Imagine if you will, you have interviewed property management companies and believe you have found one that is a good fit. Then you review the management agreement, where it says something about “authorizing the Property Manager to withhold 7% of the rents and send it to the California Franchise Tax Board”. What’s that about?
I’ll explain.
Are California Property Managers Required To Withhold for State Taxes?
Yes, unless the property manager can show a rental property owner is exempt or has a waiver, a California property manager is required to withhold 7% of the rents collected and send it to the California State Franchise Tax Board (“FTB”).
Fortunately, most California rental property owners are either able to show they are exempt or obtain a waiver or a partial waiver from the state.
However, property managers must have an exemption on file or a waiver from the state, or they will be required to withhold 7% of the rents they collect and send it to the California State Franchise Tax Board (“FTB”).
What Determines if a California Rental Property Owner Is Exempt From Having State Income Taxes Withheld?
California residents are exempt from having state income taxes withheld from rents collected. They must submit a Form 590 Withholding Exception Certificate to their property manager certifying they are exempt from state withholding taxes. The form needs to be completed and signed by the rental property owner.
Form 590 has eight different boxes that can be checked to declare different forms of residency or tax-exempt status. The property manager needs to keep a copy of the 590 Form on file, and the rental property owner needs to notify the manager if they become a nonresident. If this is done, then no withholdings are required.
How Do Nonresident Rental Property Owners Obtain a California State Tax Withholding Waiver?
A waiver may be obtained by submitting a Form 588 Nonresident Withholding Waiver Request to the California State Franchise Tax Board. If the state does not issue a waiver, then 7% of rent collected must be withheld and submitted to the FTB.
Form 588 gives five different “reason codes” to request a waiver.
The first is: “A Payee has California state tax returns on file for the two most current taxable years in which the payee has a filing requirement. Payee is considered current on any tax obligations with the Franchise Tax Board (FTB).”
The second is: “B Payee is making timely estimated tax payments for the current taxable year. Payee is considered current on any tax obligations with the FTB.”
There are a couple of other “reason codes” for corporations, and one called “Other”. There is also a Form 589 Nonresident Reduced Withholding Request to request a reduced withholding.
Questions on these forms should be made to a qualified tax professional. It is important to note that that Form 588 and 589 need to be submitted to the California State Franchise Tax Board, and the state mails out a waiver. The waiver can be sent to the Payee, which is the rental property owner, or the Withholding Agent, which is the property manager. Either way, the property manager needs to keep it on file.
What Does the Property Manager Have To Do if They Don’t Obtain an Exemption or Waiver?
If the property manager does not have a signed exemption Form 590 on file or a waiver from the state of California, the property manager must withhold 7% of the rents collected and make quarterly payments to the Franchise Tax Board as the “Withholding Agent”.
The payments are sent each quarter with Form 592 to the California State Franchise Tax Board. At the end of the year, the property manager is required to send Form 592-B to the nonresident property owner declaring how much withholdings where made.
What Does a Nonresident Rental Property Owner Who Has Been Withheld From Need To Do?
Nonresident rental property owners who have had withholdings taken from rents collected on their behalf need to file taxes with the state, reporting California source rental income and claiming tax withheld, attaching Form 592-B to the California income tax return.
If the amount withheld exceeds the tax liability, a refund will be issued. Of course, the property owner should seek the assistance of a licensed tax professional familiar with the California state requirements.
Once the nonresident rental property owner has been filing taxes and or making any necessary estimated tax payments to the state, they will likely qualify for a waiver, which would make the withholding unnecessary in the future.
What Happens if the Property Manager Does Not Make Appropriate Withholdings?
If the property manager does not make the required withholdings, the property manager can be fined. They can get fined if they withhold and don’t send the money to the state on time, they can get fined if they fail to withhold at all, and they can get fined if the paperwork is not kept up to date.
Are State Tax Withholdings Part of Your Property Management Agreement?
Yes, every credible property management agreement used in the state of California will include language covering potential tax withholdings from rent collected. The California Association of Realtors® (CAR) Property Management Agreement is probably the most commonly used management agreement in the state addresses tax withholdings as follows:
“6. TAX WITHHOLDING AND REPORTING:
A. If RPO is not a California Resident or a corporation or LLC qualified to conduct business in California, RPO authorizes Property Manager to withhold and transmit to California Franchise Tax Board (“FTB”) 7% of the GROSS payments to RPO that exceed $1,500 received by Property Manager in a calendar year, unless RPO completes and transmits to Property Manager FTB form 589, nonresident reduced withholding request, FTB form 588, nonresident withholding waiver, or FTB form 590, withholding exemption certificate.”
Yes, it is confusing, but it is a mandatory part of the contract. This is not an optional box that can be checked because it is a legal requirement.
What Does It All Mean?
Essentially, the state is just trying to make sure that rental property owners are properly filing state taxes and paying any money owed. They are requiring property managers to be Withholding Agents when rents are being sent out of state.
The good news is that when the paperwork is in order and everything is filed with the state, the management company does not need to make any withholdings.
Like a lot of tax laws, this can be very confusing. This is why you need to consult a qualified tax professional. This is true for both the rental property owner and the property manager.
Bottom Line
If you cannot show that you are exempt or obtain a waiver from the state, your property manager will need to withhold 7% of rents collected for the state of California every quarter.
California residents can declare they are exempt using the California Franchise Tax Board (FTB) Form 590.
Nonresidents can request a waiver from the FTB by submitting Form 588 Nonresident Withholding Waiver Request or Form 589 Nonresident Reduced Withholding Request.
Nonresidents' reasons for waiver include:
- Payee has submitted California Tax returns for the last two years, being considered current on any tax obligations with the Franchise Tax Board (FTB).
- Payee is making timely estimated tax payments for the current taxable year. Payee is considered current on any tax obligations with the FTB.
The waiver request must be submitted to the state, and the waiver is held by the property manager. If these requirements are not met, then the property manager will need to withhold 7% of rents collected and make quarterly payments to the state.
The rental property owner will need to file with the state to get any refund for which they may qualify. Once the property owner has been filing with the state, they can file and are current, then they should be able to qualify for a waiver, making withholding unnecessary.
This is part of your property management agreement. It can be confusing, so please consult a qualified tax professional.
Thank You
Thank you, and we hope that you found this helpful and informative. Remember, we are not attorneys, so we don’t give legal advice. Laws are always changing and vary depending on the specific municipality in which the property is located. For legal advice, please consult a real estate attorney familiar with the laws in your area.
For Real Estate Advice
If you are looking for a reliable property management company to help you handle a rental property or a real estate broker to guide you through the sales process in Long Beach, Los Angeles, or Orange County, California, or if you are just considering it and have a few questions about real estate, contact the Mike Dunfee Group today! We are happy to help.
Dunfee Real Estate Services, Inc. DRE # 02026232
