How Can I Reduce My California State Income Taxes?
California is well-known for its high taxes. Depending on your income, you could be looking at a hit as high as 13.30% come tax time.
But what can you do about it?
In this article, we’re going to list out several ways you can legally lessen your tax liability. We’ll cover deductions, credits, and other strategies you have at your disposal. And you’ll see which you might be able to leverage depending on your unique situation.
Table of Contents
- Lower Your Taxable Income
- Comprehensive Tax Planning
- For Business Owners
Lower Your Taxable Income
Use A Health Savings Account
If you’re enrolled in a qualifying high-deductible health plan, you can start contributing to a health savings account (HSA). These tax-deductible contributions are one of the three major tax advantages HSAs offer users.
With an HSA your funds are also able to earn interest tax-free. And as long as withdrawals are made for qualifying medical expenses, you won’t face taxes there either.
Additional benefits for HSAs include funds that roll over year after year. And after age 65, withdrawals can be made for non-qualified medical expenses without a 20% penalty. This essentially turns the functioning of your HSA into that of a traditional IRA.
Save For Retirement
This method will depend on your retirement account type. But you may be able to deduct contributions up to certain limits. Below, are some qualified retirement account types that allow for tax-deductible contributions:
- Traditional IRAs
Each of these account types will have different IRS limitations. So make sure to speak with your advisor to find the one that works best for you. Additionally, know that any Roth-variety retirement account is funded with after-tax dollars. But this lack of an immediate tax benefit may make more sense in the long run depending on your situation.
Shift Your Income
Through income shifting, you’re able to move your unearned income (e.g. dividends, interest, alimony) to another taxpayer. The idea is to move the income to someone in a lower tax bracket. That way, come tax time, a smaller chunk is taken out.
An example of this can come when running a family business. You can shift your unearned income by paying it to your hired children. Instead of paying taxes on the kept money, you can claim a business deduction on the wages paid to your kids.
Donor-advised funds are 510(c)(3) public charities. Given this status, you can use them to save big time on taxes for stocks you’re interested in donating.
First, there’s the possibility of eliminating the capital gains tax you’d take on if you sold the stock yourself, and donated the proceeds afterward. This has the potential to increase the amount of your donation by as much as 20%.
Secondly, you can claim the fair market value charitable deduction in the tax year you make your gift. You can then use those savings to give more to charity should you choose.
Establish A Nevada Incomplete Gift Non-Grantor (NING) Trust
When you live in a high-income tax state like California, it may be worth looking into a Nevada Incomplete Gift Non-Grantor (NING) trust. These irrevocable trusts are established in Nevada, and use the state’s laws to build and protect your wealth.
Since Nevada has no state income tax, a California resident can use a NING trust to potentially grow their assets state-tax-free. This strategy comes in handy when transferring wealth to designated beneficiaries, or lessening the impact of a capital gains tax on the sale of an asset.
Consider Itemizing Deductions
Itemizing your deductions has the potential to lower your tax liability. However, this only makes sense under certain conditions. Either you don’t qualify for the standard deduction, or your itemized deductions exceed your standard deduction.
Examples of commonly itemized deductions in California include:
- Medical and dental expenses
- Home mortgage interest
- Gambling losses
Use Military Deductions
Are you involved in military service? If so, you may be eligible for work-related tax deductions. The IRS stipulates that if you’re a member of the National Guard or military reserve, you may be eligible for deductions related to unreimbursed travel expenses.
Your expenses must be ordinary and necessary, and:
- Travel must have been overnight and 100+ miles from your home
- The deduction is limited to the standard federal per diem rate for meals, incidental expenses, and any lodging
- The deduction is also limited to the standard mileage rate for car expenses, tolls, parking fees, and ferry rides
Please Note: The IRS also highlights options for active members of the armed forces. During active duty, you may be able to deduct unreimbursed expenses incurred when moving from one base to another. But the move must be due to a military order or permanent change in station.
Comprehensive Tax Planning
Harvest Tax Losses
Through the process of tax loss harvesting, you can use down investments to your advantage. You’re able to sell underperforming assets at a loss, offset capital gains tax and ordinary income, and reinvest into similar assets for long-term growth.
When your investment losses total more than your gains, you can use tax-loss harvesting to offset up to $3,000 dollars of ordinary income (or $1,500 if married filing separately) each year. Any amount over these thresholds can then be applied to future filings to offset more income.
When your investment gains exceed your losses, this process can still be used to lower your liability by decreasing your capital gains tax. But know that the degree to which this can happen will depend on factors such as the duration of your holding of the investment (i.e. short vs. long-term).
Deduct Disaster Losses
In California, you can deduct losses from President, or Governor-declared disasters. The damages must have occurred from an event that was unexpected, sudden, or unusual. Examples of events like these include floods, earthquakes, and fires.
You can deduct disaster losses experienced in California on, or after January 1, 2014 to before January 1, 2024. For a list of qualifying disasters, and more information on how to apply for the deduction visit the State of California Franchise Tax Board’s page.
Time Your Expenses
In the eyes of the IRS, the timestamp on your spending is a big deal. So the timing of tax-deductible expenses is a key consideration.
For example, let’s say there’s a charity you sponsor. It may make more sense to make a sizable, tax-deductible contribution in December rather than January. That’s because the donation in January will only be able to lower your liability for the next filing year.
Treasury Bills and Municipal Bonds
Diversification is key to a healthy portfolio. And after you consider their tax benefits, you may want to diversify into treasury bills and municipal bonds.
Municipal bonds are debt securities issued by local, county, and state government institutions. The interest earned from such securities is tax-exempt on the federal level. And they’re usually free from state taxes too when the bond issuer is from the buyer’s home state.
Treasury bills are short-term U.S. government debt obligations. They’re backed by the Treasury Department and have maturity dates of one year or less. Their interest isn’t tax-exempt on the federal level. But you’ll be in the clear on the state and local levels.
Apply For Earned Income Tax Credits (EITC)
If you earned a lower income, it may be worth looking into an earned income tax credit (EITC). Your eligibility for an EITC will depend on factors like your adjusted gross income (AGI), filing status, and number of qualifying dependents.
EITC 2022 Eligibility Requirements And Credits:
Maximum AGI Filing As Single, Head Of Household, Or Widowed
- If you have zero claimed children or relatives, your AGI cannot exceed $17,640
- If you have one claimed child or relative, your AGI cannot exceed $46,560
- If you have two claimed children or relatives, your AGI cannot exceed $52,918
- If you have three + claimed children or relatives, your AGI cannot exceed $56,838
Maximum AGI Filing As Married Filing Jointly
- If you have zero claimed children or relatives, your AGI cannot exceed $24,210
- If you have one claimed child or relative, your AGI cannot exceed $53,120
- If you have two claimed children or relatives, your AGI cannot exceed $59,478
- If you have three + claimed children or relatives, your AGI cannot exceed $63,398
Maximum Investment Income
- Income from investments may not exceed $11,000
Maximum Credit Amounts
- Zero qualifying children $600
- One qualifying child $3,995
- Two qualifying children $6,604
- Three + qualifying children: $7,430
For Business Owners
Deduct Self-Employment Taxes
Are you self-employed? If so, according to the Self-Employed Contributions Acts (SECA) you can deduct the self-employment tax – or at least a major portion of it.
When you’re self-employed, you’re responsible for paying into Social Security and Medicare as both an employee and employer. With no boss paying their share, you pay the full 15.3% SECA tax on 92.3% of your net self-employment income yourself.
Thankfully, the IRS allows you to deduct 50% of your SECA taxes to make up for this double-sided burden.
Deduct Your Home Office
Since the pandemic, working from home has become far more of a norm. Consequently, so has the ability to qualify for a home office deduction.
Rules for a home office deduction include, but are not limited to:
- No home office deduction eligibility for employees
- The home must be the taxpayer’s primary place of business
- There must be a designated space in the home where that business is conducted (ex: a spare room)
Should you meet the IRS eligibility requirements, there’s a variety of ways to calculate your deduction amount. The simplest method uses a rate of $5 per square foot of the business use of a home. The maximum size that can be deducted is 300ft, which limits the deduction to $1,500.
The other method accounts for the percentage of a home that’s used for business purposes. Taxpayers who use a whole (or partial) space for business, must calculate its percentage of the home and use it to deduct indirect expenses of operation (ex: mortgage interest, utilities, office equipment, supplies, etc.).
Write Off Business Trips
For 1099 employees, travel deductions are possible when a business-related trip takes you from your tax home or main place of work. The time away must be significantly longer than a typical workday. And the journey must require sleep or rest to meet the demands of the work.
Employers can also deduct travel expenses. These include ones paid, or incurred during a temporary work assignment, if the work period is no longer than one year.
All travel-related expenses must be considered ordinary and necessary. This rules out personal extravagances. But possible deductible expenses may include, but are not limited to transportation, food, lodging, baggage shipping, and tips.
Our Advisory Recommendations
At Fischer Investment Strategies, we’re well aware of the burden California taxes can have on hardworking professionals. We see it as our responsibility to help you alleviate as much of that burden as possible.
As a team, we’re able to take inventory of your unique tax circumstances, and together, we’ll uncover the tax strategies that work best for you.
If you’re looking to minimize your tax liability this year, and for the years to come, call us directly at our Westlake office at (805) 418-7686, or our San Clemente office at (949) 433-7768. You can also schedule a complimentary consultation at a time that works best for you.
Editor’s Note: This article was originally published in December 2022. It has been updated to reflect 2023 numbers.
This material does not constitute accounting, legal or tax advice. Investors should consult with their legal or tax advisors.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Fischer Investment Strategies or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.
Ted Fischer is a Fee-Only Certified Financial Planner® & fiduciary, and the founder of Fischer Investment Strategies.
Drawing from more than 25 years of experience in the financial services industry, Ted's expertise includes retirement planning, investment analysis, tax planning, estate planning, and insurance.
Ted has an extensive academic background. He received his Certified Financial Planning (CFP®) designation from UCLA in 2011. He became a Qualified Plan Financial Consultant (QPFC®) and an Accredited Investment Fiduciary (AIF®). Ted has a Bachelor of Science in Marketing, with a minor in Finance, from San Diego State University.