Reevaluating California’s Equal Protection Clause Amid COVID-19

Maria is a billionaire executive of a large company and a citizen of X. X is located on the other side of the Pacific Ocean. All of her family lives in X. She owns several houses, including her principal residence there. X does not have any applicable tax treaties with the United States.

On February 1, 2020, Maria came to California on an L-1 intracompany transfer visa to conduct business for her enterprise.¹ She planned to work for six months before returning to Country X on July 30, 2020. She timed her stay so that she should not be subject to California taxation on her worldwide income.² When she arrived here, she rented a large expensive mansion for $10,000 a month (something that her status as a billionaire executive easily allowed her to afford), subscribed to a local gym, bought a local SIM card, and made several personal investments in a few promising California start-ups. She also joined a local yacht club. She did not maintain any other close ties to California.

Two months ago, X closed its borders because of COVID-19. All flights to and from X are now canceled. Maria is effectively stuck here indefinitely. Seeing no way to return home, Maria feels obligated to buy the house that she rents for fear that she will be otherwise homeless. She also begins seeing a local psychologist because of the depression she feels for being separated from her family indefinitely. With each day that passes after July 30, 2020, she will become increasingly exposed to potential California income tax liability on her worldwide income.³

Aside from any statutory relief the Legislature may grant out-of-state taxpayers who are indefinitely sheltered in California because of the coronavirus, or who are fearful of returning to their place of origin, does she have any arguable protections under the California Constitution? In particular, can she successfully claim that imposition of taxation on her worldwide income under the present circumstances would violate the California state constitutional right of equal protection,⁴ as applied to her?

This article will explore the California equal protection clause and will examine how it might apply to someone like Maria or to other foreign taxpayers present in California during the age of COVID-19. The article will compare the state equal protection right with its counterpart under the U.S. Constitution. It will explain how the state constitutional equal protection right may reach further and deeper than the corresponding federal right regarding Maria’s situation.

Among other distinctions that this article will explain, the California equal protection clause covers several “suspect classifications” (groups of individuals who may be entitled to enhanced legal protections) in addition to those included within the federal clause. Furthermore, California equal protection is not subject to the preliminary requirement of state action before it can be invoked. Finally, the California clause is stronger in covering equal protection violations “as applied” to specific circumstances regarding otherwise facially neutral laws. All these differences could be of great benefit to Maria.

This article is not just a case study of a specific statutory tax matter, the taxation of worldwide income. It is a springboard for considering fundamental personal protections guaranteed under the California equal protection clause in connection with a broad host of state tax issues that state and local tax and other tax practitioners confront on a daily basis. With the spread of COVID-19, and the economic devastation it has left in its wake, tax issues are bound to expand and resurface.

As just one example, the partial reopening of schools might begin soon on a district-by-district basis. Wealthier school districts may be able to offer Zoom-based learning, superior onsite social distancing for staff and students, better healthcare and contact tracing, and a greater variety of after-school activities than poorer school districts. The disparities in local income raised by the property tax — a main source of school funding — may rekindle the contentious legacy of Serrano v. Priest, in which the California Supreme Court invalidated the statewide property-tax-grounded school funding system in place at the time as violating the state’s equal protection clause because it discriminated based on wealth.⁵ Wealth is a suspect classification under the state clause, but it is not such a classification under the federal clause.⁶

This article will focus exclusively on the equal protection clause of the California Constitution,⁷ but tax practitioners in other states may find similar opportunities to raise arguments based on their own state constitutions.

Potential Taxation of Foreigners’ Worldwide Income

The IRS and California Franchise Tax Board use two different systems to determine whether a person qualifies as a resident for tax purposes and thus is taxable on all income, wherever and whenever earned during a tax year. The specific factors that apply under each system are beyond the scope of this article. The following brief overview is nevertheless important to provide context for Maria’s unanticipated prolonged stay in California during the coronavirus epidemic.

The Federal Government Uses the Substantial Presence Test

To determine if a foreigner like Maria is a resident of the United States for federal income tax purposes, and therefore is subject to taxation on her worldwide income, the federal government uses the “substantial presence test.”⁸ This test is mechanical and somewhat complicated. It involves counting the total days of Maria’s “presence” in the United States over a three-year period, discounting days that are excluded, and then possibly applying exceptions to the entire formula.⁹ The most commonly sought exception is known as the “closer connection” exception, which requires a foreigner to demonstrate both the existence of a “tax home” in another country and a closer connection to that country than to the United States.¹⁰

The Mechanics of the Substantial Presence Test

The IRS first examines whether Maria has been present in the United States for 31 days during the current tax year. If that requirement is satisfied, the next step is to calculate if she has been present in the United States for a total of 183 days during a three-year period that includes the current year and the two years immediately beforehand.¹¹

The IRS will weigh each of the three years differently:

• For the current year (in Maria’s case, 2020), each day will be counted as a whole day.

• For the previous year (2019), each of her days will count as a third of a day.

• For the initial year (2018), each day will count as one-sixth of a day.

If the IRS determines that the taxpayer has been present in the United States for a total of 183 days or greater, as calculated above, the taxpayer will then need to assess if she can eliminate any of these days under exceptions enumerated in 26 U.S.C. section 7701(b).¹² Otherwise, she may be taxed on all of her includable income, regardless of its origin.¹³

Under normal circumstances, Maria would be subject to federal income taxation on her worldwide income if she stays in the United States for a total of more than 183 days over three years and cannot exempt any of her days of presence.¹⁴ But because of COVID-19, the IRS has come to her assistance by releasing Rev. Proc. 20-2020,¹⁵ which can extend the amount of days Maria can exclude from her presence under the three-year substantial presence test.¹⁶

The Franchise Tax Board Uses the California Residence Test

Unlike the federal government’s primarily mechanical substantial presence test, California has a different approach to determining if Maria is a resident. In California, nonresidents are subject to tax on California-source income only, whereas residents are subject to California taxes on their worldwide income.¹⁷ California’s test is based primarily on Maria’s individual facts and circumstances.¹⁸

Under Revenue and Taxation Code section 17014, a resident is an individual who is (1) in the state for other than a temporary or transitory purpose (the “purpose” test) or (2) domiciled in the state who is outside the state for a temporary or transitory purpose (the “domicile” test).¹⁹

Each test might affect Maria adversely.

Purpose test. For state tax purposes, California defines a resident as a person who is “in [California] for other than a temporary or transitory purpose.”²⁰ The FTB lists a series of factors to weigh when determining residency as a starting point.²¹ However, the main case identifying the major factors to be considered is the Appeal of Stephen D. Bragg.²² These factors are:

On one hand, the breadth of some of these factors will probably aid Maria. No matter how long she is constrained to remain in California, her spouse and children will almost certainly remain in X. Her principal residence, vehicles and financial accounts will likely remain in X, as well (although these circumstances could conceivably change with a long passage of time, should Maria find that she needs more economic connection with California). So too might the location of her banks, attorneys and accountants. On the other hand, because of COVID-19, she has now created more economic ties with California, through buying the California house and seeing the psychologist. Though the house might be a drop in the bucket for Maria, given her billionaire status, when combined with her SIM card, gym membership, yacht club membership, and investments, these facts might enough to make her a resident for California purposes. As with any “facts and circumstances” weighing, there are no hard and fast rules. The taxing authorities, and ultimately the courts, are vested with wide discretion. What may seem an overall lack of purpose to remain in California to one factfinder may seem the opposite to another factfinder.

Because of this ambiguity and the high stakes of being taxed by California on her worldwide income, Maria might seek out written guidance from the FTB. The FTB provides two examples of what may or may not constitute a “temporary or transitory purpose”²⁴:

• The first example is an executive who comes from New York to California for less than six weeks. The executive averages one to two weeks at a time in California while her family stays in New York. Her visits would be deemed temporary or transitory, and she would not be subject to California tax.²⁵

• In the second example, an individual moves to California from Illinois on an indefinite job assignment. That individual keeps her house in Illinois before eventually selling it. She would be considered a California resident and subject to taxation.²⁶

These examples are of limited use in assessing Maria’s situation, because they involve interstate travel, not international travel, and they assume the individual can freely travel to and from California. Unlike the IRS substantial presence test, which applies only to foreign individuals who stay in the United States, the California residence test applies to individuals who come to California from sister states as well as from foreign nations.²⁷ It would most likely be much less of a burden for a person to return home to Nevada, Oregon, or even a state on the East Coast than it would be for Maria to cross the Pacific Ocean and return to X, given the lockdown there and lack of available flights. This disparity of circumstances may give Maria grounds to raise an equal protection objection in a California court should the FTB seek to tax her on her worldwide income.²⁸

Domicile test. In addition to assessing residency based on purpose, California also has a second category of individuals who are deemed residents for state tax purposes. Any individual who is “domiciled in [California] who is outside the state for a temporary or transitory purpose”²⁹ will also be considered a tax resident for California purposes. In this category, “domicile” is defined as a person’s permanent home; that is, the place to which she intends to return from wherever else she may be residing at the moment.³⁰

It is difficult to say whether this test would apply to Maria (she finds herself stranded within California, not outside of the state). Although she bought the California mansion, she also has several homes in X. A good argument could be raised that the place where she intends to return is her home in X, not the house in California.

Even if the test does not apply, however, a concern remains, because the test contains a rebuttable statutory presumption that every individual “who spends in the aggregate more than nine months of the taxable year within this State shall be presumed to be a resident.”³¹ The presumption of residency can be overcome by satisfactory evidence, usually based on intent.³²

If Maria remains in California for more than nine months during 2020, she might need to overcome the presumption of California residency under the “domicile” test. She needs to take that language into account.

Explanatory Language in Rev. Proc. 20-2020 That May Provide Bases for a Constitutional Challenge in California

The mechanics of Rev. Proc. 20-2020, which apply to federal income taxation only, are not directly pertinent to Maria’s possible exposure to California state income taxation. What is significant about Rev. Proc. 20-2020 is its succinct language summarizing numerous reasons why a foreign resident might be detained in the United States longer than expected because of the coronavirus:

This same language from the IRS revenue procedure should apply by direct analogy to Maria’s exposure to California taxation too. If she is assessed California taxes, the factors listed in Rev. Proc. 20-2020 provide her with a factual basis for raising possible constitutional, if not statutory, challenges to state taxation under the California residence test.

Equal Protection Rights Under the California Constitution as Potentially Applied to an Individual Like Maria

SALT practitioners and others are well aware that tax controversies that start out as issues of specific statutory interpretation can lead swiftly into the larger arena of constitutional rights. One instance in which a constitutional question may arise is when the language of a California statute, ordinance, or regulation is nondiscriminatory on its face but unexpectedly becomes inequitable when applied to an individual client or a unique situation.

That is the potential predicament in which Maria finds herself. The rules governing the California taxation of worldwide income may be facially rational and uniform,³⁴ but their impact could be unfair if imposed on Maria because of COVID-19. She would have greater difficulty avoiding the taxation of her worldwide income by returning home overseas to X than would other temporary residents who have come to California from sister states. The equal protection clause of the California Constitution, as applied, could probably aid Maria. As this article will explain, it could probably do so more extensively than its counterpart under the federal 14th Amendment. It is important to start by comparing the two protections.

Overview of the Federal and State Equal Protection Clauses

Among other provisions, section 1 of the 14th Amendment prohibits any state from denying “to any person within its jurisdiction equal protection of the laws.”³⁵ With some delimited limitations, California Constitution Article I, section 7(a) similarly states that a “person may not be . . . denied equal protection of the laws.”³⁶ Although the language of the state and federal equal protection clauses is virtually identical, the origin, scope, and interpretation of these two clauses are not.

The 14th Amendment was adopted July 28, 1868. Before that date, the U.S. Constitution contained no mention of equality.³⁷ The Fifth Amendment in the original Bill of Rights, which ultimately served as the foundation for the 14th Amendment, guaranteed due process of law but not equal protection.³⁸ Moreover, the original Bill of Rights did not extend its scope to the states.³⁹

The 14th Amendment was promulgated decades after the Fifth Amendment and only three years after the end of the Civil War.⁴⁰ It was part of reconstruction and the federal government’s overall response to the end of slavery.⁴¹ The U.S. Supreme Court did not meaningfully address the application of the federal equal protection clause until the very end of the 19th century.⁴² When the Supreme Court finally began considering the scope of equal protection, the earliest decisions involved primarily economic controversies, and almost all of them rejected the equal protection challenges under the rational basis analysis, to be discussed later.⁴³

Although California adopted the current version of the state equal protection clause in 1974, its origins date back far earlier, to 1849.⁴⁴ The 1849 constitution predates California’s admission to the United States on September 9, 1850.⁴⁵ The original equal protection provisions in the 1849 constitution predate their federal counterparts, and the end of the Civil War, by almost 20 years. The territory of California had for many years been subject to Spanish and Mexican civil law systems.⁴⁶ Under these civil law systems, especially regarding community property, the equality principle was already deeply embedded.⁴⁷ The 1849 California Constitution was not a reaction to slavery, which was never lawful in the state either before or after its admission to the United States.

In short, the equal protection guarantees of the 14th Amendment and the California Constitution have vastly dissimilar histories. They should not necessarily be interpreted in lockstep with each other.

Reasons Why California Tax Lawyers Should Argue Both the Federal and State Equal Protection Clauses

To be thorough, tax lawyers will generally advance the same equal protection claim twice: under the identical or nearly identical language in both the U.S. and state constitutions. Many courts have tended to rule on these federal and corresponding state claims as if they are essentially duplications, although the same courts recognize in principle the individual nature of the two provisions. For instance, in Department of Mental Hygiene v. Kirchner, one opinion stated:

This tendency toward uniform interpretation is unfortunate, because the two clauses diverge from each other in important ways.

State courts are entitled to interpret their constitutional provisions independently of federal courts, even when the constitutional language of the provisions is identical.⁴⁹ In fact, numerous scholars and jurists, including a distinguished former member of the U.S. Supreme Court, maintain that state courts should ideally look to their own state charters first before examining the U.S. Constitution regarding a state protection.⁵⁰ Tax attorneys can best advance their clients’ positions by explaining how equal protection may reach further and deeper under the California Constitution than under the federal counterpart.

The Deferential Rational Basis Test Normally Applies to the Power of Legislative Bodies to Enact Tax Laws

It is important to note that the differences between the equal protection clauses of the California and federal constitutions occur primarily when suspect classifications are involved. In most cases, including tax cases, a large measure of uniformity exists concerning equal protection claims. California and federal jurists habitually apply the same deferential rational relationship test to the power of municipalities, counties, special districts, and legislatures to enact tax laws, even if those laws deliberately place a greater burden on some taxpayers than they do on others.⁵¹

Under the rational relationship test, a law will withstand an equal protection challenge as long as some rational basis supports the disparate treatment of individuals or entities, and the law itself is not “palpably arbitrary.”⁵² The burden is on the taxpayer, not the state, to prove the unconstitutionality of the statute.⁵³ The courts instruct that tax statutes “generally. . . can be justified on the basis of administrative convenience and promotion of legitimate state interests.”⁵⁴ Thus, the taxing entity often has a great deal of leeway.

In City of San Jose v. Donohoe, the California Court of Appeal summarized these rules when affirming a San Jose utility tax ordinance against a taxpayer’s claim of an equal protection violation⁵⁵:

This list of justifications is daunting, and equal protection objections to taxing schemes almost always fail as a result.

Strict Scrutiny Applies When the Discrimination Affects a Suspect Classification, and California Recognizes More Suspect Classifications Than the Federal Courts

The similarity between the federal and California courts’ equal protection clauses diminishes in situations when the strict scrutiny test applies. Under the strict scrutiny test, if a law treats a member of a “suspect class” differently from others, the burden shifts to the state to prove a compelling interest justifying the different treatment.⁵⁷ Absent such proof, the law is deemed to be unconstitutional.⁵⁸ The federal courts have identified a limited number of suspect classes.⁵⁹ California courts have added others that are not covered under federal jurisprudence.⁶⁰

One of these additional suspect classes, wealth, has played an essential role in the most famous property tax decision in recent California history.⁶¹ In Serrano v. Priest (Serrano I),⁶² the California Supreme Court originally found that “the California public school financing system, with its substantial dependence on local property taxes and resultant wide disparities in school revenue, violates the equal protection clause of the Fourteenth Amendment.”⁶³ The state supreme court reasoned that the funding scheme “invidiously discriminates against the poor because it makes the quality of a child’s education a function of the wealth of his parents and neighbors.”⁶⁴

In Serrano II, the state supreme court essentially reaffirmed its ruling in Serrano I but based it exclusively on the California equal protection clause rather than the 14th Amendment.⁶⁵ The reason for the change of emphasis was that between the dates of Serrano I and II the U.S. Supreme Court had decided that wealth is not a suspect classification under the 14th Amendment.⁶⁶

In Serrano II, Justice Raymond Sullivan wrote that the intervening U.S. Supreme Court decision was not binding on the California court’s interpretation of the equal protection guarantees under the California Constitution. Sullivan reasoned that:

Thus, wealth remains a suspect classification under the California Constitution despite its nonrecognition as such under the 14th Amendment.⁶⁸

The California Equal Protection Clause Does Not Require State Action as a Prerequisite

There is a second big difference between the federal and California equal protection clauses. California does not require state action in order to pursue a claim, whereas the 14th Amendment does.⁶⁹ The 14th Amendment acts as a limitation on the power of states — “nor shall any state . . . deny to any person within its jurisdiction the equal protection of the laws.”⁷⁰ The federal courts have long found that to be remedied, an equal protection denial must be the result of state action.⁷¹ In other words, the government must have been responsible for the violation.⁷² If discrimination is not the result of state action, there is no equal protection remedy under the 14th Amendment.⁷³

Unlike the federal Constitution, the state constitution lacks a state action requirement. The California Constitution merely states that a “person may not be . . . denied equal protection of the laws.”⁷⁴ California has a history of applying the California Constitution’s equal protection clause to private actors and in the absence of state action.⁷⁵

This difference is important for understanding how Maria could advance a claim that taxing her on her worldwide income would violate California’s equal protection clause. An argument could be made that the coronavirus is a medical calamity that did not arise from governmental action. Because no state action caused it, Maria might face difficulty mounting a claim under the federal equal protection clause based on the fact that she is stuck in California because of COVID-19 whereas American nationals are not. She might have more success under the California equal protection clause, which contains no state action requirement.

The California Equal Protection Clause More Consistently Covers Discriminatory Effect as Well as Intent

Another important distinction between the scope of the federal and state equal protection clauses is their treatment of laws that have no discriminatory intent but cause discriminatory effects. The U.S. Supreme Court has found that the federal equal protection clause generally prohibits only purposeful discrimination.⁷⁶ Former California Supreme Court Justice Joseph Grodin notes:

Thus, the federal equal protection clause often does not protect against laws with no discriminatory intent but with discriminatory effect.

On the other hand, courts have invoked the California equal protection clause to strike down facially neutral laws with discriminatory effects. For instance, during the era of school busing, the California Supreme Court ruled that school boards had an obligation to take reasonable steps to alleviate school segregation “regardless of [the] cause.”⁷⁸ Even when the segregation had not been purposeful, the California Supreme Court found the then-existing laws allowing students to transfer out of their assigned schools to be a violation of the California equal protection clause.⁷⁹ The court ruled that these laws inevitably promoted segregation.⁸⁰ The court in Crawford noted:

The broader reach of the California equal protection clause could help Maria advance her claim. The California rules on the taxation of worldwide income are not discriminatory on their face. Maria could nonetheless make a strong argument that they have the effect of discriminating against her based on national origin.⁸² Unlike her counterparts from other states who can simply avoid taxation by returning to their states of origin, Maria does not have the same luxury of being able to return to her home country.

One might argue that Maria could simply pick up and move to another state, thereby avoiding California taxation on her worldwide income. This argument ignores the fact that most other individuals returning to their home states because of the coronavirus already have homes and connections there. Maria likely has none of these. The cost of Maria relocating to a state that she has even less of a connection to and desires to be in even less than California would be far greater than for these people, as would be the disruption to her life and her job.

Recap

In summary, Maria may be more successful in advancing a claim that California’s taxing her on her worldwide income violates her right to equal protection under the California Constitution than under the 14th Amendment. California recognizes more suspect classifications than the federal courts. The California equal protection clause does not require state action as a prerequisite. Lastly, the California clause is more often applied to laws with no discriminatory purpose but with a discriminatory effect.

Other California Equal Protection Issues That May Arise

Maria’s situation is likely not the only California equal protection issue that could arise because of COVID-19. For instance, as an article in The New Yorker recently pointed out, there will be great disparities in how rich and poor school districts cope with the closing and reopening of schools⁸³:

Such differences could well find their way to the California courts, where Serrano and its progeny would certainly be reexamined. Courts could very well hold that funding disparities among school districts, still dependent to some degree on property taxes, do not violate the federal equal protection clause but violate the California equal protection clause.

Conclusion

In the age of COVID-19, tax lawyers should be aware that their clients stranded in California may be able to claim that existing tax regimes violate the California equal protection clause as applied. The California clause is broader in scope than the federal clause, and it is often interpreted differently. By understanding and advocating for these differences, tax lawyers can ultimately better represent their clients. Tax lawyers in other states should likewise carefully examine their state constitution to ascertain if they can find advantages for their clients.