Tax Considerations and Analysis When Moving Your Business Away From California
Our firm has experienced many clients move their companies away from California in recent years. Typically the shareholders focus on the logistics of the move but do not fully grasp the tax consequences before making the move.
The tax consequences for a company moving operations away from California, either partial or total, are anything but superfluous. Careful analysis of the Internal Revenue Code, the California tax scheme, and the tax scheme of the target state are essential. When considering a move away from California, you do NOT want an advisor who looks at the existing tax laws and provides you with a static picture of the tax consequences related to the move. The tax analysis needs to be a comprehensive one which looks at the short-term issues directly related to the move itself and the long-term savings as compared to the costs and disruptions related to the transition. It may be that as the owner of a company, the unfriendly business atmosphere in California is so disruptive that you have made the decision to make the move to another state irrespective of the cost/savings analysis. However, you still have to understand the impact of the tax consequences to budget in both the short-term and long-term.
A complete analysis of the seemingly endless considerations is not a realistic goal for this article. It is, however, the standard with which we review our client’s potential business migrations. This article provides a brief snippet of the planning involved.
First, we analyze the sources of your income, whether active or passive, which is to ask, ” What activities or events trigger or precipitate your income? Where do those activities take place? Where can they take place? Are the sources bifurcated? Can they be bifurcated?” and so on. The reason for this is that income sourced inside California is subject to California tax regardless of where the business or you reside. We consult with you regarding your business operations and income sources and determine what can be done to transfer the source of income.
Second, we analyze the tax consequences, if any, of such a transfer. This includes, but is not limited to, the tax effects of the termination of a business, changing from a C corporation to an S corporation, or vice versa, changing to a partnership, changing to a sole proprietorship, merging businesses, dividing business, making distributions, contributions, tax reorganizations, and transfer taxes of real property.
This analysis necessarily involves a review of your prior tax returns and current taxation status. We must look at Form the 1120s for C Corporations, Form 1120Ss for S Corporations, Form 1065s for Partnerships, and Schedule Cs for sole proprietorships and disregarded entities (e.g. single member LLC), and, of course, your individual Form 1040.
This information is coupled with the determination regarding which areas of your life will migrate from California; that is you, your financial assets, your business, or a combination of the three. Only then can we provide the most tax efficient model for migrating from California.
While moving only part of your life and obtaining a tax benefit may seem impossible, recent rulings from the Franchise Tax Board and Internal Revenue Service have expanded the use of trusts for precisely this type of planning. Certain types of trusts will be treated as separate and distinct taxpayers with a residency all to itself. This residency can be in a state other than California and by so doing, avoid California taxes. Moreover, there are even ways to structure these trusts such that income distributions from the trusts to you are also not taxable by the State of California.
California’s tax system is one of the most burdensome and there is much to be gained from considering and carefully structuring a partial or total migration from California to a more favorable state.