Steve Coker, CFP
Leaving California Taxation in Retirement
California is a wonderful and expensive place to live. It has incredible beauty, amazing weather, and some of the highest tax rates in the country. And with the anticipated cuts in the federal tax rates, the rates in California are starting to look even higher. If you are one of the thousands of retirees considering whether to leave the state in order to lower your taxes in retirement, here are the basics of getting away from California taxation.
Generally, taxpayers will be taxed in their state of residency, which sounds easy enough, but be wary because California does have a reputation of policing the line between residents and non-residents, and establishing a residency is not as easy as simply declaring yourself a resident of another state. According to the California Franchise Tax Board, “the underlying theory behind residency is that you are a resident in the place where you have the closest connections”. Therefore, the state will look at many factors to decide what ‘connections’ you have to California. The starting point is where you own a home, but additional factors include where your spouse and children live, where your children attend school, business ties, professional organizations, where you have bank accounts, voter registration, vehicle registration, driver’s licenses, how much time you spend in the state, and more. There is no one factor that will determine residency, but rather all factors will be taken into consideration by the state.
Therefore, if you are a retiree who intends to sell your home in California and permanently establish residency in another state then it is a good idea to clearly and deliberately sever ties with California and establish new ties in your new state. Purchase a new home, register your vehicles, get a driver’s license, register to vote, etc. in your new state. If you no longer have ‘connections’ to California then you should not have a problem establishing residency in another state.
On the other hand, if you still own property in California, such as a vacation house, or rental property, especially if you or your family are living in the property a portion of the year, then it is good idea to talk with a tax advisor to make sure you have sufficient connections in your new state to avoid having a residency problem. California residents are taxed on all income, so making an error with your California residency can be a costly mistake.
Many retirees ask how their retirement will be taxed, and the good news is that income from retirement accounts are generally taxed only in your state of residency. For example, pension distributions are not taxable by the State of California if you have established residency in another state, even if you were a resident of California when you earned the pension. Similarly, interest and dividends, capital gains from the sale of stocks and bonds, lump-sum distributions, and IRA distributions are taxed in the state where you have residency, not where the money was earned.
On the other hand, income from rental properties, business income, or wages and salaries earned in the State of California will be taxed by California even if you establish residency in another state. So if you are a Californian receiving a bonus check or vacation check on your way out the door then it will be taxed in California even if you have already moved out of state. Similarly, non-qualified stock options are treated as wage income and will be taxed as California wages if they were earned while working in the state. Non-residents are required to file a non-resident tax return to declare the California sourced income, but can still avoid California taxation on the non-California income.
Obviously, this can be a complex part of the tax code, so it is a good idea to talk with your tax advisor, but for many retirees, moving out of California can save thousands in taxes, and sometimes make the difference between being able to retire now and years from now. If you have been wondering how to get out of the state, then I hope these basics will help you plan your own escape.
“FTB Publication 1031 Guidelines for Establishing Residency Status”. California Franchise Tax Board. https://www.ftb.ca.gov/forms/2015/15_1031.pdf
“How California Taxes Residents, Non-Residents, and Part Year Residents.” California Franchise Tax Board. https://www.ftb.ca.gov/individuals/fileRtn/Nonresidents-Part-Year-Residents.shtml#how_taxed