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Must California Residents Pay State Tax on Income Earned Outside of California?


This blog will summarize general guidelines published by the California Franchise Tax Board. Keep in mind that we are not allowed to provide specific tax advice and that you are encouraged to review information in this blog with a qualified tax advisor who can better assist you to determine your personal tax liabilities.   

With tax filing deadlines looming, many of our California clients are asking about their obligations to pay California state income taxes on income earned from outside the state including on the proceeds from the sale of their rental properties located outside of California.

The unfortunate answer is:

Yes, California residents must generally pay state income taxes earned from ALL sources worldwide.

Per guidelines issued by the California Franchise Tax Board, all sources of income regardless of where earned “in the form of money, goods, property, and services” is subject to state income taxes unless exempted. 

Furthermore, if you earned income while working in another state or sold property in a state with a lower tax rate, you are still obligated to pay the higher California tax rate even if the other state has a lower tax rate. 

How About Income Earned in a State with No State Income Tax?

The following nine states do not have a state tax on earned income:  Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. As a California resident, you are still required to pay California taxes on income from tax-free states.  As an example, if you are receiving income from a rental property in Texas, you will need to report this income on your California tax return and pay applicable state income tax. 

While you will not be required to file a non-resident return in the tax-free state, the income must be included on your California return. 

How About Income Earned in States Having an Income Tax?

As a California resident, you will be obligated to file a non-resident tax return in the state where the income was earned and pay tax on the income earned in that state. Since California does not have any reciprocal agreements with any other states regarding taxes, you will be need to file state tax returns for both states unless it’s an income tax-free state.

However, you may claim a credit for income taxes paid to another state on your California return so you are not paying taxes twice.

Sale of Real Estate 

Following are examples of real estate transactions that may be subject to California income taxes. 

Example 1 – If you sell your California real estate and move out of state, the gain is taxable by California. The gain is taxable by California even if the real estate is sold when you are a nonresident. 

Example 2 – You are a resident of Idaho. You sold undeveloped real estate located in California at a gain. Because the property is in California, the gain is subject to California state taxes. 

Example 3 – You are a resident of California. You sold real estate located in a foreign country at a gain. Because you are a California resident, you are taxed on all income, regardless of source. The gain on the sale is taxable by California. 

Summary

As long-time residents have learned, California has some of the most aggressive tax rules in the US. In recent years, we have seen a growing number of California residents selling their California rental properties and reinvesting their equity in more landlord and tax friendly states. 

Keep in mind that moving equity from the sale of rental properties to states with lower tax rates does not necessarily reduce your obligations to pay California income taxes. 

Please contact us if you wish to receive referrals to tax advisors who may be able to provide further assistance to you. 

References:

https://www.ftb.ca.gov/forms/2019/2019-1031-publication.pdf

https://www.ftb.ca.gov/file/personal/credits/other-state-tax-credit.html

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Paul Getty

Paul Getty is a licensed real estate broker in the state of California and Texas and has been directly involved in commercial transactions totaling over $3 billion on assets throughout the United States. His experience spans all major asset classes including retail, office, multifamily, and student, and senior housing. Paul’s transaction experience includes buy and sell side representation, sourcing and structuring of debt and equity, workouts, and asset and property management. He has worked closely with nationally prominent real estate brokerage and investment organizations including Marcus Millichap, CB Richard Ellis, JP Morgan, and Morgan Stanley among others on the firm’s numerous transactions. Paul also maintains a broad network of active buyers and sellers of commercial real estate including lenders, institutions, family office managers, and high net worth individuals. Prior to founding First Guardian Group/FGG1031, Paul was a founder and CEO of Venture Navigation, a boutique investment banking firm specializing in structuring equity investments made by institutions and high net worth individuals. He possesses over 35 years of comprehensive worldwide business management experience in environments ranging from early phase start-ups to multi-billion-dollar corporations. His track record includes participation in IPOs and successful M&A activity that has resulted in investor returns of over $700M. Paul holds an MBA in Finance from the University of Michigan, graduating with honors, and a Bachelor’s Degree in Chemistry from Wayne State University. Paul Getty holds Series 22, 62, and 63 securities licenses and is a registered financial representative with LightPath Capital Inc, member FINRA /SIPC. Paul is a noted speaker, author, and actively lectures on investments, sales, and management related topics. He is author of The 12 Magic Slides, Regulation A+: How the JOBS Act Creates Opportunities for Entrepreneurs and Investors, and Tax Deferral Strategies Utilizing the Delaware Statutory Trust (DST), available on Amazon and other retail outlets.

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