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Leaving California: Tax Implications for Out-of-State Workers

In the wake of the COVID-19 pandemic, America is experiencing a wave of suburban relocation unseen since the 1950s. As interest rates fall to historic lows and professional sector jobs have pivoted to fully remote work, millions of Americans are departing expensive rentals in cities for larger, cheaper homes in less populous regions. “Zoom towns” are on the rise in lieu of the company towns of the past, with developments like Remote Shoals in Alabama offering up to $10,000 cash for remote employees and freelancers alike to relocate and remain at least one year.

For Californians in particular, mass relocation is not only motivated by the pandemic but also by the devastating wildfires, heatwaves, and rolling blackouts. Freelancers, entrepreneurs, and anyone else who works primarily in an independent contractor role may have also found their incomes severely decimated or even vanished entirely with the passage of AB5, with redress from AB 2257 not arriving until several months later.

Whether your departure is motivated by safety or economics, there could be tax consequences even if your move is temporary.

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How do taxes work if I move out of state and work as an employee from a different state?

Typically, this depends on whether your move is permanent or temporary, and how you will prove it. You are ultimately taxed on all income as a resident, and California-sourced income as a part-year resident or nonresident.

If you are no longer a California resident and can prove it, you will only be taxed as a part-year resident for the months of the year you were still present. However, if your move is seen as temporary and does not meet the safe harbor rule, you are still a full resident.

What if I’m only moving temporarily out of state?

While roughly 20% of Americans moved, or plan to move, due to COVID-19 and the subsequent shift to remote work, Pew Research estimates that only 3% of these moves will be permanent in the long term. Even if you plan to return to California some time in the future, but you’re not sure when, you may want to commit to some important decisions now if you’re hoping to avoid unnecessary tax liability.

The California Franchise Tax Board is likely to take a number of factors into consideration to figure out if you’ve actually left the state for good or if you have enough connections still in California to be considered a resident in the state for tax purposes. For example, if you’ve moved but still have a house in California and belongings in a storage facility, that might indicate that you have not permanently moved out of the state. In other words, whether your move is permanent or temporary depends on your particular situation. The Franchise Tax Board makes these determinations on a case-by-case basis.

So if you’re planning to move out of California and want to try and establish that you are no longer a California resident for tax purposes, some actions that may show your move is not temporary might include:

  • Selling your home or ending your lease
  • Taking your belongings instead of leaving them in storage in California
  • Changing your drivers license to your new state
  • Enrolling your children in local schools
  • Registering to vote in your new state
  • Joining local social, civic, and professional societies in your new state

Even if your job or business comes with you, you must prove permanence to avoid additional taxation from the state of California.

How do I avoid paying taxes to two states?

Paying taxes to two states is often inevitable if you move late in the year, as you will have two part-year state tax returns to contend with unless you live in one of seven states that does not have an income tax. If you anticipate a large taxable item like a relocation bonus or stock sale, you may want to change and assert your residency as quickly as possible, then time the transaction for when your California residency has ceased. By the way, the seven states that do not levy personal income taxes are:

  • Alaska
  • Florida
  • Nevada
  • South Dakota
  • Texas
  • Washington
  • Wyoming

If I want to move but still work for the same California company, does it make a difference if I’m an employee or independent contractor?

Ultimately, this depends on how you choose to structure your career and relationship to the company, as well as federal and state labor laws. Under AB5 in California, it is more difficult to establish that a worker is an independent contractor. However, in other states that do not employ the ABC test, an independent contractor relationship is freer to form and relieves your employer of legal liability and tax burdens.

If you wish to remain an employee, you will need to notify your employer of your new residence so your state tax withholding and mandatory fund payments appropriately change. If moving out of state is still an idea, rather than a reality, then you may want to discuss your desire to remain an employee with your employer should you move. If you move, your employer will be subject to the labor laws in the new state, which may or may not make them amenable to this arrangement.

Which states provide the best tax policy for remote workers?

States that make it simpler for tax filing across the board, such as Pennsylvania’s flat tax scheme, or have no income tax like Florida or Nevada, have proven to be popular destinations for remote workers.

Business-friendly states like Florida, Alabama, and Nevada have also appealed to freelancers and entrepreneurs in search of lower business taxes and administrative burden. Multi-state and temporary residencies are a difficult tax matter to navigate. Ask a lawyer today if you have nonresident and part-year residency tax questions.

This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.

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