California Source Income

California Source Income Learning Objective Be able to define California source income California residents are subject to California income tax on all income; the source is not an issue. Nonresidents of California, however, are only taxed on their California source income. Therefore, determining what is California source income is important to nonresident taxpayers. Nonresident taxpayers with California source income file a California Form 540NR and associated schedules. Form 540NR is also used for part-year residents. Part-year resident taxation is discussed later in this chapter. The California tax treatment of various specific types of income is illustrated below. Wages and salaries have a source-a location where the services are performed. The location of the employer, where the payment is issued, or the taxpayer’s location where he or she received payment affects the source of wage and salary income. A resident must include all wages and salaries earned, regardless of where the services were performed. A nonresident must include the income for services performed in California and file a Schedule CA (540NR), reporting the California source income. In general, California (and most other states) uses a “games played” method of calculating nonresident California source income for professional athletes for all sports except professional football. In the past, the FTB has used a “days worked” formula for football, which would include practice days and other days. Example Anthony plays basketball for the Denver Nuggets and is a Colorado resident. His salary for playing basketball is $4,000,000, or $48,780 per game ($4,000,000/82 games). This year, the Nuggets play eight games in California. As a result of these games, Anthony has to report $390,240 ($48,780 x 8) as taxable California source income on his Schedule CA (540NR). In addition, for every game he plays out of Colorado, he would have to report $48,870 in income to the state and, in some cases, the city (e.g., New York) tax where the game is played. Business income or loss. For a trade or business owned by a nonresident that operates both within and outside California, only income from the part conducted in California is California source income. If, however, there is any business relationship between the parts within and outside California (flow of goods, etc.), the portion of income (or loss) taxable by California is normally determined by using the apportionment formula for corporations engaged in multi-state businesses. This topic is covered in corporate tax texts and courses. Example Christel, an Oregon resident, is a sole proprietor in California. Because the business is located in California, it produces California source income and Christel is subject to nonresident California taxation on the income from the sole proprietorship. Interest and dividends are deemed to have as a source the state in which the taxpayer who receives them is a resident. Example Bruce is a resident of Nebraska and has interest from a California bank account of $4,000. Since Bruce is a Nebraskan, the interest is considered to have a source in Nebraska, so the interest is not taxable by California. Also, Bruce has dividends of $800 from a California corporation. Again, because he is Nebraska resident, the dividends are deemed to be Nebraska source income and are not taxable by California. However, there is an exception to the general interest and dividends rule. Interest and dividends are deemed to have a source in California if the account or security is used in a trade or business or pledged as security for a loan, the proceeds of which are used in a trade or business in California. Example Jerry, a Nevada resident, is a sole proprietor in California. The business has $4,500 in interest income in a California bank account used for the business. Because the business is located in California, it produces California source income. Therefore, the $4,500 is considered California source interest income to Jerry. Sale of California real estate gains are taxable both to residents and to nonresidents. Example Wes is a resident of Oregon. He sold undeveloped real estate located in California at a gain of $45,000. Because the property is in California, the $45,000 gain is California source income. As a nonresident, Wes must include this California source income on his California Schedule CA (540NR). Example Loretta, a resident of Nevada, owns residential rental property located in California. Her rental property has always shown a loss. As a result, Loretta has never filed a California return. She sells the California rental property for a $90,000 gain. Because the property is located in California, the gain on the sale is taxable by California. Since owning rental real property is classified as a passive activity, the sale causes the release of suspended losses incurred in income years beginning on or after January 1, 1987. The suspended losses may be used to offset any gain from the sale or income from other passive activities. See Form 3801, California Passive Activity Loss Limitations, and instructions for more information. Sale of stocks and bonds gains and losses has as a source the state where the taxpayer is a resident at the time of the sale. If, however, buying and selling stocks and bonds is the taxpayer’s trade or business and the trade or business is located in California, he or she may have California source income. Example Ed is a resident of Arizona and sells stock of a California corporation at a $20,000 gain. Because he is an Arizona resident, the gain has an Arizona source and is not taxable by California. Installment sales payments received by a nonresident on the sale of California property are taxable by California. The interest earned by the nonresident on the installment note, however, is not taxable by California. Example Steve is a Maine resident who sold California real estate and received an installment note on the sale. This year he receives a payment of $5,000, of which $2,000 is return of basis, $2,200 is gain and $800 is interest. The $2,200 is California source gain and would be taxable in California. Since Steve is a Maine resident, the $800 interest would be Maine source income and not taxable in California. The $2,000 return of basis would not be taxable at all. Covenant not to compete. The source of payments received from a covenant not to compete is the state where the competition would have occurred if there were no covenant. Hence, if the competition would have occurred in California, then payments received by a California nonresident are taxable by California. Partnership income (or loss). Partners who change residency status during their own or the partnership’s tax year must prorate items of income, deduction and credit between residency and nonresidency periods to determine the amount to be reported as income taxable by California. In addition, partnership income for the period of nonresidency must be reported as California income if it is derived from sources, such as a business or rental property, within the state. If the taxpayer has an actual breakdown of the amounts earned by the partnership during the residency and nonresidency periods, that breakdown should be used rather than a proration of income. Income and other pass through amounts from S Corporations and certain trusts are treated in the same manner as partnership income and pass through amounts discussed above. Example Kurt is a Maine resident and a partner in a Maine partnership that owns California real estate. The partnership sells the California real estate at a $50,000 gain. Since the real estate was located in California, the gain is California source gain. As a nonresident, Kurt must include his portion of the gain on Schedule CA (540NR). Example John was a resident of Vermont from January 1 to June 30. On July 1 he became a California resident. He is a partner in a Vermont partnership with a tax year ending December 31. The partnership does business solely in Vermont. Fifty percent of Jason’s Vermont partnership income is taxable by California. He should prorate the Vermont partnership income for the period he was a nonresident of California, assuming he has not been provided an actual accounting by the partnership. Reimbursement of moving expenses. The source of reimbursed moving expenses is the state to which a taxpayers moves, regardless of residency at the time the reimbursement is made. Airline employees. The wages of nonresident flight personnel (e.g., pilots; flight attendants) are not taxable by California unless more than fifty percent of the individual’s scheduled flight time is in or over California. If more than fifty percent of the scheduled flight time is in or over California, wages are apportioned to California by the ratio of scheduled flight time in California to the total scheduled flight time. Flight personnel who are California residents are taxed on all wages received regardless of where the flights were. Interstate rail and motor carrier employees. Income earned in the performance of regularly assigned duties in more than one state is deemed to be sourced in the state of residence. Merchant seamen who are in California only because this state is a port of call and who maintains no other contact or connections with this state is a nonresident. A seaman who maintains close connections with California, however, remains a California resident while at sea. Under such circumstances, the seaman’s absence is for a temporary or transitory purpose. Example Captain Nimitz is a merchant seaman and spends eight to ten months a year aboard a ship outside California. He is single and has no dependents. Nimitz spends fifty percent of his off-duty time (ten percent of his total time) in California. He returns to California only when his employment brings him there. When visiting California, he stays in hotels. The Captain has a California bank account in joint tenancy with his father. He has a California driver’s license, but no car and he owns no real property in California. Captain Nimitz is a nonresident of California since his ties to California are not substantial and his time in California is temporary or transitory. Residents of foreign countries who reside and perform services in California and/or receives income from California sources, he or she may have a California income tax filing requirement even if they do not have a Federal filing requirement. For instance, a tax treaty between the United States and another country may not affect the taxation of California income. Example Chan, a resident of China, is a visiting professor at Stanford University in California and receives wages of $90,000 for doing research. For Federal income tax purposes, the wages are not income due to the tax treaty between the United States and China. Although the wages may be exempt from income for Federal income tax purposes, the wages will be taxable by California. The tax treaty specifically states that the taxes covered by the tax treaty are Federal income taxes imposed by the Internal Revenue Code. Tax treaties between the United States and other countries which expressly limit their application to Federal income taxes do not apply to California. Nonresidents are taxed by California on wages for services performed in California. Since Chan received wages for services performed in California, the $90,000 in wages is taxable by California. Questions and Problems A California resident would not be taxed on which of the following income? Interest income from a New York bank Dividends from a Texas corporation Rental income from property in England Salary from a 30-day work assignment in Canada All of the above would be taxable Ralph earns a salary of $5,000 per month. On June 1, he is transferred from Modesto, California to Tucson, Arizona for a new, permanent job assignment. How much of Ralph’s salary is taxable for California purposes? $0 $25,000 $35,000 $60,000 Some other amount For a nonresident of California, which of the following would be taxed by California? Interest on a California credit union savings account Dividends of a California corporation Gain on the sale of real estate in California Interest on US Series II Saving Bonds None or all of the above Berta, a resident of Nevada, sold California real estate and received an installment note on the sale. This year she receives a payment of $12,000, of which $7,000 is return of basis, $3,800 is gain and $1,200 is interest. What is California taxable income from this note? $1,200 $3,800 $7,000 $10,800 Some other amount For a nonresident of California, which would not be taxed by California? $100,000 prize winnings by a professional golfer from a golf tournament in California Profits from a sole proprietorship located in California Gain from the sale of California real estate A partner’s share of partnership gain on the sale of California real estate All of the above would be California taxable What is the percentage of flight time that requires an airline employee to be subject to California individual income taxation? 20% 30% 50% 75% Some other percentage A nonresident merchant seaman spends 10% of his total time in California. He has a California driver’s license and bank account. He earns $80,000 salary in the current year and has $1,000 interest income on his California bank account. What is his California source taxable income?. $0 $1,000 $80,000 $81,000 Some other amount Lionel plays baseball for the Atlanta Braves and is a resident of Georgia. His salary for playing baseball is $1,539,000 per year and there are 162 games during the baseball season. This year, the Braves play 16 games in California. What is Lionel’s California taxable income for the year? $_______________ Vic, a Nevada resident, has the following income items for the current year. Profit from sole proprietorship in Nevada$157,000 Net rental income from a California apartment building35,000 Interest income on a CD at an Arizona bank13,000 Gain on sale of California land200,000 Dividends on stock of a California corporation4,000 Gain recognized on California installment note38,000 Interest on California installment note4,700 What is Vic’s California income or loss for the year? $_______________ Spencer, a Georgia resident, is a partner in the Atlanta office of Kiefer, Diamond and Pollard an international accounting firm. The firm has 10 offices in California. Spencer’s share of the firm’s income for the year is $400,000 of which $26,000 was earned by the partnership in California. In addition, he had a $50,000 gain on California real estate he held as an investment. Spencer also owned Sacramento city bonds which paid him interest of $10,000. What is Spencer’s California income for the year? $_______________ Bella was a resident of Missouri from January 1 to September 30. On October 1 she became a California resident. She is a partner in an accounting firm that has 8 offices in California and 100% California source income. The partnership has a tax year ending December 31. For the current year, Bella’s share of partnership income was $360,000. Of the $360,000, $270,000 was earned by Bella prior to becoming a California resident. What is her California source income? $_______________ Captain Keller flies for Southwest Airlines and is a resident of Phoenix, Arizona. This year he was scheduled to have sixty percent of his total flight time over California. Herb’s wages for the year were $154,000 of which $92,400 was for flight time over California. What is Herb’s California source income? $_______________ Casey Jones is a railroad engineer for the Union Pacific Railroad and a resident if Reno, Nevada. He spends eighty percent of his time operating trains into and out of California. Casey’s wages for the year are $60,000. What is Casey’s California source income? $_______________ Chou is a visiting professor at San Diego State University. He is paid $55,000 for the year. The $55,000 is exempt from Federal taxation because of a US — China tax treaty. What is Chou’s California source income? $_______________