How to Pay Less in California State Taxes
Understand the key differences between state and federal tax rules to effectively manage your California income tax liability and financial decisions.
California has some of the highest state income tax rates in the nation. The state’s tax code, while complex, provides several methods for individuals to lower their annual tax liability. Navigating these options requires understanding California’s specific rules, which often differ from federal regulations. Taxpayers can reduce what they owe by examining eligible deductions, credits, and how they structure savings and investments.
Maximizing California Tax Deductions
A primary decision for California taxpayers is whether to take the standard deduction or itemize. For the 2024 tax year, the state’s standard deduction is $5,540 for single filers and $11,080 for joint filers, heads of household, and qualifying widow(er)s. You should itemize only if your total deductible expenses exceed your standard deduction amount, which will result in a lower state taxable income.
One of the most significant itemized deductions for homeowners is mortgage interest. Unlike federal law, California allows taxpayers to deduct interest on home acquisition debt up to $1 million, or $500,000 if married filing separately. This provides a substantial benefit for those with larger mortgages, which are common in many of the state’s housing markets.
The treatment of state and local taxes (SALT) is another area of divergence. While federal law caps the SALT deduction at $10,000 annually, California has no such limit on its state return. Taxpayers can deduct the full amount of their property and state income taxes on their California Schedule CA (540).
Taxpayers can also deduct certain medical and dental expenses. In California, you can deduct qualifying medical expenses that exceed 7.5% of your federal adjusted gross income (AGI). Qualifying expenses include payments for doctor visits, hospital care, prescription drugs, and transportation for medical care.
Utilizing California Tax Credits
Unlike deductions that reduce taxable income, tax credits provide a dollar-for-dollar reduction of your final tax liability. The California Earned Income Tax Credit (CalEITC) is a refundable credit for low-to-moderate-income workers. For 2024, those with earned income up to $31,950 could receive up to $3,644. To qualify, you must be at least 18 or have a qualifying child and have lived in California for more than half the year. This credit is claimed using Form FTB 3514.
The Young Child Tax Credit (YCTC) offers additional support to families. To be eligible, you must qualify for the CalEITC and have a child under age six. For 2024, this refundable credit provides up to $1,154 per return. Eligibility can be met even with zero earned income if other requirements are satisfied.
The Child and Dependent Care Expenses Credit helps taxpayers who paid for care for a dependent so they could work. To be eligible, care must have been provided in California, and your federal AGI must be $100,000 or less. The qualifying person is a child under 13, or a spouse or dependent incapable of self-care. The credit is a percentage of the federal credit, using up to $3,000 in expenses for one individual or $6,000 for two or more.
California offers a nonrefundable Renter’s Credit for those who rent their primary residence for at least half the year. For 2024, eligibility requires a California AGI of $52,421 or less for single filers and $104,842 or less for joint filers. The credit is $60 for single filers and $120 for most other filing statuses.
Strategic Retirement and Savings Contributions
Contributing to employer-sponsored retirement plans like a 401(k) or 403(b) reduces current tax obligations. California conforms to federal law for these plans, so employee contributions are excluded from taxable income on both federal and state returns. This pre-tax contribution lowers your adjusted gross income while building retirement savings.
A point of divergence is the tax treatment of Individual Retirement Arrangements (IRAs). While the federal government allows a deduction for traditional IRA contributions, California does not. Any deduction for a traditional IRA on a federal return must be added back as income on the California state return, meaning there is no state tax deduction for these contributions.
Health Savings Accounts (HSAs) are another area of non-conformity. Federally, HSAs offer a triple tax advantage, but California does not recognize these benefits. For state tax purposes, HSA contributions are not deductible, and any interest or investment earnings are considered taxable income for that year.
For education savings, California offers the ScholarShare 529 College Savings Plan. While contributions are not deductible on a state tax return, the earnings grow tax-deferred from state taxes. Withdrawals for qualified higher education expenses are also free from California state income tax, providing a state-level benefit.
Managing Investment and Capital Gains Income
Tax-loss harvesting is a strategy applicable for both federal and California taxes. It involves selling investments at a loss to offset capital gains from other investments. If capital losses exceed gains, you can use up to $3,000 of the excess loss to offset ordinary income, with any remaining losses carried forward to future years.
California’s taxation of capital gains differs from federal rules. The federal system has lower tax rates for long-term capital gains from assets held over a year. California makes no distinction between short-term and long-term gains, taxing all capital gains as ordinary income at the state’s marginal rates.
For tax-advantaged income, California municipal bonds offer a benefit. Interest income from bonds issued by California or its municipalities is exempt from both federal and California state income tax for residents. This “double tax-free” status makes these bonds an attractive option for those in higher tax brackets.
Adjusting Your Tax Residency Status
Changing your residency status can alter your California tax obligation. The state has three taxpayer types: full-year residents, non-residents, and part-year residents. Full-year residents are taxed on all worldwide income, while non-residents are only taxed on income from California sources. Part-year residents are taxed on all income earned while a resident and only on California-source income while a non-resident.
The California Franchise Tax Board (FTB) determines residency based on where you have the closest connections, a concept known as “domicile.” Domicile is your true, fixed, permanent home and the place you intend to return to. The FTB examines numerous ties, including:
- The location of your spouse and children
- The location of your principal residence
- The state where you claim a homeowner’s property tax exemption
- Where you are registered to vote
- Where your vehicles are registered
- The location of your bank accounts and professional service providers
Legally changing your residency requires severing ties with California and establishing them elsewhere. This involves concrete steps like selling your California home or treating it as a secondary property. You must also obtain a driver’s license, register to vote, and move personal belongings to the new state to prove a genuine intent to relocate.
When moving out of California, you must file a final tax return as a part-year resident using Form 540NR. On this return, you will report all income earned while you were a resident and any California-source income earned after your move. Documenting your move date and maintaining records that substantiate your change in domicile is important.