From Russ Fox, EA, of Clayton Financial and Tax of Las Vegas, NV. All of the items below are for information only and are not meant as tax advice. Please consult your own tax advisor to see how each item impacts your own situation.
As we continue with our Bozo Tax Tips–things you absolutely, positively shouldn’t do but somewhere someone will try anyway–it’s time for an old favorite. Given the business and regulatory climate in California, lots of businesses are trying to escape taxes by becoming a Nevada business entity. While I’m focusing on California and Nevada, the principle applies to any pair of states.
Nevada is doing everything it can to draw businesses from California. Frankly, California is doing a lot to draw businesses away from the Bronze Golden State. But just like last year you need to beware if you’re going to incorporate in Nevada.
If the corporation operates in California it will need to file a California tax return. Period. It doesn’t matter if the corporation is a California corporation, a Delaware corporation, or a Nevada corporation.
Now, if you’re planning on moving to Nevada forming a business entity in the Silver State can be a very good idea (as I know). But thinking you’re going to avoid California taxes just because you’re a Nevada entity is, well, bozo.
Households receiving the California Earned Income Tax Credit for 2020 (typically making $30,000 or less)
Taxpayers with Individual Tax Identification Numbers (ITINs) who didn’t receive federal stimulus checks
Households with Individual Tax Identification Numbers and income below $75,000
ITIN taxpayers who also qualify for the California Earned Income Tax Credit will receive a total of $1,200.
The payments will be going out after taxpayers file their 2020 tax returns. One client asked me, “Is that payment going to be taxable income on my federal tax return?” The answer is clearly yes.
Any accession to wealth is taxable unless exempted by Congress. State grants are taxable income. That $600 payments will be taxable income on taxpayers’ 2021 federal tax returns, and impacted taxpayers should receive Form 1099-MISC forms from the state of California. However, these payments will not be taxable income on taxpayers’ California tax returns–California has said these are nontaxable grants, and a state has the right to exclude that income from its taxation system.
Every year the Tax Foundation publishes its State Business Tax Climate Index. As they state, they look at how each state taxes, not on the how much. Per usual, the names at the top and the bottom haven’t changed much.
The top ten states are:
Wyoming
South Dakota
Alaska
Florida
Montana
New Hampshire
Nevada
Utah
Indiana
North Carolina
The bottom ten states:
41. Alabama 42. Louisiana 43. Vermont 44. Maryland 45. Arkansas 46. Minnesota 47. Connecticut 48. New York 49. California 50. New Jersey
This is what the Tax Foundation states about the bottom ten:
The states in the bottom 10 tend to have a number of afflictions in common: complex, nonneutral taxes with comparatively high rates. New Jersey, for example, is hampered by some of the highest property tax burdens in the country, has the second highest-rate corporate and individual income taxes in the country and a particularly aggressive treatment of international income, levies an inheritance tax, and maintains some of the nation’s worst-structured individual income taxes.
I deliberately waited until election day to make this post. Why? Because some states have ballot measures today that will impact their rankings. For example, Californians will vote on whether to have a “split-roll” property tax, where business properties would be assessed annually based on current value rather than only when a property is sold. California today ranks 14th in property tax; if this measure passes, the ranking will fall dramatically. Illinois votes today on changing their personal income tax from a flat-rate tax to a progressive system.
Nevada, my state, ranks seventh. It’s not that every tax is great in Nevada (we have a poor sales tax system and unemployment insurance taxes); however, we lack income taxes. (We do have a gross receipts tax, called the Commerce Tax, that large businesses must pay.)
Some states, like Utah and Indiana, have most taxes but they administer them neutrally, simply, and with relatively low rates. Contrast that with California, which has an awful income tax system, high rates, and ridiculous regulations.
Below is a map (from the Tax Foundation) of the United States with the rankings of each state. If you’re considering locating a business, it makes sense to look at taxes (and other factors, too); the Tax Foundation’s annual guide is a tremendous resource.
For both disasters, tax deadlines are extended that began on August 10th for the derecho and August 14th for the wildfires until December 15th. This impacts 2019 personal tax returns on extension, business returns on extension, payroll tax filings, and estimated tax payments. California’s Franchise Tax Board automatically extends deadlines for federal disasters, so those impacted have identical extensions for California taxes. I assume the Iowa Department of Revenue will similarly extend Iowa deadlines.
California, like many states, has financial difficulties because of the Covid pandemic. So is the legislature looking at cutting spending? A little. How about raising taxes? Definitely, especially on the rich.
California’s top marginal tax rate today is 13.3% (on those earning $1 million or more). Proposed legislation would increase the tax rate to 14.3% on those earning more than $1 million, to 16.3% on those earning more than $2 million, and to a whopping 16.8% on those earning more than $5 million.
Today, California gets 40% of its revenues from the top 0.5% of taxpayers. But something lost by the California legislature is what happened after the last tax increase (to 13.3%). As Josuha Rauh notes,
The problem is that high earners do not simply sit there and take it when the state goes after their income.
In a detailed study of the 2012 California ballot measure that raised the top state rate to 13.3 percent, Ryan Shyu and I found that just two years later, the state was only collecting 40 cents of every dollar that it had hoped to raise from the tax increase.
The reason?
High income taxpayers affected by the 2012 tax increase suddenly began to flee the state at higher rates, especially to zero tax states like Nevada, Texas, and Florida.
This is an obvious corollary to the Laffer Curve. Economist Arthur Laffer noted that at 0%, no taxes are collected and that at 100%, no taxes would be collected. So there must be a curve that describes tax collection by tax rate.
The unspoken issue for California is, “Will this increase drive the top 0.5% out of the Golden State?” Mr. Rauh, a Senior Fellow at the Hoover Institution and a Professor of Finance at Stanford, clearly believes the answer is yes. When this measure passes (and given the makeup of the legislature, it will pass), the question is not will top-earners leave, but how many will leave. Alan Greenspan famously said, “Whatever you tax, you get less of.” California is conducting an experiment, and we will find out the results in a year or two. I believe that if you’re a realtor specializing in high-end properties in Nevada, Texas, Florida, or Arizona, you’re about to get more business.
Nearly nine years ago, we moved from Irvine, California to Las Vegas. The home in Irvine was sold, a home was purchased in Las Vegas, and the belongings went from the Golden State to the Silver State. Cars were re-registered, doctors changed, and no one would say that we didn’t become Las Vegas residents.
But some people like to have it both ways. Nevada’s income tax rate is a very round number (0%), while California’s maximum income tax rate is a ridiculous (in my opinion) 13.3%. That certainly could drive individuals to move in name only. California’s Franchise Tax Board (FTB) realizes that, and they (along with New York State) lead the country in residency audits.
If you really do relocate, a residency audit is a minor annoyance. But let’s say you reside in Silicon Valley, and you buy a home in Reno but keep your home in Los Altos. Did you move? Or did you just move in name?
The Bozo strategy is the latter: moving in name only. I’ll just have that little home in Reno, spend the ski season in Nevada but really continue to live in Los Altos.
In a residency audit, the FTB will look at where you’re actually spending time, where you’re spending money (if eight months of the year you’re patronizing businesses in Silicon Valley, it doesn’t look like you really moved), and a variety of other factors. ( The FTB has an excellent Residency and Sourcing Manual that explains California laws on the subject.)
Given the current pandemic, state revenues are being squeezed. The one government agency where increasing employees increases revenues is the tax agency (especially employees in audit). While I expect to see states cut employees, I’ll be surprised to see anything but minor cuts in tax agencies. We’re also likely to see an increase in audits looking at telecommuting issues. In any case, if you move in name only you’re painting a target on your back for a residency audit.
As we continue with our Bozo Tax Tips–things you absolutely,
positively shouldn’t do but somewhere someone will try anyway–it’s time
for an old favorite. Given the business and regulatory climate in
California, lots of businesses are trying to escape taxes by becoming a
Nevada business entity. While I’m focusing on California and Nevada, the
principle applies to any pair of states.
Nevada is doing everything it can to draw businesses from California.
Frankly, California is doing a lot to draw businesses away from the Bronze Golden State. But just like last year you need to beware if you’re going to incorporate in Nevada.
If the corporation operates in California it will need to file a
California tax return. Period. It doesn’t matter if the corporation is a
California corporation, a Delaware corporation, or a Nevada
corporation.
Now, if you’re planning on moving to Nevada forming a business entity
in the Silver State can be a very good idea (as I know). But thinking
you’re going to avoid California taxes just because you’re a Nevada
entity is, well, bozo.
The bottom ten has a couple of surprises (for me):
41. Alaska
42. Hawaii
43. Oregon
44. Washington
45. Massachusetts
46. Connecticut
47. New Jersey
48. Illinois
49. New York
50. California
That Texas is at the top isn’t a surprise. “Employers continue to be attracted by the state’s lack of an individual income tax, low business taxes, friendly regulators, a reasonable cost of living, and diverse and growing labor force.” [emphasis added]. Contrast that with California: ” Business owners—especially companies that make things— continue to abandon the state as fast as they can.”
I was surprised by Alaska and Washington. Neither state has a state income tax. Alaska, of course, is hard to get to, and the cost of living is a big issue. In Washington state, it appears that the cost of living and regulations lower the ranking.
I wanted to emphasize the impact of regulations. Regulations are hidden costs for businesses. It’s not that all regulations are bad (that’s absolutely not the case); rather, over-regulations cost business money. Consider a widget manufacturer in Los Angeles. He’ll face California’s burdensome regulations at the state, county, city, and regional level (the air quality district regulates). Here in Nevada, there are state and local regulations, but they’re integrated without the quadruple level of regulations. I read years ago it took Carl’s Jr. (a fast food chain) over a year to get regulatory approval to build a new location in California; it took less than two months in Texas.
In good times, California has prospered because of the entertainment industry and Silicon Valley. We’re not in good times right now, and the budget hit to the Golden State is severe (they’re projecting a $54 billion deficit). Sure, Covid isn’t the fault of California (or any other state). But the reaction of the legislature demonstrates that they’re not learning anything: Increase taxes and hope for a federal bailout (one that I doubt is coming).
For those who think that state policies don’t matter, this survey tells you otherwise. The states at the top (run by Democrats or Republicans get this). The states at the bottom mostly don’t.
It would be nice if the IRS were to do the same thing. As of today, the federal filing deadline remains April 15th; however, federal payments due on April 15th are now due on July 15th. More on this in a second post shortly.
Yesterday, California’s Franchise Tax Board, the state’s income tax agency, extended the deadlines for taxpayers to both file and pay 2019 California income taxes (and 2020 California estimated taxes) by 60 days. Here is the announcement in full:
Sacramento — The Franchise Tax Board (FTB) today announced special tax relief for California taxpayers affected by the COVID-19 pandemic. Affected taxpayers are granted an extension to file 2019 California tax returns and make certain payments until June 15, 2020, in line with Governor Newsom’s March 12 Executive Order.
“During this public health emergency, every Californian should be free to focus on their health and wellbeing,” said State Controller Betty T. Yee, who serves as chair of FTB. “Having extra time to file their taxes helps allows people to do this, as the experts work to control the spread of coronavirus.”
This relief includes moving the various tax filing and payment deadlines that occur on March 15, 2020, through June 15, 2020, to June 15, 2020. This includes:
· Partnerships and LLCs who are taxed as partnerships whose tax returns are due on March 15 now have a 90-day extension to file and pay by June 15.
· Individual filers whose tax returns are due on April 15 now have a 60-day extension to file and pay by June 15.
· Quarterly estimated tax payments due on April 15 now have a 60-day extension to pay by June 15.
The FTB’s June 15 extended due date may be pushed back even further if the Internal Revenue Service grants a longer relief period.
Taxpayers claiming the special COVID-19 relief should write the name of the state of emergency (for example, COVID-19) in black ink at the top of the tax return to alert FTB of the special extension period. If taxpayers are e-filing, they should follow the software instructions to enter disaster information.
The FTB will also waive interest and any late filing or late payment penalties that would otherwise apply.
I expect we will see a similar announcement from the IRS next week. It appears (at least for now) that the March 16th deadline for filing federal S-Corp and partnership returns will hold.
Kudos to the FTB for being proactive during this crisis.
