How should an S corporation report a shareholder who left California mid-year, and what does a lower apportionment factor save while the shareholders are residents?

The two rules that split a move year

A part-year resident is a taxpayer who is a resident of California for part of the taxable year and a nonresident for the rest (Rev. and Tax. Code section 17015.5). Whether and when the person stopped being a resident is a question under section 17014 and the Franchise Tax Board's residency cases, which the library's articles on changes of residency and day-count evidence cover; this article assumes a move date that will hold.

Once the date is fixed, section 17041(i) does the work. A part-year resident's taxable income includes, for the part of the year the taxpayer was a resident, all items of gross income and all deductions regardless of source, and, for the part of the year the taxpayer was not a resident, gross income and deductions derived from sources within California (section 17041(i)(1)(A) and (B)). The tax is computed at the rate that would apply to a full-year resident with the same total income (section 17041(b)), and the sourcing rules for the nonresident period are those of sections 17951 through 17955 and the regulations under section 17954.

For a shareholder of an S corporation operating within and without California, the California-source rule for the nonresident period is the apportionment rule, not the intangible rule. A nonresident shareholder's pro rata share is computed as if the S corporation were a partnership: the corporation's business income is apportioned at the entity level under the Uniform Division of Income for Tax Purposes Act, and the shareholder's share of the California-apportioned business income is California-source income (Cal. Code Regs., tit. 18, section 17951-4(d) and (f); Rev. and Tax. Code section 17087.5, applying Subchapter S except as otherwise provided). Nonbusiness items are sourced as if the shareholder had earned them directly, so a nonresident's share of nonbusiness intangible income falls under section 17952 and is not California-source absent a business situs. The library's article on a nonresident shareholder's share of an S corporation's sale gain works through that framework and the cases behind it.

The two rules meet at the move date, and the Franchise Tax Board has published how. Legal Ruling 2003-1 (April 7, 2003) holds that a part-year resident's distributive share of partnership, S corporation and trust income is allocated between the resident and nonresident periods in a manner that reflects the actual date of realization and, in the absence of information reflecting that date, by a daily pro rata method applied to the annual amount. The ruling rests on the repeal of former section 17554, the accrual rule for income earned before a change of residency, for taxable years beginning on or after January 1, 2002: the question is no longer when the income became ascertainable but when the entity realized it, and under the conduit rule a shareholder realizes the pro rata share as the corporation does, through the year. Publication 1100, Taxation of Nonresidents and Individuals Who Change Residency (Rev. 10/2024), Section L, states the same rule with worked examples, and the Schedule CA (540NR) instructions for line 5 repeat it.

Two features of the rule matter in practice. The proration runs over the entity's taxable year, not the shareholder's calendar year; the publication's examples use fiscal-year S corporations ending October 31 and May 31 and count days within those years. And the date of realization controls whenever it is known: the publication assigns a partnership's gains to the periods in which each sale closed, and divides an S corporation's ordinary income from interim statements the shareholder obtained from the corporation. Daily proration is the fallback for income that cannot be dated, not a choice.

What Schedule K-1 (100S) can and cannot show

The California K-1 is built for a shareholder who is one thing all year. Item G asks "Is this shareholder a resident of California?" with a yes and a no box (Schedule K-1 (100S), 2024). The pro rata share items run in five columns: (a) the item, (b) the amount from federal Schedule K-1 (Form 1120-S), (c) the California adjustment, (d) the total amount using California law, and (e) the California-source amount and credits. Table 1 reports the shareholder's share of nonbusiness income from intangibles, which is not reflected in column (e) because its source is determined at the shareholder level, and Table 2 reports the shareholder's share of the corporation's business income, of nonbusiness income from real and tangible property sourced to California, and of the corporation's property, payroll and sales within and without California.

The shareholder's instructions assign the columns by status. Shareholders who are California residents use the amounts in column (d). Nonresident shareholders who do not conduct a business unitary with the corporation use column (d) for total income and column (e) for California-source income, with Table 1 sourced at the shareholder's residence or commercial domicile, and the line 18 instructions direct nonresidents and part-year residents to column (e) for their pro rata share of California source pass-through income (Shareholder's Instructions for Schedule K-1 (100S), 2024, General Information E and line 18). A nonresident who holds 20 percent or more of the stock and conducts another business unitary with the corporation does not use column (e) but combines and apportions with the Table 2 factors (section 17951-4(d)(6) and (f)); because an S corporation's activity is generally not unitary with a shareholder's other activities (section 17951-4(d)(5)), that path is the exception.

Apart from the line 18 instruction sending part-year residents to column (e), neither the form nor the shareholder's instructions addresses a shareholder who was a resident for part of the corporation's year: no part-year box, no date field, no instruction to prorate column (e). The shareholder who moved will need column (e), because the instructions send part-year residents there, and column (d), because the resident period is taxed on the total. A K-1 prepared as for a resident, with Item G answered yes and column (e) blank, gives the shareholder half of what the return needs. A K-1 prepared as for a nonresident, with Item G answered no, column (e) at the full-year California-source amount, and Table 1 and Table 2 completed, gives the shareholder everything. The corporation does not prorate; it reports annual amounts, and the split by period is made on the shareholder's return from the corporation's dates or from days. Answering Item G no also changes the corporation's own compliance: the Form 100S instructions require withholding on certain payments to nonresident shareholders, who claim the credit on Form 540NR with Form 592-B rather than from the K-1, a subject the library's article on California pass-through withholding for domestic nonresident owners covers.

The residency answer on the K-1 is a representation, not a determination. The Franchise Tax Board decides residency on the facts under section 17014, and the K-1, the Form 540NR residency dates and the shareholder's conduct are read together; a K-1 that says resident for a year the shareholder claims to have left is an inconsistency an examiner will ask about. The sound sequence fixes the move date first and prepares the K-1 and the return to the same date.

The shareholder's return: Form 540NR and the Part-Year Resident Worksheet

The shareholder files Form 540NR with Schedule CA (540NR), whose Part I asks for the period of California residency and the days spent in the state. Schedule CA (540NR), Part II, runs in five columns: A, the federal amounts; B, subtractions; C, additions; D, the total using California law as if the taxpayer were a full-year resident; and E, the portion of column D that California taxes. For a part-year resident, column E for the income lines comes from the Part-Year Resident Worksheet at the end of the instructions, which has three columns of its own: A, income in column D earned or received while a California resident; B, income in column D received from California sources while a nonresident; and C, the total, which transfers to column E (Schedule CA (540NR) instructions, 2024, Part II and Part-Year Resident Worksheet).

For the S corporation line, worksheet column A takes the resident-period portion of K-1 column (d), and worksheet column B takes the nonresident-period portion of K-1 column (e), plus any Table 1 item with a California business situs. The line 5 instructions state the allocation rule: the shareholder allocates the income between the periods so that it reflects the actual date of realization and, absent that information, allocates the annual amount on a daily pro rata basis, with Publication 1100 as the reference. The tax is then the effective-rate computation of section 17041(b), with deductions and most credits prorated and the other state tax credit allowed in full (Publication 1100, Section B).

The shareholder-employee has a second line on the same return: wages the corporation pays a shareholder who also works for it are sourced by where the services are performed, with compensation for work within and without the state in the nonresident period allocated by working days or another method that reasonably attributes it to services performed here (Cal. Code Regs., tit. 18, section 17951-5). The K-1 answers only one of the two lines.

A worked move year

An engineering and design consulting firm taxed as an S corporation is headquartered in California and files on the calendar year. It has three shareholders: the founder with 50 percent and two others with 30 percent and 20 percent. For years it assigned all of its receipts to California because the work was performed and billed from the headquarters. A sourcing study assigns receipts from services to the state where the business customer receives the benefit of the service (Rev. and Tax. Code section 25136(a)(1)), and under the single sales factor (section 25128.7) the California apportionment percentage falls from 90 percent to 40 percent. The corporation's ordinary business income in the move year is $4,000,000.

On October 1 of the move year, the 30 percent shareholder becomes a nonresident; the other two remain residents. The shareholder's pro rata share of ordinary income is $1,200,000, and the California-source share at 40 percent is $480,000. The corporation issues that shareholder a K-1 with Item G answered no, column (d) at $1,200,000, column (e) at $480,000, and Table 2 completed; the two resident shareholders receive K-1s with Item G answered yes and use column (d). The corporation itself pays 1.5 percent of $4,000,000 times 40 percent, $24,000, against the $54,000 it paid at 90 percent.

On the shareholder's Form 540NR, the resident period runs January 1 through September 30, 273 days, and the nonresident period October 1 through December 31, 92 days. With no information dating the corporation's ordinary income within the year, the worksheet uses days, with the ratios rounded to four places as the publication's examples do: resident period, $1,200,000 times 273/365, or $897,480; nonresident period, $480,000 times 92/365, or $121,008; column E for the line, $1,018,488, taxed at the effective rate on the full $1,200,000. Had the corporation kept its 90 percent factor, the nonresident period would carry $1,080,000 times 92/365, or $272,268, and the line would total $1,169,748. The lower factor is worth about $151,000 of California taxable income to this shareholder in the move year and $600,000 a year in every full year of nonresidency that follows, at the shareholder's own rates, while it is worth $30,000 a year to the corporation at 1.5 percent.

The date of realization changes the move year again when an item can be dated. If the corporation closes the sale of a small line of business on November 15 for a $2,000,000 gain reported as business income and apportioned at the same 40 percent (receipts of a substantial and occasional sale being excluded from the sales factor, the operating percentage governs), the shareholder's share of the gain is $600,000 and the California-source share is $240,000. Because the sale closed in the nonresident period, the realization-date rule places the whole item there: $240,000 in worksheet column B and nothing in column A. A daily proration of the same item, used only if the date were unavailable, would put $448,740 in column A and $60,504 in column B, $509,244 in all; the corporation's closing documents are the information that reflects the actual date of realization. The same logic runs the other way: a gain closed in March belongs entirely to the resident period and is taxed in full regardless of the apportionment percentage. The two resident shareholders see none of this; each reports the column (d) amount whether the corporation's factor is 90 percent or 40 percent.

What a lower California factor saves while every shareholder is a resident

The S corporation's own tax is where a lower factor lands first. An S corporation remains subject to the franchise or income tax at 1.5 percent in place of the general corporate rate (Rev. and Tax. Code section 23802(b)(1); the FTB's S corporations page states the rate), subject to the minimum franchise tax (section 23802(c)), and a corporation deriving income from sources within and without the state measures that tax by the net income derived from or attributable to sources within California under the apportionment rules (section 25101; Schedule R). Fifty points of factor on $4,000,000 of net income is $30,000 of entity tax a year, and that is the whole of the saving while every shareholder is a resident.

A resident is taxed on all income regardless of source, and the corporation's apportionment percentage does not enter the resident's California computation. What it changes is the other states' side: receipts assigned away from California are assigned to other states, and where those states tax the shareholder on the share apportioned there, the resident claims the credit under section 18001 for net income taxes paid to another state on income also taxed by California. Three limits shape that credit. The income must be from sources within the other state as determined under California's own nonresident sourcing rules (section 18001(c)), so the credit follows California's apportionment, not the other state's. The credit cannot exceed the share of California net tax that the doubly taxed income bears to total income subject to California tax (section 18001(a)(3)), so a higher rate elsewhere is a cost the credit does not absorb, and a lower rate elsewhere leaves the shareholder paying the difference to California. And net income taxes the S corporation itself pays to a state that taxes S corporations, or that does not recognize the election, count as paid by the shareholder in proportion to the shareholder's share (sections 18006 and 18001(b)). Receipts assigned to a state where the corporation does not file produce no tax elsewhere and no credit; for a resident shareholder they change nothing at all.

The pass-through entity elective tax follows the same line. The elective tax is 9.3 percent of qualified net income, the sum of the consenting shareholders' pro rata shares of income subject to California personal income tax (section 19900 for taxable years beginning in 2021 through 2025; section 19910 for taxable years beginning on or after January 1, 2026, and before January 1, 2031). A resident's share is the whole share, so apportionment does not change it; a nonresident's share enters only to the extent it is subject to California tax, so the base for that shareholder shrinks with the factor.

The shareholder-level saving therefore begins on the move date and not before. From that date, the moving shareholder's California-source share of business income is the apportioned share, and every point of factor the corporation can support with customer-location evidence under section 25136 and its regulation reduces that share for as long as the shareholder remains a nonresident. A shareholder who moves inherits whatever sourcing method the corporation has been using. A lower factor also carries costs that a resident-only analysis ignores: filing and tax in the states that receive the receipts, including entity-level taxes on S corporations where states impose them, and the records to support the market-sourcing assignment in a California examination.

Practice notes

For a corporation with a shareholder who is leaving, the sequence is the move date first, documented to the standard the residency articles describe; then the K-1 prepared to that date, with Item G answered no, column (e) at the full-year California-source amount, Table 1 and Table 2 completed, and the withholding rules for nonresident shareholders applied from the move date; then a package for the shareholder's return that the K-1 alone does not carry: interim statements dividing ordinary income at the move date, and the closing dates of every item large enough to matter, because the realization-date rule applies only to income the shareholder can date and daily proration takes the rest. For a fiscal-year corporation the day counts run within the corporation's year. For a corporation whose shareholders are all residents, the value of an apportionment study is the 1.5 percent entity tax and the credit mechanics in other states; its value multiplies when a shareholder becomes a nonresident, which is also when the method and the evidence behind it are tested, so a corporation that expects a shareholder to move has a reason to settle its sourcing method, and to begin filing on it, before the move year rather than in it. G&G State Tax Group advises on K-1 presentation, part-year sourcing and apportionment for S corporations and their shareholders who change residency alongside its state and local tax practice.