California is a beautiful place to live, but living in the Golden state comes with a complicated income tax system. In fact, California’s tax system varies significantly from the federal tax system in many different ways. For example, this state has its own deductions and credits that you may benefit from, especially with the new Senate Bill 113 and California AB 150.
If you want to learn more about how you can reduce your tax liability or if you need to pay state taxes, continue reading below. This brief California state income tax guide will walk you through what you can expect for this tax year.
Do I Pay California State Income Tax?
In general, if you are a non resident, full-time resident, and part-year resident, you will have to file a California state tax return. Also, if you are required to file a federal tax return, you may have to pay California state income tax. Anyone who has income above certain tax thresholds or who received a source of income from California during the tax year will also need to file a return.
There are three residency statuses in California: nonresident, part-year resident, and a full-time resident. Each of these statuses determines what portion you will have to pay state taxes on.
If you are a full-time resident, the state will tax all of your income from all sources regardless of it is inside or outside of California. Part-time residents will have all income received while they were a resident taxed.
If the part-time resident receives income from California sources while they were a nonresident of the state, that will also be taxed. Nonresidents must pay taxes on all income from any California sources.
Figuring Out Your Residency Status
Before we get into how much you will need to pay in taxes, you will first need to figure out your residency status. For example, you are a California resident for tax purposes if you lived in California and your presence was not transitory or temporary.
An example of a situation that makes you a resident of California for tax purposes is if you lived in California or spent time in California for more than nine months during the tax year.
Other California residency status situations:
- Your employer assigns you an office in California for an indefinite period or a long time
- You decide to stay in California for some time with no plans to move out
- You’re in California to recuperate from an illness for a long time
Students from California who go to college out of state aren’t automatically named nonresidents. This is the same for those who go to school in California. If you attend college in California, you aren’t automatically a resident.
In general, you are a part-year resident if you were a nonresident for a portion of the tax year. This is typically the case for people who recently have moved into the state from a different state.
If you fall into this category, you will need to pay California state tax on all of your income received when you were a resident of California. You also will need to pay taxes on income from California sources when you were a nonresident.
Nonresidents still need to pay California state tax on any income from California sources. This means that you may have to file a California state tax return even if you lived in a different state, but you still made money from a source in the state of California.
Examples of California related sources of income:
- Income from a California trade, business, or profession
- Sale or transfer of real estate
- Rent from real estate in California
- Any services performed in California
In other cases, you may be considered a nonresident for tax purposes even if you lived in California. If you went out of state for at least 546 consecutive days because of an employment contract.
Keep in mind that this exception won’t apply if you had more than $200,000 in income while the employment contract was in effect or if the state thinks that you purposely left the state to evade taxes. This exception also won’t apply if you were in California for more than forty-five days during the tax year.
Pass Through Entity Tax Update
On Feb 9, 2022, Governor Gavin Newson signed a bill known as Senate Bill 113, which allows businesses to elect the pass through entity tax. Previously, business owners were not able to reduce their net income tax below the tentative minimum tax. This senate bill now allows many business owners to reduce their net income below the tentative tax income.
This bill also expands the definition of what a qualified taxpayer is. It now includes single member LLCs owned by trusts, estates, or individuals to receive a pass through entity tax credit.
It also expands the definition of a qualified taxpayer to include entities that have partnerships as partners. It is important to note that partnerships are not considered qualified taxpayers. This means that their income is not included in the pass through entity tax credit.
This new tax bill also includes guaranteed payments to consenting qualified taxpayers for the purposes of computing the pass through entity tax.
When Is This Bill Effective?
Senate Bill 113 is effective for the tax year beginning on or after Jan 1, 2022. This allows other state tax credits to be used before the pass through entity tax credit. This bill also ends the temporary suspension of net operating losses, and it also takes away the five million dollar business credit limit enacted under Bill 85.
For taxable years after Jan 1, 2019, Senate Bill 113 excludes gross income any amount received from federal restaurant revitalization adopts and grants. Businesses that consider making a pass through tax entity election could see significant tax benefits.
It is very important to note that making the decision to elect pass through entity requires modeling and analysis of your business. In order to do that, you may want to reach out to a reputable tax advisor to help you sort through this new bill to see if it will benefit you and your business.
California AB 150
Governor Gavin Newson also recently signed AB 150 (Assembly Bill 150), which creates a workaround for the $10,000 limitation on state and local taxes deduction. This workaround creates an elective tax that allows taxes on pass-through income.
Business owners now can bypass the federal cap limitation, paying their taxes at the entity level. This bill is effective through all of 2021 and continues up until the tax year 2025.
How to Elect AB 150
During the tax years of 2021 to 2025, qualified entities can make this election annually on their original and timely filed returns. Once they do that, they can pay the tax on their share of the net income of their qualified entity.
Qualified entities for this bill are limited liability companies with multiple members, S corporations, and partnerships. Any pass-through entities with partnerships or a disregarded entity as an owner of a public traded partnership are disqualified from this bill. Any entities that must be in a combined reporting group also do not qualify for this bill.
How Does AB 150 Work
Qualified owners must consent for their qualified business to pay the 9.3% tax rate on their share of net income. Each qualified owner must elect to be subject to the pass through entity tax. If they do not elect to be included, the qualifying business entity can still elect to pay the pass through entity tax for other members.
The qualified business entity pays this elective tax on the sum of their qualified net income for the tax year of each qualified taxpayer. Qualified owners will receive a nonrefundable credit against their income tax liability. If the allowable credits exceed their California tax liability, the excess can be carried over into upcoming tax years for up to five years.
Income Exempt From California Tax
There are certain types of income exempt from tax in California, but they are still taxable on your federal return. An example of income exempt from the tax is any interest earned on federal bonds.
Other sources of income exempt from California tax:
- State income tax refunds
- Social security benefits no included in your federal adjusted gross income
- Distributions from HSAs (health savings accounts)
- California state lottery winnings
- Railroad retirement benefits
Keep in mind that on the flip side, you will have to pay taxes on some types of income, such as foreign earned income. That type of income is not taxed at a federal level, but it may be subject to taxes at the state level. Any interest earned on local, municipal, and state bonds from outside California may also be taxed.
If you received any alimony, that alimony is considered taxable income in California even though it is not taxable at the federal level after 2018. If you are the spouse paying spousal support or alimony, you are entitled to a tax deduction for the amount you pay.
California Itemized Deductions
California does not allow some federal itemized tax deductions such as adoption expenses, higher education expenses, or contributions to health savings accounts. The number of federal deductions such as charitable giving and IRA contributions is also very limited in the Golden State.
There is no need to fret; there are other deductions that California does have that you can take advantage of. For example, interest on loans from utility companies is deductible when the loan is used to purchase and install energy-efficient products.
California Standard Deduction
The California standard deduction is remarkably lower than what the Internal Revenue System offers. For the 2021 tax year, the return you file in 2022, the state level deduction is $4,803 for single taxpayers, any registered domestic partner, and married taxpayers who file their returns separately.
The state-level deduction for registered domestic partners and married taxpayers who file jointly is $9,606. Any head of households or qualifying widows or widowers also qualifies for that standard deduction.
When comparing these state level deductions to the federal level of deductions, you will find that it is $12,550 for married taxpayers filing separately and for single taxpayers. For heads of households, their federal deduction is $18,800, and it is $25,100 for qualifying widows/widowers and married taxpayers filing joint returns.
Other California Tax Credits
Tax credits in California are deducted from any tax you owe the government. This makes these credits more advantageous than deductions. Deductions only reduce the income you’re taxed on.
In California, there is a $60 credit for single renters with incomes below $43,533. This number increases to $120 for registered domestic partners and married couples who file jointly with an income below $87,066. This credit is nonrefundable, and you must pay rent in California for at least half the tax year.
Child and Dependent Care Credit
There is a percentage of federal credit allowed for qualified dependent and child care costs. This credit is refundable, and it largely mirrors rules set out for the federal child and dependent care credit.
Joint Custody Head of Household Credit
Single and registered domestic partners/married who file separately and have a child can qualify for this credit. This credit is worth up to $484 for the 2021 tax year.
California Tax Rates
California tax rates vary each year slightly because they are based on California nonresidents’ income and resident incomes. California has nine tax brackets as of 2021.
California’s top individual income tax rate is approximately 12.3% on incomes over $599,012 for married/registered domestic partnerships who file separately and single taxpayers.
For registered domestic partners/married taxpayers who file together, the 12.3% threshold is $1 million. For the head of household filers, their threshold is $814,658.
At current, the lowest rate is 1% on incomes of up to $8,932 for single filers, and for all others, the lowest threshold is $17,864.
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Additional California State Income Tax Information
It is no doubt that living in California is a costly feat, especially if you own a business and need to write off certain tax deductions. The good news is, there is help with trying to figure out what your business can and cannot write off.
To help you navigate through these new changes, it is best to reach out to a reputable tax professional. If you found this article helpful and wish to learn more about different taxes you can write off in California, check out our blog.