Does California Impose Double Taxes on Income Earned in Another State?

California’s tax laws can be complex, especially for those earning income in multiple states. Many wonder whether the state imposes double taxation on out-of-state earnings, leading to higher tax burdens. Understanding how California treats such income is crucial for residents and nonresidents alike.

Residency Classification

California taxes individuals based on residency status, which falls into three categories: residents, nonresidents, and part-year residents. The Franchise Tax Board (FTB) defines a resident as anyone domiciled in California or physically present in the state for more than temporary purposes. Residents must pay California tax on all income, regardless of where it is earned, while nonresidents are taxed only on income sourced to California.

Domicile refers to an individual’s permanent home. Even if someone spends most of the year outside California, they may still be considered a resident if they maintain strong ties, such as a California driver’s license, voter registration, or property ownership. The FTB evaluates residency on a case-by-case basis, considering employment location, business interests, and family connections.

Part-year residents are taxed as residents while living in California and as nonresidents for the rest of the year. Income earned during the resident period is fully taxable, while earnings from outside California during the nonresident period are generally excluded.

Income Sourcing Rules

California taxes income based on where the income-generating activity occurs rather than where the taxpayer resides. This affects wages, business income, and investment earnings, as each category is sourced differently under state law.

For wages, the key factor is where the work is physically performed. A California resident working remotely for an out-of-state employer must still pay California tax on those earnings. A nonresident working in California owes state tax on that income, even if their employer is based elsewhere.

Business income follows different rules. Sole proprietors and pass-through entities, such as partnerships and S corporations, allocate income based on where business activities take place. California uses a market-based sourcing method for service-based businesses, meaning revenue is attributed to where the customer receives the benefit. For tangible goods, sales are sourced to the delivery location.

Investment income, including interest, dividends, and capital gains, is generally sourced to the taxpayer’s state of residence. California residents owe state tax on investment earnings regardless of where the brokerage account is held, while nonresidents are taxed only on gains from California-based assets, such as real estate in the state.

Dual-State Liabilities

Earning income in multiple states can create tax obligations in more than one jurisdiction. California residents working in another state may find that both California and the other state claim taxing rights over the same earnings. This occurs because California taxes residents on worldwide income, while the state where the work is performed also imposes its own tax.

To prevent double taxation, California offers a credit for taxes paid to other states under Revenue and Taxation Code Section 18001. This credit applies when a resident is taxed by another state on income also subject to California tax. However, the credit is limited to the lesser of the actual tax paid to the other state or the amount of California tax attributable to that income. For example, if a California resident earns $50,000 in a state with a 5% tax rate and pays $2,500 in taxes there, but California’s tax on that income would be $3,500, the credit would be capped at $2,500. Any remaining California tax must still be paid.

Not all situations qualify for this credit. California does not extend the credit for taxes paid to foreign countries, localities, or states that impose taxes not based on net income, such as Washington’s business and occupation (B&O) tax. Additionally, states with no personal income tax, like Texas or Florida, do not create a creditable tax liability, meaning a California resident earning income there would owe full California tax without any offset.

Nonresident Filings

Individuals who earn income from California sources but do not meet the state’s residency criteria must comply with specific filing requirements. The Franchise Tax Board (FTB) requires nonresidents to file a California Nonresident or Part-Year Resident Tax Return (Form 540NR) if their California-source income exceeds the state’s minimum filing threshold, which varies based on filing status and age. Failing to file when required can result in penalties, including a late filing penalty of 5% per month (up to 25% of the unpaid tax) and potential accuracy-related penalties if errors lead to underpayment.

Determining taxable income requires accurate apportionment. Nonresidents must report only California-sourced earnings on their state return, often necessitating prorating total income. For example, a consultant earning $120,000 annually who performs 30% of their work in California would report $36,000 in taxable income. Proper recordkeeping is essential, as the FTB may request documentation such as contracts, work logs, or travel records to substantiate income allocation.