Overview
- In Appeal of J. Otting and Y. Otting1 , the California Office of Tax Appeals (“OTA”) reversed the Franchise Tax Board’s (“FTB”) proposed assessment of approximately $1.8 million for the 2016 tax year.
- The OTA concluded that payments received by Mr. Otting, a former California resident, were termination payments and therefore the payments should be sourced to his domicile unless they had acquired a California business situs.
Background
Mr. Otting previously served as president and CEO of OneWest Bank, a California-based regional bank. In July 2014,in connection with CIT Group Inc.’s acquisition of OneWest Bank, CIT Bank, N.A. provided Mr. Otting with an offer letter for a three-year employment term.The offer letter included salary, deferred compensation, restricted stock unit arrangements, and severance terms if Mr. Otting’s employment ended without cause.
After the acquisition closed in August 2015, Mr. Otting became president and CEO of CIT Bank. CIT later announced that his employment would terminate effective December 31, 2015. The Ottings moved from California to Nevada on December 9, 2015. For the 2016 tax year, they filed their California return as nonresidents, taking the position that they were no longer California residents or domiciliaries when the payments were received.
In 2016, following execution of a separation and release agreement, Mr. Otting received severance payments, medical premium payments, and payments related to restricted stock units that vested under the termination provisions. The taxpayers included the payments in federal adjusted gross income but did not treat them as California-source income. Following an audit, the FTB issued a Notice of Proposed Assessment asserting additional California tax of $1,800,858, plus applicable interest. The Ottings protest of the notice was unsuccessful, so they appealed to the California OTA.
The Issue
The issue before the OTA was whether the 2016 payments constituted California-source income. California taxes non-residents only on income from California sources. Compensation for personal services performed in California is typically sourced to California. By contrast, income from intangible personal property of a nonresident is sourced to the taxpayer’s state of domicile unless the intangible has acquired a California business situs.
The FTB argued that the payments represented compensation for services previously performed in California. The taxpayers argued that the payments arose from contractual rights connected to the early termination of the employment arrangement and should be treated as income from intangible personal property.
Taxpayers’ Position
The taxpayers maintained that the severance payments, medical premium payments, and RSU payments were not made for services performed in California during 2016. The taxpayers argued that the payments were received in exchange for rights arising from the offer letter, severance agreement, RSU arrangements, and related separation and release agreement.
Under that characterization, the taxpayers asserted that the payments were attributable to intangible contract rights. Generally, termination-related payments received by a nonresident are sourced to the recipient’s state of domicile unless the underlying intangible rights have acquired a California business situs.
The Decision
The OTA found that the severance payments and medical premium payments were not California-source income, but that the 2016 RSU payments were California-source income because the RSU rights had acquired a California business situs. The OTA relied on California precedent treating payments for the early termination of an employment contract as income from a contract right, an intangible asset, rather than compensation for services performed in California.
The OTA rejected the FTB’s attempt to distinguish that precedent on the basis that Mr. Otting may have been an at-will employee. The OTA found that the offer letter provided specific contractual rights to compensation if employment ended without cause before the conclusion of the three-year term. As a result, the payments arose from termination-related contract rights, not merely from prior California services.
The OTA also declined to treat Form W-2 reporting and federal employment tax authorities as controlling for California income tax sourcing purposes. The opinion emphasized that nonresident sourcing must be evaluated under California’s income tax sourcing rules, including the rules applicable to intangible personal property.
The OTA distinguished between the rights giving rise to each category of payment. The severance and medical premium rights did not acquire a California business situs and were therefore sourced to the taxpayers’ Nevada domicile. By contrast, the RSU rights were tied to Mr. Otting’s prior California services and had acquired a California business situs, causing the 2016 RSU payments to be treated as California-source income.
Implications
While the decision’s precedential status is currently being reviewed by the OTA (designated as pending precedential), the decision illustrates that California may look to the legal right giving rise to a payment when determining whether post-employment income received by a nonresident is California-source income. The result may depend on whether the payment is tied to prior services, vesting of equity compensation, release of claims, contract rights, or a combination of those items.
Taxpayers should not assume that all amounts reported on a Form W-2 are automatically sourced as California wages for nonresident income tax purposes. Conversely, taxpayers should be cautious in applying the decision where payments are clearly tied to services performed in California or where equity compensation vests based on prior California workdays.
Businesses and individuals with California employment history should review offer letters, employment agreements, equity award agreements, severance arrangements, and separation agreements before determining the California-source income treatment of post-termination payments.
How Forvis Mazars Can Help
Forvis Mazars can assist individuals and businesses with explaining the potential California sourcing treatment of nonresident compensation, severance payments, equity compensation, and other post-employment payments. Our state and local tax professionals can read employment and separation agreements, discuss filing positions, help prepare supporting documentation, and assist with FTB notices, audits, protests, and appeals.
- 1Appeal of J. Otting and Y. Otting, 2026-OTA-403P, OTA Case No. 230914221 (Cal. Off. Tax App. 2026).