Out-of-state visitors who own vacation homes in California or otherwise spend significant time here are often anxious about their residency status. Let’s go over the basics of California residency taxation. They can be confusing, if not brutal.
How Residents And Nonresidents Are Taxed
California residents are subject to California state income tax on all income regardless where earned. It doesn’t matter what or where the source. If a California resident derives income from investments in Saudi Arabia or from pensions accrued while working out-of-state, California will tax that income. The resident may qualify for a credit for paying taxes to other states, but the default rule is, a resident’s global income is subject to California income tax. Period. With a rate that is currently the highest in the nation, California residency comes with a significant tax impact.
In contrast, nonresidents are only subject to California state income tax on their “California-source” income. That may be zero or it may be significant. California-source income takes many forms, some obvious, some not so obvious. It could be rents derived from California real estate or income from business operations or wages for performing temporary work in-state (obvious). Or it could be a portion of the sales proceeds attributed to a noncompete clause when a founder sells his California business, or distributions from non-statutory stock options vested while the employee worked in California (not obvious). To celebrity name drop, when LeBron James, an Ohio resident, used to play the Lakers at Staples Center for the Cleveland Cavaliers, he paid California taxes on the income he made on game night, which in his case was no small amount. [By the way, now that James signed with the Lakers, he has a different problem: whether he can work for a California employer, train and practice here for a significant part of the year, and still remain a nonresident – the answer is yes, but that’s a different analysis.]
So the stakes are high when determining whether a taxpayer is a California resident or not.