Our last couple of blog articles have been geared toward business owners who are thinking about moving their business out of California. Today, I would like to present a couple relatable scenarios and how each situation may affect a decision to move.
Many businesses are tied to their California locations because that’s where their core business is. They depend on local customers and benefit from consumers with higher average incomes. In this case, it really doesn’t make sense to pick up and move the business elsewhere. A high-end clothing boutique that was once on Rodeo Drive isn’t going to thrive in rural Nebraska, no matter how great the tax savings.
Such a move might only make sense if you are confident that your business will do well in a new location. A good example may be a restaurant. You will be starting over in your new city/state, but with time you could end up being more profitable thanks to cheaper rent and lower taxes.
E-commerce is a situation where a move out of state may be viable. You aren’t dependent on your California location as you sell your goods and services anywhere. Any business sales made in California will still be subject to our state sales tax anyway (no matter where your physical business is located). However, you may benefit from lower business taxes and income taxes if you based your e-commerce business in a low-tax state.
Some business owners think they can benefit from keeping their business in California while they move to a new state. If you read the most recent article in this series (if not, click here), you may remember the California nonresident taxation laws we discussed. If your income derives from a California-based business, it will still be subject to California state income taxes. You are not really escaping anything in this situation, other than having cheaper cost of living.
However, there are strategies that can work if executed properly. The owner can change legal residency and then establish an employment contract with the California entity. The owner must carry out any predetermined administrative or management services remotely. Any income must be derived from W-2 income rather than distributive shares of capital.
Another option is to establish a pass-through entity from out of state to perform the contracted services. California taxes will still apply to at least a portion of this income. The owner would be working remotely and receiving a salary for his or her work. The portion of California revenues that pass-through as distributive shares would be taxed by the state.
Even with the clever strategies above, federal taxation also comes into play. Receiving income as wages rather than distributive shares of capital means the income is subject to higher taxation from the IRS. You may not end up saving much at all unless all entities have really complex (and possibly legally questionable) corporate structures
One situation that can present real long-term tax savings is when non-qualified stock options (NSOs) are involved. This happens a lot with startup businesses, which are popular in California tech hubs like Silicon Valley and Orange County. The owner may receive stock options that vest over time as part of the compensation package.
However, it depends on where the owner’s work is performed. If their work is performed in California, the proceeds of any ultimate sale are still taxable by California in proportion to where the work was performed. If you work in California half the time, then 50% of your vested earnings are taxable by the state. If none of your work is performed in California, then none of the gain is taxed by the state.
This is a decision only you can make after talking to a trusted advisor (or several legal and financial experts you trust). The important thing to remember is that there is no quick fix. Packing up a business and/or a residence is not something that happens overnight. It takes time, careful planning and strategic execution. Even then, simply moving yourself or your business to a lower-tax state may not present the windfall you hope. It depends on a variety of factors and California will always come after any revenue or income generated in the Golden State.
If you are looking for help with your business planning and financial strategies, contact Illumination Wealth and talk with one of our leading business advisors.