California state law (California Code, Revenue and Taxation Code – RTC § 18662) states such that all real property being sold requires the payment of tax at the close of escrow in an amount equal to 3.33% of the sales price. An Alternative Calculated Amount can also be used which involves some computations to determine the seller’s gain or loss on sale.
The amount is withheld from the seller’s proceeds by the Settlement Agent at the close of escrow and sent to the Franchise Tax Board (FTB). The amount is considered a “prepayment” of income taxes on the potential gain.
The withholding applies to all sellers, whether they are U.S. citizens, permanent residents with green card, foreigners, individuals who live out-of-state, or individuals who live in the State.
Some Common Exemptions to Withholding
The full list of exemptions can be found on Part III and Part IV of 593 form. Here are the most common exemptions to fully exempt the sale from withholding:
- The seller can claim a loss or zero gain for California income tax purposes on the sale.
- If the property was last used as the seller’s principal residence for at least two years during the five year period prior to the sale date, no withholding is required.
- The seller is a corporation (or a limited liability company (LLC) classified as a corporation for federal and California income tax purposes) that is either qualified through the California Secretary of State or has a permanent place of business in California.
- The seller is a California partnership or qualified to do business in California (or an LLC that is classified as a partnership for federal and California income tax purposes that is not a single member LLC that is disregarded for federal and California income tax purposes).
- The seller is a tax-exempt entity under California or federal law.
Whose responsibility is it to complete the forms?
It may be the Settlement Agent who provides the forms and does the withholding, but it is the seller’s responsibility to complete the forms correctly and seek independent financial and legal counsel.
As the forms state, “title and escrow persons, exchange accommodators are not authorized to provide legal or accounting advice on the withholding amounts”.
Please note: the 593 form is completed under penalties of perjury. Perjury means to willfully make a false statement..
Penalties
The penalty for a false certification by the Seller to avoid the withholding requirements is $1,000 or 20% of the required withholding amount, whichever is greater.
Additionally, there are other penalties (which may be charged to the Remitter or Seller):
- Late filing
- Intentional disregarding the reporting requirements
- Failure to withhold
- Failure to remit the funds
- Failure to provide forms to the Seller
Audits
The Franchise Tax Board audits Settlement Agents to make sure that the regulations are followed.
The Settlement Agent is mandated to send all 593 forms for every real property sale transaction to the Franchise Tax Board who will, in turn, review all the data entered and marked, including computation of the amounts. They will also check to make sure that they received the 593 forms within 20 days following the end of the month in which the transaction closed.
What if the property is partially a principal residence and partially income generating?
The Seller can claim the principal residence exemption only on the percentage allocated to the principal residence portion. This means that two 593 forms should be completed, one to be marked as his principal residence and the other marked as income property. The proper percentage allocation needs to be made on both forms.
What if there are multiple Sellers in one transaction?
If the sales price in the transaction is less than $100,000, an automatic withholding exemption applies.
If the sales price in the transaction is more than $100,000, then each seller would have to complete their own 593 form and show their ownership percentage.
If one of the sellers does not actually own a percentage but is listed as a seller for loan co-signing purposes, for instance, then he would mark “zero” as his ownership percentage on the 593 and no withholding is required for that particular seller. The withholding would fall on the other seller(s).
State regulations and forms change from year to year and it is important to use and review the most up to date information on the FTB website.