What Is California Source Income and How Is It Determined?
Understand how California determines source income, including wages, business profits, rental income, capital gains, and royalties.
Understanding California source income is essential for individuals and businesses with financial ties to the state, as it determines tax obligations. This concept includes various forms of earnings originating within California’s borders, impacting state tax liabilities. Income such as wages earned in the state, self-employment or business profits, rental income from California properties, capital gains from in-state assets, and royalties from intellectual property used in California all fall under this category.
Wages and Salaries Earned Within the State
California taxes wages and salaries based on where the work is performed. For instance, a Nevada resident commuting to California for work will have their earnings classified as California source income. This principle is outlined in the California Revenue and Taxation Code Section 17951, which grants the state authority to tax income derived from services performed within its borders.
For remote workers, the situation can be more complicated. If an individual works remotely for a California-based company, their income may still be taxable by California, depending on the nature of the work and contractual agreements. The rise of remote work has made it crucial for employers and employees to carefully assess their tax obligations, often requiring consultation with tax professionals to ensure compliance with state regulations.
Self-Employment or Business Profits in the State
Entrepreneurs and business owners generating income from activities conducted in California are subject to state taxation, regardless of residency. This includes profits from sole proprietorships, partnerships, and LLCs operating within the state, as specified in California Revenue and Taxation Code Section 17952. The location of the business activity, whether it involves providing services to California clients or operating a physical storefront, determines the taxability of income.
Taxable income for self-employed individuals and businesses is influenced by factors such as the nature of the business and the location of customers. For example, a consultant serving California-based clients must report these earnings as California source income. The Franchise Tax Board (FTB) requires businesses to apportion income based on the proportion of sales, property, and payroll within California to ensure tax obligations reflect in-state economic activity.
Rental Income From Real Property Located in the State
Rental income from real property located in California is classified as California source income, regardless of the property owner’s residency. This is established under California Revenue and Taxation Code Section 17955. Property owners can reduce taxable income by taking deductions for expenses such as maintenance, repairs, and management fees. Depreciation, as outlined in Internal Revenue Code Section 167, also allows property owners to allocate the property’s cost over its useful life, reducing taxable income and potentially improving the investment’s returns.
Capital Gains on Property Tied to the State
Capital gains from the sale of property located in California are taxable by the state, regardless of the owner’s residency. The tax is based on the property’s physical location, with gains calculated as the difference between the sale proceeds and the property’s adjusted basis, which includes its purchase price and any improvements or depreciation as per Internal Revenue Code Section 1011.
California taxes capital gains at the same rate as ordinary income, which can be as high as 13.3% for high earners—significantly higher than federal long-term capital gains rates. This underscores the importance of strategic tax planning for property owners to manage their tax liabilities effectively.
Royalties From Intellectual Property Generating State-Based Income
California taxes royalties from intellectual property (IP) if the income originates from activities or users within the state. Creators, licensors, or rights holders must report royalties as California source income when the IP is commercially utilized in the state, regardless of their residency. California Revenue and Taxation Code Section 17952.5 provides guidance on this, emphasizing the location of use over the rights holder’s domicile.
For instance, royalties earned by a songwriter licensing music to a California-based production company or a software developer licensing code to businesses operating in the state are taxable by California. Non-residents earning royalties in California may face double taxation if their home state or country also taxes the income, though credits for taxes paid to California may mitigate this issue. Proper documentation, such as licensing agreements and income records, is essential for compliance with California tax regulations.