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A Guide To Successful (Tax-Free) Snowbirding

A GUIDE TO SUCCESSFUL (TAX-FREE) SNOWBIRDING

by
Christopher Manes

It doesn't get much better. After escaping the snows of Michigan or New York or Alberta, you're lounging by a Palm Springs pool, a perfect azure sky above, and only the faint rustle of wind in the palm fronds disturbs an afternoon calm as profound as the desert heat. A snowbird has landed.

Then in the mailbox comes a letter from the Franchise Tax Board, California's taxing authority, saying something about unreported income and filing a California tax return and demanding all kinds of financial information. It's enough to take make the snowdrifts and low tax rates of South Dakota look heavenly.

An increasing number of part-time residence in the Coachella Valley have received this rude awakening. And if handled improperly, what appears to be just an irritating government form can result in an expensive audit, and a huge tax liability. But a few simple rules about how to use local services (such as banks and brokers) can help snow birds avoid getting entangled in California's tax system and preserve the tranquillity that makes the desert the place they want to visit.

Here is what's going on. Over the past few years, the Franchise Tax Board (FTB) has been sending out a new form to any nonresident who didn't file a California income tax return, but had some California source income or paid mortgage interest on local real estate. Usually this involves small amounts of interest from a local bank account, dividends from stock held in a local brokerage account, or mortgage payments on a vacation home. These are financial matters that most snow birds are probably not even thinking about after getting away from it all. But be assured, the FTB is.

The income or interest payments appear on the FTB's radar scope when the bank, broker, or mortgage company sends the information to the IRS (as a 1099 or 1098 form), as they are required to. The FTB gets a hold of this information and cross references it with their records to see if the recipient of the income or interest deduction filed a state income tax return. If the taxpayer didn't, bingo, the FTB sends out a form called "Request for Tax Return." The form asks for some information about financial and residency status. The taxpayer is supposed to sign the form under penalty of perjury and return it to the FTB. (By the way, you can get a full explanation of the form in all its variations at the FTB's website: www.ftb.ca.gov. Just search for form 4600A)

The form spells trouble. In most cases, the FTB isn't interested in whether or not the person filed a return. The real aim is in many cases -- especially for folk who live part-time in the desert, which is ground zero for residency tax disputes -- to get financial information from snow birds; specifically, the amount of taxable income from out-of-state sources. Why? If a snow bird has significant non-California income, the FTB refers the file to a special residency unit in Sacramento to determine if a residency audit is in order. The purpose of the audit is to claim that a snow bird is really a California resident, and hence subject to California tax on all income, from whatever source, including out-of-sate income. Since California has a higher income tax rate than virtually every other state (not to mention many a medieval feudal kingdom), this is bad news.

So what's a snow bird to do?

First, know the rules for keeping your status as a part-time resident. Snow birds have a presumption of non residence if they follow certain guidelines. The total amount of time you spend in California during the year has to be less than 6 months. You can own a vacation home (but it should probably be smaller or of less value than your main out-of-state residence). You're allowed to have a small local bank account to handle your financial needs related to your stay. Your can have a membership in a local country club. Limit your California contacts to these, and you will probably avoid a lengthy audit, form or no form.

This doesn't mean that those who have more contacts are doomed to California residency. It just means you may have a fight on your hands if the FTB gets you in its gun sights and goes forward with a residency audit.

Second, lower your local profile. The FTB doesn't know you're here unless you or the financial institutions you deal with let them know. For instance, any interest generated on your local bank account gets reported to the FTB as a form 1099. You can fly under the FTB's radar by opening a non-interest bearing account. It may cost you a few bucks in interest, but it may avoid an expensive residency audit. Given the ease with which you can access funds across state lines nowadays, it may not even be necessary for you to open a local account.

Similarly, a lot of part-time residents like to have local brokerage accounts. It seems free time and sunshine go together with playing the market. The problem arises when stock in a local account issues dividends, which get reported to the FTB. You should consult your broker concerning ways to avoid this. Again, because of the ease of trading stock nowadays, the broker may be able to hold the stock for you in an out-of-state affiliate of his office, or you can forget about brokers and trade online (you didn't hear that from me). At the very least, have all brokerage statements sent to your out-of state address. The same is true for bills from all local professional services.

Sometimes you can't avoid California contact beyond what the rules allow for keeping the nonresident presumption. Some snow birds rent their vacations home when out of state. Some buy real estate in addition to a vacation home, or make other in-state investments. Some need to consult local CPA or other professionals to handle matters that arise in state. You got to do what you got to do. Just be aware that the more contacts you have with California, the more likely the FTB will become aware of your presence and initiate a residency audit. This is particularly true for those with high out-of-state income.

And by the way, sometime the FTB's form is really about filing a tax return. If you make income from a California source, such as rentals or a partnership, then you're obliged to file a nonresident return. The bad part the nonresident return must include a copy of your federal tax returns, which alerts the FTB to your total income, possibly triggering a residency audit.

If you do get the notorious FTB form, treat it like kryptonite. Put a wooden stake through it, handle it only with rubber gloves, wear a gas mask while reading it. Which is to say do not fill it out by yourself. There are "magic words" that need to be used in responding to the form to may reduce the chances of a residency audit. You should consult an attorney experienced in residency tax issues before filling it out and returning it. If you answer the form correctly, you get a free "get out of jail" card, meaning the FTB will send a note saying it accepts your explanation of why you haven't filed a tax return. If you answer the form wrong, you get a "go directly to jail" card, meaning an expensive residency audit. Finally, if after all your efforts to enjoy your vacation without getting involved in California's byzantine tax system, you do get notice of a residency audit, consult a tax attorney immediately. Dealing with the FTB over residency issues without legal representation is financial suicide. Then your halcyon poolside vacation will be over for good, because according to the FTB you'll be a full-time, fully taxable California resident.

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