Ask The California Employment Tax And Payroll Tax Attorney – Is The “California Method” For Taxing Non-Resident Income Legalized Theft?

By Robert S. Schriebman

2022

Introduction

We do many unique things here in California that sets us apart from the rest of the nation. Such is the case where the FTB computes the income rate for non-residents or part-year residents. This is called the California Method. In the recent case of S. Guha and B. Murphy this method was used to extract almost 4 times more in taxes than was paid on only their California-source income. This article will discuss their case. The matter was decided by the Office of Tax Appeals (OTA).

The Appeal of Guha and Murphy OTA Case No. 20127027, December 2021

Guha and Murphy (GM) resided part-time in California during 2015. They also resided in Texas and Connecticut. They earned wages in each state. When they filed their California non-resident income tax return with the FTB, they reported and paid a tax of $2,493 as the correct tax for their California based income. They paid no state income tax in Texas, but they paid $6,770 to the State of Connecticut (CT). They did not include their CT and Texas incomes on their CA FTB return. The FTB conducted an audit and assessed almost $5,682 more than they initially reported for a total of $8,075. In doing so, the FTB used the California Method. To understand the complexity of this Method, you are going to have to follow the bouncing ball below.

The California Method

Part-year California residents, such as GM, are taxed on their entire taxable income for the period of their residency, and only on income from California sources for the period of their non-residency (R&TC §17041(b) & (i)). Nevertheless, the FTB determines the applicable California rate of a part-year resident based on that resident’s income from all sources during the taxable year using a formula commonly known as the California Method. This Method is a multi-step process in which the part-year resident’s total income is used to compute his/her FTB tax rate and to prorate the part-year resident’s California deductions and credits. Stated another way, California did not tax GM’s earnings in Texas or CT. It only taxed California based income. However, the tax rate on California based income included the income derived elsewhere. In other words, if GM earned $20,000 in California but an additional $50,000 in Texas, and an additional $50,000 in CT, the tax rate on the $20,000 California based income is computed as if GM earned $120,000 in California. This caused their initially reported California income tax of $2,493 to be taxed at $8,075, an increase of $5,582. The bottom line is that the California Method taxed GM’s total income and not just the relatively small amount earned while a part-time California resident.

The OTA ruled that the use of the California Method preserves the progressive nature of California’s personal income tax system so taxpayers with higher incomes are taxed at a higher rate than taxpayers with lower incomes.

Is the California Method constitutional? The OTA found that the fundamental fairness and constitutionality of using out-of-state income to calculate the tax rate had been upheld by New York’s highest court, and the US Supreme Court refused to hear an appeal from the New York decision.

Are GM Entitled to a California Credit for Taxes Paid in Connecticut?

GM paid the State of CT. $6,770 in personal income tax. They sought a credit of that amount against the assessment based on the California Method. The OTA denied their request because CT did not tax GM’s California based income.

Conclusion

We all the know the difference between right and wrong and we are familiar with the Ten Commandments, “Thou shalt not steal.” Judge for yourself – is the use of the California Method a form of legalized theft?!

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Robert Schriebman has a successful practice in the Rolling Hills Estates area of Los Angeles County serving clients throughout California and the United States. He has successfully dedicated more than 50 years to helping individual taxpayers, business owners, CPAs, Enrolled Agents, and tax attorneys navigate the complicated tax systems of the federal and state governments. Mr. Schriebman is in private practice. He is not affiliated in any way with the EDD and he is not employed by the EDD or any other agency of the State of California.

Robert Schriebman has written the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House.

Robert Schriebman has written over 20 books including the major manual used nationally by practitioners and the IRS, “IRS Tax Collection Procedures – A Manual for Practitioners” published by Commerce Clearing House in addition to the only 2 books ever published dealing with how California Employment Development Department (EDD) operates. See “California Tax Collection Practice and Procedures” and “California Taxation Practice and Procedure,” both published by Commerce Clearing House.

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