When the Franchise Tax Board opens a residency audit, most taxpayers focus entirely on California. They gather documentation, engage representation, and prepare to defend their position that they successfully established domicile in their new state. What many fail to consider is what's happening in that new state while the California audit drags on.
This oversight can be devastating. California residency audits routinely take 12 to 24 months to resolve, sometimes longer. During that entire period, the statute of limitations for claiming a refund in your claimed new state continues to run. If California ultimately prevails, you may need to amend your return in the other state to recover what you paid there. However if too much time has passed, you may have lost that right entirely.
Understanding the Exposure
When you move from California to another state and file as a resident of that new state, you pay tax there on your worldwide income. If FTB later audits and successfully asserts that you remained a California resident, California will assess tax on that same worldwide income. Your remedy for the resulting double taxation is to amend your return in the other state, changing your status from resident to nonresident and recovering the tax you paid on income that wasn't actually sourced there.
California's Other State Tax Credit doesn't solve this problem. The OSTC under Revenue and Taxation Code Section 18001 provides a credit for taxes paid to another state "on income also taxable by California," but this credit only applies to income that the other state had a legitimate right to tax—meaning income actually sourced to that state. If you're determined to be a California resident with no source income in your claimed new state, the OSTC provides no relief. You paid tax to a state that never had jurisdiction over that income, and your only remedy is to get it back from them directly.
The math of exposure: Your double taxation risk is concentrated in income that isn't sourced to either state. If you have $1 million in total income and $400,000 is sourced to your claimed new state (perhaps from W-2 wages for work physically performed there), California will give you credit for the tax on that $400,000. Your exposure is the remaining $600,000—if you can't amend the other state's return, you pay tax on that amount to both states with no offset.
Which Taxpayers Face the Greatest Risk
The people most vulnerable to this trap are those with highly portable income. Remote workers, retirees living on investment and retirement income, business owners with interests in pass-through entities that aren't tied to either state—these taxpayers may have little or no source income to provide natural protection through the credit mechanism.
By contrast, an employee who physically worked in New York three days per week has a substantial chunk of income sourced to New York regardless of the residency determination. If California prevails on residency, California gives credit for tax paid on the New York-source portion. The credit doesn't make the taxpayer whole, but it significantly limits the damage.
The fully remote tech worker who left California for Austin and has no Texas income tax, the retiree who moved to Nevada and lives on dividends and IRA distributions, the business owner whose S corporation income isn't anchored to any particular state—these taxpayers face maximum exposure if they can't amend their returns in their claimed new state.
The Timeline Problem
States generally allow taxpayers to claim refunds within a defined window, typically three to four years from the original return due date. Here's how the timeline creates a trap.
You claim to have moved from California to State X in 2021 and file your 2021 return as a State X resident in April 2022. State X has a four-year refund statute, so your window to amend that return closes in April 2026. FTB opens a residency audit in early 2024. The audit takes 18 months—not unusual for a contested residency case. FTB issues its final determination in mid-2025, asserting you remained a California resident.
You now owe California tax on your 2021 worldwide income. You go to amend your State X return to nonresident status to recover what you paid there. If State X's statute is still open, you can file the amended return and get most or all of that tax back. But if the audit dragged past April 2026, or if State X has a three-year statute instead of four, your window may have closed. The tax you paid to State X is gone, and you still owe California.
Know the deadlines: Refund statutes vary by state. Most are three or four years from the filing date or due date. Some states measure from payment. The specific rules matter enormously—if your other state has a three-year statute and FTB's audit takes two years, you may have very little margin for error.
Protective Claims: Preserving Your Rights
A protective claim for refund is a filing that preserves your right to claim a refund when that right depends on a future contingency. You're telling the taxing authority that you may be entitled to a refund depending on how a pending matter resolves, and requesting they hold your claim in abeyance until the matter is finalized. A valid protective claim stops the statute of limitations from running against you, giving you time to perfect the claim with specific amounts once the underlying issue is decided.
At the federal level, courts have long recognized the validity of protective claims even without explicit statutory authorization. A valid protective claim must be in writing, identify the contingency affecting the claim, clearly describe the essential nature of the potential refund, and identify the specific tax years at issue. It doesn't need to state a precise dollar amount.
Many states have very clearly defined and statutorily established mechanisms for filing protective claims for refund. In other states, procedures are less clearly established and can be subject to administrative grace and/or getting in touch with the right section of the state revenue department. It's our experience that nearly all states with a personal income tax will accept a protective claim for refund when timely presented in the correct manner, but the process for achieving this will vary depending on the state in question. Even without formal recognition, this will create a paper trail and may support an equitable argument if the statute question is later contested.
Reverse Credit States Create Additional Exposure
Three states have reciprocal agreements with California that flip the normal credit mechanism: Arizona, Oregon, and Virginia. Under these arrangements, when a resident of one state earns income sourced to the other, it's the nonresident state that provides the credit for taxes paid to the resident state—the reverse of the usual approach.
For taxpayers in these states, the exposure to double taxation is even greater. In the normal credit structure, your source income provides some protection because California gives you credit for tax legitimately paid on that income. In a reverse credit state, even source income doesn't provide that cushion. If you claimed to move from California to Arizona and had California-source income, the credit would have been claimed on your California nonresident return for Arizona taxes paid. When FTB reclassifies you as a California resident, that credit disappears, and you need to recover from Arizona.
The practical result is that Arizona, Oregon, and Virginia cases have heightened urgency around protective claims. The income that would normally be "safe" under the regular credit mechanism is at risk. Your exposure isn't limited to the "neither source" bucket—it potentially extends to your entire worldwide income.
What to Do When FTB Opens an Audit
The moment you learn FTB is auditing your residency, take these steps for all affected tax years:
Calculate the other state's refund deadline. Determine exactly when the statute of limitations for amending that state's return will close. Work backward to understand how much time you have and how that compares to a realistic audit timeline.
Research the other state's protective claim procedure. Look for explicit statutory authorization, published forms, or administrative guidance. If nothing is published, consider contacting the state directly to ask how they handle such situations.
File a protective claim as early as possible. Don't wait until the California audit is nearing resolution. The whole point is to get the filing on record while the other state's statute is still comfortably open.
Document everything. Keep copies of all filings, any correspondence with the other state, and any acknowledgments you receive. If the statute question is contested later, this documentation will be essential.
Factor this into your overall audit strategy. The protective claim issue is one piece of a larger picture. Your approach to the California audit itself—how aggressively to contest, whether to seek settlement, how long to extend the process—should account for what's happening with the other state's limitations period.