Who Is Exempt From California Tax Withholding?

California tax withholding applies to certain non-wage payments made to individuals and entities, serving as a prepayment of estimated state income tax. This mechanism helps ensure tax compliance for various income types, including those from real estate transactions and services performed by nonresidents within California. While withholding is generally required for these payments, several exemptions exist that can relieve individuals and businesses of this obligation. This article will detail the specific criteria and processes for claiming these exemptions.

Exemptions for California Real Estate Withholding

Sellers of California real property may qualify for several exemptions from state income tax withholding, which is 3 1/3% of the sales price.

One common exemption applies to the sale of a principal residence. To qualify, the seller must have owned and used the property as their principal residence for at least two out of the five years preceding the sale, as defined by Internal Revenue Code Section 121. An exemption may still apply if its last use was as the seller’s principal residence.

An exemption is also available for properties sold at a loss or for zero gain for California income tax purposes. This means the adjusted basis of the property, after accounting for selling expenses, is equal to or greater than the selling price. The seller calculates this using a specific form, certifying the outcome.

Additionally, sales involving like-kind exchanges under Internal Revenue Code Section 1031 may be exempt, particularly if no “boot” (money or non-like-kind property) exceeding $1,500 is received. If boot is received, withholding may be required only on that amount.

Certain entity types are exempt from real estate withholding. This includes corporations, partnerships, or limited liability companies (LLCs) registered with the California Secretary of State to do business in California or maintaining a permanent place of business within the state. Tax-exempt organizations and government entities are also exempt. Withholding is not required if the total sales price of the real property is $100,000 or less.

Exemptions for Payments to Nonresidents and Other Payees

California requires withholding on various non-wage payments made to nonresidents, independent contractors, and other payees for California-sourced income, such as services performed in the state, rents, or royalties. The standard withholding rate is 7% of the gross payments. Several criteria can lead to an exemption.

A primary exemption applies if the payee is a California resident. Payments to certain business entities are also exempt, including those registered with the California Secretary of State or having a permanent place of business in California. Tax-exempt organizations and government entities are also exempt from this withholding.

Another common exemption is for total payments to a nonresident payee that do not exceed $1,500 during the calendar year. Payees can also seek a withholding waiver from the Franchise Tax Board (FTB) in specific circumstances.

Reasons for a waiver include demonstrating no or reduced California tax liability, a history of tax compliance, or making timely estimated tax payments. The FTB issues a determination letter if a waiver is approved, which the withholding agent must receive before eliminating withholding.

How to Claim a California Withholding Exemption

To claim an exemption from California withholding, specific procedural steps must be followed, involving the completion and submission of designated forms from the Franchise Tax Board (FTB). These forms are available for download from the FTB’s official website.

For real estate transactions, sellers use FTB Form 593, Real Estate Withholding Statement. If electing an alternative withholding amount based on gain or loss, FTB Form 593-E, Real Estate Withholding – Computation of Estimated Gain or Loss, may be used.

For payments to nonresidents and other payees, appropriate forms include FTB Form 587, Nonresident Withholding Allocation Worksheet, or FTB Form 588, Nonresident Withholding Waiver Request. FTB Form 587 is used by the payee to certify residency or permanent place of business in California, or to allocate income subject to withholding. FTB Form 588 is used to request a waiver from withholding.

When completing these forms, accurate taxpayer identification numbers and the specific reason for the exemption must be entered. Sellers provide FTB Form 593 to the real estate escrow person (REEP) or buyer before closing. For non-wage payments, the payee provides FTB Form 587 to the withholding agent.

If a waiver is sought using FTB Form 588, the request should be submitted to the FTB at least 21 business days before the payment. The withholding agent or REEP must retain copies of these forms for five years and provide them to the FTB upon request.