CA Question

[Kram BergGold]

My client is a non resident of CA. He has an investment in a CA investment partnership. All income from the partnership is from dividends and capital gains from stocks. The CA K-1 shows this as CA source income. To me, this is not CA source. I pointed this out to the head of the partnership but he refused to amend the K-1. Now the Federal K-1 was amended but still the CA K-1 shows the stock sales as CA source. Is there something peculiar to CA which allows them to tax stock sales of non residents or is the partnership just doing the K-1 incorrectly?

[JSLATER]

CA investment partnership. The income earned by the partnership is considered Ca source income.

[Kram BergGold]

JSLATER is incorrect

JSLATER's answer made me uncomfortable so I called the Franchise Tax Board. The Rep told me that the Partnership instructions state that a non resident limited partner is not taxed on stock sales. The representative suggested I file a CA 540 NR to prevent any problens with the FTB showing zero CA source income.

[MAMalody]

Taken from CA 565 instructions.

Investment Partnership Income If you are a nonresident individual, the amounts in column (e) will generally not be taxable by California (R&TC Section 17955). However, nonresident individuals will be taxed on their distributive share of California source income from an investment partnership if the income from the qualifying investment securities is interrelated with either of the following:
• Any other business activity of the nonresident partner
.
• Any other entity in which the nonresident partner owns an interest that is separate and distinct from the investment activity of the partnership and that is conducted in California.

[Roland Slugg]

Actually, JSLATER's reply above IS correct, but it is a little misleading. The question of "California source income" needs to be looked at first from the partnership's perspective, for the purpose of completing its partnership return, Form 565, and Schedules K-1 (Form 565), and then by the non-resident partner when completing his own California return. Form 540-NR.

For a partnership operating only in California all its income is California source income. If a partnership operates in California plus one or more other states, then and only then do the apportionment rules come into play. When they do, such a partnership will have to allocate each type of income, reporting only the California amounts in Column E of Schedules K and K-1. This includes all types of income, including interest, dividends and capital gains.

For a partner who is a full-year nonresident of California, however, he is only taxed by California on his income from a trade or business operating in California and on income such as rents received from tangible property located in California. As a general rule this does not include interest, dividends or capital gains, unless those types of income are earned in connection with a trade or business operated in California. Examples of the latter might include interest on accounts receivable, gain on the sale of business equipment ... things like that.

A nonresident of California allocates his California income on California Schedule CA (Form 540-NR), reporting the amounts taxable by California in Column E of that schedule. For the types of income described in the OP, if it was not earned from the operation of a "trade or business," you should enter zeroes in that column, at least for that particular income.

Those interested in reading about this for themselves may do so by viewing the instructions for California Schedule K-1 (Form 565) and Schedule CA (Form 540-NR). Both may be easily found on the California Franchise Tax Board's web site. Most states tax non-residents in an identical or substantially similar way as the above. Thus, the above summary may be of interest to readers in other states as well.