California income of a non-resident

[mhlester]

Hello tax experts,

A client is thinking of moving to Texas from California and establishing permanent residency there. He wants to know if he will be taxed on certain income in California after he becomes a Texas resident for income tax purposes. Here are the facts as I understand them.

A Texas S corporation (T), which is a partner in a California LLC taxed as a partnership (C), receives non-passive income from C whose employees and partners perform talent management services in California. C files a California income tax return and issues T a K-1 as a non-resident partner. T files a California tax return to report the K-1 income from C and pays an equal amount to the Texas resident owner/employee of T (O/E) as wages reported on a W-2. O/E performs no services in California. Does O/E have California income to report on a nonresident California income tax return?

Same facts, except T is a California S corporation.

[George4Tacks]

I think you are possibly using "he" moving to Texas as the S-Corp is moving to Texas. The taxpayer moving does not change the fact that the S-Corp is still a CALIFORNIA S-Corp.

Too many single letters for me, or maybe not enough. I think T would owe tax in CALIFORNIA from any income received, especially if it from C deriving income from CALIFORNIA. 

[Strongsilence-CPA]

2024 FTB Publication 1031 Guidelines for Determining Resident Status

[mhlester]

Hi, George4Tacks,

Thank you for your reply.

You are right... this question is hard to ask.

I will try to clarify.

The individual moves from California to Texas.

He creates a new Texas S corporation to acquire his old California S corporation's interest in a California LLC taxed as a partnership.

The LLC has California income that it reports on the Texas S corporation's K-1.

The Texas S corporation zero's out its K-1 income by paying the same amount of wages to the employee/shareholder, now a Texas resident.

Thus, the Texas S corporation has no income to be taxed in California.

The individual performed no services in California related to this income.

So, under the rules, as I understand them, even though the income is sourced in California at the LLC and Texas S corporation levels, he, as a W-2 employee, because he did not perform services in California, is not taxed on that income in California.

It seems like the result would be the same if it was a California S corporation that zeroed out its income by paying it all out as wages to the Texas resident employee/shareholder.

I am just looking to see if I have this right.

Also, a new question comes to mind... will the LLC be required to withhold tax on distributions to the Texas S corporation as a non-resident partner? I think so.

[George4Tacks · Accepted solution]

The California S-Corp has filed for dissolution and has (or will do) a final tax return. It somehow "sells" it's k-1interest to the new Texas S-Corp?  

Is all the work don't virtually? Does your person EVER physically going to CA to earn the W-2 income.  

My gut tells me California is going to look for a CA return from the Texas S-Corp for the LLC income reported as CA income. 

The Partnership may have to do withholding. https://www.ftb.ca.gov/forms/misc/1017.html#:~:text=A%20withholding%20agent%20is%20required,an%20app....

I think this is above my paygrade and experience. CA is vicious in terms of seeking out anything that hints of avoiding CA taxes.