For a decade, the top California income tax rate was 13.3%, but effective on January 1, 2024, the new top rate is an eye-watering 14.4%. It could get even worse. There been several proposals over the last few years to increase the top rate as high as 16.8%, and even to exact a proposed wealth tax, although so far these measures did not pass. If the latter is ever enacted, it could tax California’s wealthy every year on wealth—not income—and even follow and tax wealthy people after they left the state. However, a more modest 1.1% increase in the income tax rate passed in 2023 and is now in effect.
The new 14.4% rate is the result of no limit on California’s 1.1% employee payroll tax for State Disability Insurance. It translates to a top 14.4% rate for those earning over $1 million. However, there is a modest tax break for capital gain, so small it seems hard to call it a break. California’s 13.3% rate still applies to capital gain, and that very high rate has long been an irritant to California investors. At the federal level, there is a big benefit accorded to long term capital gains.
The top federal ordinary income rate is 37%, while the federal capital gain rate is 20% for higher income taxpayers. Add the 3.8% net investment tax under Obamacare, and you have 23.8%. By paying 23.8% plus 13.3%, Californians are paying more on capital gains than virtually anyone else in the world. Will more people move away? Probably not over this 1.1% increase, but people contemplating big stock sales, sales of a company, a big lawsuit settlement or other major income event—and facing California’s 13.3% tax on capital gains may consider moving and then selling.
California loses citizens for no-tax states like Texas, Nevada, Washington, Wyoming and Florida, and you don’t have to move to a no-tax state to pay less. Every other state has lower income tax rates than California, either no tax or lower tax. Of course, the details matter. Moving sounds easy, but if you aren’t careful how you do it, you could end up saying goodbye California taxes, and hello to a residency audit.
California’s tough Franchise Tax Board (FTB) monitors the line between residents and non-residents, and can probe how and when you left. The burden is on you to show you are not a Californian. If you are in California for more than nine months, you are presumed to be a resident, and more than six months can often cause problems too. In some cases, California can assess taxes no matter where you live.
Many people who leave have unrealistic expectations and have a hard time distancing themselves from California, and procedure counts. California looks to objective factors to determine residency. Your time in California versus time outside counts. California uses a comparative analysis to see if you have closer connections to another state.
Audit periods can also be scary. The IRS can audit 3 or 6 years, California can sometimes audit forever. That is, California, like the IRS, gets unlimited time to audit if you never file an income tax return. That can make filing a non-resident tax return—just reporting your California-source income as a non-resident—a smart move. Continuing to file in California as a nonresident can be wise. That way, you are just reporting your California source income, but not everything else. California source income would include rental income from California property, Schedule K-1s that you might receive from California partnerships or LLCs could reflect some California source income too.