California Tax Pulse

What happens when a California executive leaves the state and later receives a multimillion-dollar severance payment tied to the job he actually performed in California? According to the California Office of Tax Appeals, the answer may depend less on where he worked before leaving and more on where his contract required him to work in the future.

California has a reputation for following former residents, and their income, long after they leave the state. But a recent Office of Tax Appeals decision Appeal of J. Otting and Y. Otting, 2026-OTA-403P, currently designated pending precedential, shows that California’s sourcing rules have limits, even where the underlying employment was unquestionably centered in California. The OTA held that severance payments and employer-paid medical premiums received by a former California resident after moving to Nevada were not California-source income because they had not acquired a business situs in California. At the same time, the OTA held that certain restricted stock unit payments remained taxable by California because they were attributable to services actually performed in the state and had acquired a California business situs.

The facts made the severance holding particularly interesting. Otting was the president and CEO of California-based OneWest Bank and later became president and CEO of CIT Bank after OneWest was acquired by CIT. He worked from a main office in Pasadena. On December 8, 2015, CIT filed a Form 8-K announcing his termination, and Otting moved from California to Nevada the very next day. CIT's formal termination letter, dated December 14, 2015, set his last day of employment as December 31, 2015, the same date on which the first tranche of his RSUs was scheduled to vest. In 2016, after signing a separation agreement and release, he received severance calculated as a set monthly rate times the 32 months remaining on his three-year employment agreement (effectively mirroring his maximum potential future wages and bonuses), along with medical-premium payments and payments relating to those RSUs. CIT reported the amounts on a Form W-2, and the FTB's proposed assessment on audit totaled $1,800,858 in additional tax, plus interest.

The FTB argued that the termination payments were essentially California wages because Otting’s employment had been performed in California. OTA disagreed.

Relying on the longstanding Appeal of McAneeley, OTA concluded that a payment received for termination of an employment contract is income from an intangible contract right, rather than compensation for previously rendered services. For a nonresident, income from an intangible is generally sourced to the taxpayer’s domicile unless the intangible has acquired a business situs in California under Regulation Section 17952. OTA also rejected the FTB’s reliance on federal and California authorities treating severance as “wages” for FICA or employment-tax purposes, reasoning that those rules did not answer the separate income-tax sourcing question.

Notably, the FTB did not simply lose on the facts; it lost a direct challenge to McAneeley itself. The FTB argued that the 46-year-old precedent was wrongly decided, or at least should not extend to these facts, pointing to its own 2022 revision of its audit manual (which now treats severance tied to California employment as includible California income) and to U.S. v. Quality Stores, Inc., a U.S. Supreme Court decision treating severance as “wages” for FICA withholding purposes. OTA rejected both arguments, holding that an internal audit manual is not binding authority and that Quality Stores addressed a different question, specifically employment-tax withholding, not income-tax sourcing. McAneeley survived intact.

That’s where the decision gets particularly interesting.

Otting had actually performed his services for CIT Bank in California, and OTA acknowledged that, had his employment continued, it was reasonable to predict that he probably would have continued working predominantly in California. But that was not enough. His contract did not require the future services to be performed in California, he also worked with nationwide wholesale operations, and CIT itself was headquartered in New York. Because nothing restricted his future employment to California, OTA concluded that his right to those future wages had not acquired a California business situs.

Because the characterization of a settled claim follows the characterization of the underlying claim, OTA had to work through each right Otting surrendered under the Release separately. Beyond the waiver of future wages discussed above, the Release also released rights tied to his immediate resignation and return of company property, his nondisclosure, non-disparagement, cooperation, and release obligations, and his noncompetition and nonsolicitation restrictions. Each of those obligations extended beyond California. The noncompete, for instance, barred him from working for any competitor in the banking industry nationwide, an industry he had worked in for over 40 years. His right to future medical premiums likewise was not tied exclusively to California. None of those rights, individually or collectively, therefore had a California business situs.

The RSUs were different. The RSUs paid in 2016 related to the portion that vested on Otting’s final day of employment, and the relevant services from grant through vesting had been performed entirely in California. OTA reasoned that just as a nonresident corporate officer's compensation for a period of California employment is treated as California-source income under Regulation Section 17951-5(a)(4), compensation wholly attributable to that officer's California employment should likewise be found to have acquired a business situs in California under Regulation Section 17952, even where that compensation is deferred and ultimately paid out as part of a termination package. OTA therefore treated those rights as looking backward to services actually performed in California, rather than forward to services that might have been performed there. Those RSUs had acquired a California business situs and remained California-source income.

That distinction may be the most important takeaway from Otting. For executives leaving California with compensation still outstanding, simply asking where the individual worked before the move may not be enough. The better question is: what is the payment actually for?

Amounts attributable to services already performed in California, such as the RSUs in Otting, may remain California source. But a payment for relinquishing future contractual rights may be sourced differently, even where the employee historically worked in California and probably would have continued to do so. The geographic scope of the employment agreement, release, restrictive covenants, and other rights being surrendered can therefore matter significantly.

Since this analysis is different than some other states apply (e.g. New York), this can impact the available resident credit.  For example, what if we have the inverse of Otting where an executive works in New York, receives a large severance payable over 5 years, and then moves to California? New York will impose tax on the severance payments, but if we’re applying the “business situs” analysis, California might too, meaning this income could potentially be double taxed by New York and California!

For former California executives negotiating severance, deferred compensation, or equity payments around the time of a move, Otting is an important reminder that residency and sourcing are separate inquiries, and that the terms of the underlying agreements matter. With the decision still designated pending precedential, we'll be watching to see whether it is finalized as precedential and how the FTB responds in future audits involving departing executives.