own facts, without regard to other years.48 The implication is that a determination of residency (or nonresidency) for any given year does not and may not preclude a similar FTB inquiry for the succeeding (or preceding) year. Further, unlike judicial proceedings, formal rules of evidence do not govern FTB residency audits, leading to the legal equivalency of food fights over whose evidence is more convincing. FTB’s regulation simply provides that the type and amount of evidence necessary to rebut or overcome a presumption of California residency and to establish nonresidency “cannot be specified by a general regulation, but will depend largely on the circumstances of each particular case.”49

Declarations, affidavits or testimony of a taxpayer, his or her friends, employers or business associates, however, are most certainly relevant and may overcome the presumption to establish nonresidency and must be a part of any well-developed residency case.50

Clearly, the California residency determination is a complex inquiry, and without written formal guidance or statutory or objective tests, it is uncertain how much is “enough” to establish residency or nonresidency under the existing body of law. Query, how can a taxpayer be expected to navigate a California residency case with certainty in light of such a vague framework?

Against this backdrop of ambiguity, it should come as no surprise that some states have statutorily adopted more objective tests to determine residency for personal income tax purposes. For example, in New York, a provision commonly known as the “183 Day Rule” defines a statutory resident as an individual who is not domiciled in the state, but: (1) maintains a permanent place of abode in New York, and (2) spends in the aggregate more than 183 days of the taxable year in New York, carving out an exception for active military personnel.51 Recall also that the Section of Taxation of the California State Bar proposed in a preliminary report, over 20 years ago, that California should provide an objective standard based on the taxpayer’s presence in California for a minimum number of days.52 It may not be necessary for California to adopt such a stringent and singleminded objective test for residency, but take note of the added ease by which a properly constructed bright-line rule could be administered, as well as the added guidance and certainty it would provide to taxpayers and the FTB. In California, the complexity and nuances of residency law discussed above may have significant consequences for a taxpayer who faces a residency audit or who may simply have questions about his or her residency status. With FTB auditors aggressively pursuing residency audits for the possibility of reaping rewards of substantial revenue for the state, a taxpayer may face an uphill battle without clearer guidance from judicial and statutory authorities. Vague and ambiguous administrative and judicial tests are available, yet as discussed here, such analyses are subject to factual debates and interpretation. A similar predicament follows those taxpayers who are seeking to move into or depart from California for personal income tax purposes. With careful due diligence and expert analysis, however, it is possible for a taxpayer to successfully navigate this seemingly unmanageable body of California residency law.