Do I Have to Pay California Income Tax if I Work Out of State?

Navigating state income taxes when working across state lines can be complex, especially for those with ties to California. California’s tax regulations are unique, influenced by an individual’s residency status and income origin. Understanding these distinctions helps manage tax obligations when earning income outside California.

Understanding California Residency for Tax Purposes

California’s tax system distinguishes between “resident” and “domicile.” A resident is an individual in California for other than a temporary purpose, or someone domiciled in California but temporarily outside the state. Domicile refers to the place where an individual voluntarily establishes their permanent home, intending to return whenever absent. An individual can only have one domicile at a time.

The California Franchise Tax Board (FTB) determines residency based on a “facts and circumstances” test. No single factor is decisive; the FTB assesses the strength of an individual’s ties. Key factors include time spent in California versus elsewhere, the location of one’s principal residence, and where their spouse and children reside.

Factors also include the state that issued a driver’s license, vehicle registration, and professional licenses. Bank account location, financial transactions, and voter registration also contribute. Social ties, such as membership in religious, social, or professional organizations, and healthcare providers are also considered. Spending more than nine months in California during a taxable year presumes California residency.

Proving a change in domicile requires abandoning the prior domicile, physically moving to a new locality, and intending to remain in the new state permanently. Intent alone is insufficient; it must be manifested through actions. For instance, maintaining strong ties like owning a home where a spouse and children reside in California while working elsewhere can indicate continued California residency.

Taxation of Income Earned Outside California

California taxes its residents on all their income, regardless of where it is earned. This is known as “worldwide income” taxation. A full-year California resident’s income from all sources—within California, another U.S. state, or a foreign country—is subject to California income tax.

Wages earned remotely for an out-of-state company, rental income from properties outside California, or investment income from non-California sources are all included in a California resident’s taxable income. The location where services are performed or income originates does not alter California’s right to tax its residents on that income.

The concept of “source income” applies to non-residents. Non-residents are taxed by California only on income derived from California sources. Examples include wages for services performed within California, income from a business in the state, or rent from real property located in California.

For a California resident, almost all income is considered California-source income for tax purposes, even if physically earned elsewhere. If a California resident works remotely for an out-of-state company, the income is still taxable by California because it is earned by a California resident.

Claiming Credits for Taxes Paid to Other States

To prevent double taxation, California residents who pay income tax to another state on income also taxed by California may claim the Other State Tax Credit (OSTC). This credit is designed to alleviate the burden of paying tax on the same income to two different jurisdictions. The credit is claimed by filing Schedule S with the California income tax return.

The credit applies to net income taxes paid to another state on income simultaneously taxed by California. For the credit to be allowed, the income must have a source within the other state under California law. The credit is limited; it cannot exceed the amount of California tax due on that same income. This limitation ensures the credit only offsets California’s tax on the double-taxed income, not reducing California tax liability on other income.

To claim the OSTC, taxpayers must file their California income tax return and attach Schedule S. A separate Schedule S is required for each state, along with a copy of the income tax return(s) filed with the other state(s) to substantiate taxes paid.

Some states have reciprocity agreements or “reverse credit” rules with California. If another state allows California residents a credit for taxes paid to California, then California residents may not claim the OSTC for taxes paid to that state. In such cases, the credit is claimed on the other state’s non-resident return.

Common Work Scenarios

A California resident working remotely for an out-of-state company will be taxed by California on all their income. This is because California taxes residents on their worldwide income, regardless of where the employer is located or where services are performed. If the remote worker pays income tax to the state where the out-of-state company is located, they may claim the Other State Tax Credit on their California return to avoid double taxation on that specific income.

Consider a California resident who temporarily works on-site in another state for a few months. During this period, they likely establish tax residency in that other state and pay income tax on the wages earned there. Since California continues to consider them a resident, it will also tax that income. In this situation, the individual can use the Other State Tax Credit on their California tax return (Form 540) to offset the taxes paid to the other state, provided the income is double-taxed.

For a California resident who moves out of state mid-year for work, their tax situation changes from a full-year resident to a part-year resident. As a part-year resident, they are taxed by California on all worldwide income received while they were a California resident. During the portion of the year they are a non-resident, California will only tax income from California sources. If their new state of residence also taxes the income earned while they were a part-year California resident, the Other State Tax Credit may be applicable.