California Tax Planning for Mixed Residence Couples

At Lance Cross-Border, we often advise “mixed-residence” couples, including Canadian resident individuals having married a US citizen, California-resident spouse. We also see many out-of-state resident US citizens marrying US citizen California residents, as well. It is common in such cases for the spouses to already have a pre-nuptial agreement in place to protect the non-California spouse’s property and income. Such agreements are almost always drafted by the Canadian (or out of state) spouses’ attorneys who insert a provincial or out-of-state choice of law clause into the agreement. Indeed, I have only seen a few drafted with California marital property law in mind, as they should be.

What those couples often don’t realize is that, if the California spouse is earning income in California from employment or operating a business generating California source income, such income may be characterized as “community property” income under California law and be attributed one-half to the non-earning, non-resident spouse. Such an attribution of income will give rise to a California income tax return filing obligation for the nonresident spouse (and possibly a U.S. income tax return filing obligation for my Canadian and other foreign nonresident clients, as well). Having to file a California nonresident tax return can also lead to a host of disclosures to the FTB that could themselves lead to a California residence audit, especially where the nonresident spouse spends significant time in California (see our webpage entitled “California Residency Tax Audits”).

Which brings us to the question whether an out-of-state or foreign country pre- or post-nuptial agreement will be enforced by a California court. While it’s possible that a California court may enforce a choice of law clause in such a pre- or post-nuptial agreement, it is also possible that they will not. The latter situation is most likely to occur if something in the pre-or post-nuptial agreement is contrary to a fundamental California state public policy. As an example, we have a no-fault system of divorce in California and many out-of-state or foreign pre- or post-nuptial agreements I see contain provisions that are triggered by the fault of one of the spouses. There are other examples of such public policy differences between California and other states or countries that may lead to the lack of enforceability of an out-of-state or foreign pre- or post-nuptial agreement in California.

It is also possible that the subtleties of whether a foreign or out-of-state pre- or post-nuptial agreement is enforceable under California law may be lost on a Franchise Tax Board (“FTB”) tax auditor.

For these reasons, I recommend that my “mixed-residence” couples put in place a “mirror” pre- or post-nuptial agreement drafted by a California lawyer with California law in mind. The point is to be sure they do not find themselves surprised by an assessment of back taxes, penalties and interest for failure by the nonresident spouse to file returns and report his or her half of such community property income.

Lance Cross-Border Law and Tax can put an effective California pre-nuptial agreement in place for our “mixed residence” couple clients to both cut-off California’s right to tax the non-resident spouse on a part of the resident spouse’s earnings and prevent a tax-return filing obligation arising for the nonresident spouse. We welcome further inquiries you may have concerning your specific situation. Feel free to call us at (760) 578-5093, contact us via email at Brent@LanceCrossborder.com or by using our online contact form. We will respond to all relevant inquiries without any obligation.