California taxes are a common complaint in the Golden State, with legislators considering increases. Effective on Jan. 1, 2024, the new top income tax rate in California is 14.4%, up from the previous 13.3%. This increase is due to the removal of a limit on the State Disability Insurance employee payroll tax, resulting in a top rate of 14.4% for those earning over $1 million. The 13.3% rate still applies to capital gains, a source of frustration for California investors as it is significantly higher than rates at the federal level.
At the federal level, long-term capital gains are taxed at a lower rate compared to ordinary income, with rates varying depending on income levels. However, under Biden’s proposed FY 2025 budget, high-income taxpayers could see their long-term capital gains tax almost double to 39.6%. There is also a possibility of this rate going as high as 44.6% if various proposals are combined. While it is uncertain whether this significant increase will be enacted, it remains a concern for investors.
California residents, especially those facing the state’s high tax rates on capital gains, may consider moving to lower tax states before selling their assets. States like Texas, Nevada, Washington, Wyoming, and Florida offer no or lower income tax rates compared to California. However, moving to avoid taxes requires careful planning to avoid triggering a residency audit by California’s Franchise Tax Board. Residency audits can be rigorous, with California considering various factors to determine if an individual is a resident.
When it comes to California residency, time spent in the state versus outside, as well as closer connections to another state, are crucial factors. Failing to establish non-residency can lead to tax assessments by California, even if an individual lives elsewhere. Audit periods in California can also be lengthy, with the state having the ability to audit indefinitely for individuals who never filed income tax returns. Filing as a non-resident can be a strategic move to report only California-source income, such as rental income or income from California partnerships or LLCs.
Overall, the tax landscape in California and at the federal level is evolving, with potential increases in long-term capital gains taxes causing concern among high-income taxpayers. For Californians looking to reduce their tax burden, moving to lower tax states may be an option, but the process requires careful consideration to avoid triggering residency audits. Keeping abreast of changes in tax laws and regulations is essential for individuals looking to navigate the complex tax environment effectively.
