It’s no secret that California has a high state income tax rate. In fact, it has been the undisputed income tax champion for the past decade or so (the middle brackets are more compressed, and some states even have higher middle bracket rates). Nonetheless, despite somewhat overblown media reports, most Californians aren’t in a position to tear their businesses up by the roots and transplant them to low- or zero-income tax havens like Nevada and Florida. Often those businesses have to operate in California, since that’s where the market for the product or service is, or there is cachet in having a California location such as Silicon Valley or Newport Beach. And often for small businesses and startups, the owner has to be present in-state for the enterprise to operate and grow.
But that’s not always the case, especially when a taxpayer owns numerous entities and some of the income derives from service contracts (usually for management work) among the entities or between the entities and the owner. Further, as e-commerce continues to grow in market share, a physical presence in California becomes less and less necessary for many businesses, and relocation may result in tax savings for sales to non-California customers. In cases like this, some strategic use of out-of-state entities can result in large enough tax savings to make the major step of relocation worthwhile.
The Rules Of California Residency Taxation
But before we can address the benefits and pitfalls of relocation, we need to first give an overview of California’s income tax system relating to residency. Changing residency is not a panacea for every tax problem. It only works in certain situations. And to determine where it works requires understanding the basic rules of how California taxes individual residents, nonresidents and businesses.