California taxes have long been a point of contention among residents, with legislators considering increases regularly. Recently, the top income tax rate in the state was increased from 13.3% to 14.4% effective January 1, 2024. This increase is due to California’s 1.1% employee payroll tax for State Disability Insurance, resulting in a top rate of 14.4% for individuals earning over $1 million. Despite this high rate, California’s 13.3% rate still applies to capital gains, which has been a source of frustration for investors in the state.
At the federal level, long-term capital gains are subject to a lower tax rate, with the top federal ordinary income rate at 37% and the federal capital gain rate at 20% for higher income taxpayers. Adding the 3.8% net investment tax brings the total to 23.8%. When combined with California’s 13.3% rate, individuals in the state are paying more on capital gains than most other places in the world. President Biden has proposed further tax increases, with the potential for the long-term capital gains tax to nearly double to 39.6% for high-income taxpayers, potentially reaching as high as 44.6%.
Many Californians facing high capital gains taxes are considering moving to states with little to no income tax, such as Texas, Nevada, Washington, Wyoming, and Florida. However, the process of moving must be carefully navigated to avoid residency audits by California’s Franchise Tax Board. California law presumes individuals spending more than nine months in the state to be residents, with serious tax implications for those who are deemed residents. Objective factors and connections to other states are used to determine residency status.
California tax audits can be lengthy and intimidating, with the possibility of indefinite audits in some cases. Filing a non-resident tax return, reporting only California source income, can be a strategic move to simplify the process and potentially reduce tax liabilities. This approach involves reporting income from California sources only, such as rental income from California properties and Schedule K-1s from California partnerships or LLCs. By carefully managing their residency status and tax filings, individuals can navigate California’s complex tax laws and potentially reduce their tax burden.
