Taxes When You Work in California and Live in Another State

When you live in one state but earn income from another, it creates tax responsibilities in both your state of residence and in California. This applies to individuals who reside outside of California but work for a company there, travel to the state for business, or have other financial ties. Navigating this requires understanding which portion of your income California can tax and the specific method it uses to calculate the tax owed by nonresidents. Failing to properly account for these obligations can lead to financial penalties.

Identifying California-Source Income

California’s ability to tax a nonresident is based on “California-source income.” This is income earned for services physically performed within its borders, regardless of where your employer is located or where you reside. For W-2 employees, the income’s source is determined by the location where services are rendered.

For example, a remote employee living in a neighboring state who works for a San Francisco-based company is generally not subject to California income tax. However, if that employee travels to California for meetings or to work for a few weeks, the wages earned during those days are California-source income. This income is taxable by the state and is often apportioned using the “duty days” concept, based on days worked inside California versus elsewhere.

To apportion your income, divide the total number of days worked in California by the total number of workdays in the year. This percentage is then multiplied by your total annual salary to determine the taxable amount. This rule also applies to income from a business conducted in the state or rental income from a California property.

For independent contractors, California applies a “market-based sourcing” rule, where income is sourced to where the customer receives the benefit of the services. If a nonresident contractor performs services from their home state for a client in California, the income may be considered California-sourced. This can trigger a filing requirement for a sole proprietor with even a small amount of income from a California client, while other business entities must typically meet specific economic thresholds related to sales, property, or payroll before they are required to file.

Calculating the California Nonresident Tax

California determines nonresident tax liability by first calculating tax on your total worldwide income and then prorating it. On the California Nonresident or Part-Year Resident Income Tax Return (Form 540NR), you report your adjusted gross income from all sources. The state’s tax brackets and deductions are applied to this total income to find a preliminary tax amount. This is what you would owe if all your income were taxable by California.

Next, you must determine the ratio of your California-source income to your total income. This is done by dividing your California adjusted gross income, which is income earned from California sources, by your total adjusted gross income from all sources. The result is the percentage of your worldwide income connected to California.

This percentage is then multiplied by the preliminary tax amount to find your actual California tax liability. For example, if your total income is $100,000 and your preliminary tax is $6,000, but only $20,000 of your income is from California sources, your income ratio is 20%. Your final California tax would be 20% of $6,000, which is $1,200. This method is detailed on Form 540NR and its accompanying schedules.

Claiming a Credit for Taxes Paid

Paying tax to California on sourced income while also being taxed on all income by your home state can lead to double taxation. To prevent this, you can claim a credit for taxes paid to another state.

You claim this credit on your resident state’s tax return. However, California has reciprocal agreements with Arizona, Oregon, and Virginia. If you are a resident of one of these states, you claim the tax credit on your nonresident California return instead. For residents of all other states, the credit is claimed on the resident state tax return.

The credit is capped at the lesser of two amounts: the actual tax you paid to California or the amount of tax your home state would have charged on that same income. You cannot claim a credit for more than what your home state would have taxed on those earnings. This prevents paying high taxes in another state from erasing your tax liability in a lower-tax home state.

If you live in a state with no personal income tax, like Florida or Texas, this credit is not applicable. You are still obligated to file a California nonresident return and pay any tax due on your California-source income.

State Tax Filing Process

The primary document for a nonresident is Form 540NR, the California Nonresident or Part-Year Resident Income Tax Return. This form must be filed in addition to the resident tax return you file in your home state.

Before starting your California return, complete your federal income tax return (Form 1040), as information like your adjusted gross income is required for Form 540NR. You will also need to complete Schedule CA (540NR) to differentiate between your total worldwide income and your California-source income.

When filing Form 540NR, you may need to attach a copy of your federal tax return. When you file your resident state return and claim the credit, you should attach a copy of your California Form 540NR as proof of tax paid. Gather all relevant documents, including W-2s showing California wages, Form 592-B for contractor payments, or Form 593 for real estate transactions.

Both your home state and California returns can be filed electronically or by mail. E-filing is an efficient method and can help ensure accuracy by using software programmed with the rules for nonresident returns. Meeting the filing deadlines for both states is necessary to avoid penalties and interest.