Why Knowing Your California Nonresident Clients' Worldwide Income is Important
A common question we get from nonresidents is "Why, do I have to report my worldwide income if California can only tax California sourced income?" For tax year's beginning on or after January 1, 2002, the first step in calculating a nonresident or part year resident's California tax is to calculate the taxpayer's effective tax rate as if the taxpayer were a California resident. If the taxpayer fails to report this income a statutory adjustment will be made to the 540NR return.
These adjustments are usually made based upon information received from the IRS regarding the adjusted gross income reported on the 1040.
Why does California calculate the tax this way? Both the IRS and California assess tax based on tax brackets, which are the divisions at which tax rates change in a progressive tax system. Progressive tax systems attempt to reduce the “tax incidence” of people with a lower “ability-to-pay,” as they shift the incidence increasingly to those with a higher ability-to-pay. California law requires us to compute California tax at the effective tax rate that would be the equal to the effective tax rate of a resident with the same level of income.
The effective tax rate, based on worldwide income, is then applied only to the California taxable income of the nonresident to determine the tax amount owed to California. For more information on taxation of nonresidents and individuals who change residency, see FTB Publication 1100, Taxation of Nonresidents and Individuals Who Change Residency.
Failure to include worldwide income results in a statutory adjustment to a 540NR return. These adjustments are usually made after we receive information from the IRS on the adjusted gross income reported on the 1040.
Group Nonresident Return
On an individual return, a nonresident must report all income from all sources in addition to the California source income. On the group nonresident return, only the California source pass-through income or director’s compensation is reported.
A full year nonresident who meets other requirements, can be included in the group nonresident return.
In filing a group nonresident return, a business entity, acts as the authorized agent, and may also choose to file a group nonresident return for certain nonresidents. To participate, nonresidents must receive distributive shares of income from business entities that derive income from California sources or from those who are doing business in California. The business entity pays the tax on behalf of the nonresident individuals who elect to file a group return. A group nonresident return is considered a group of individual returns that meets the California individual income tax return filing requirement. Thus, a qualified nonresident individual who elects to be included in the group nonresident return is not required to file a separate income tax return for the tax year.The upside to the group return is that worldwide income does not need to be reported individually; however, the income reported on the group nonresident return is taxed at the highest marginal rate of 12.3 percent. See FTB Publication 1067 for more information on guidelines for filing a group 540NR.