International Tax Planning – Don’t Forget California
Around the world, the IRS is very well known and international taxpayers sometimes even know a few of the basic principles of U.S. federal tax. However, possible state taxation issues, especially in California, are frequently overlooked and many times not known at all. While there are many items to consider, the point is best illustrated through two examples – residency status and tax treaties.
California does not conform to U.S. tax treaties. For many foreigners this can come as a shock that the states would have the independence to choose not to follow a federal treaty. This can cause problems when planning using an income tax treaty. It can be a common situation where a taxpayer utilizes a treaty to avoid U.S. taxation, but without such provisions for state tax, is still subject to California taxation. As you can imagine, it can be not only surprising but very frustrating for a taxpayer that they have successfully avoided the dreaded IRS but that is not good enough for California.
Next, the same as the IRS, California taxes worldwide income. This makes it very important to determine who is a California resident for tax purposes. The IRS rules are somewhat straightforward – U.S. citizen, U.S. green card holder, or substantial presence subject to some exceptions. With California it is not so simple. California residency is based on a subjective test which looks at many factors to try to determine if the taxpayer is in California for a temporary or permanent purpose. This can lead to some unexpected situations such as a service member being deployed from California then having California considered the permanent home even after an extended absence, to a taxpayer spending a substantial time in California not considered a resident when they are in the state for a clearly temporary purpose.
Although California is one of the more aggressive states when it comes to taxation, all states have unique laws and rules that need to be considered for international tax planning. With California, at a maximum individual tax rate of 13.3% and a corporate rate of 8.84%, these are not insignificant considerations.