Though their state already has the highest personal state income tax rate in the nation at 13.3 percent (beating the next closest state, Hawaii, by 2.3 percent), California legislators are considering an Assembly Bill which would raise the tax rate even higher. Assembly Bill 1253, which already passed out of the California Assembly by a 59 to 17 vote in May, would cap the tax rate at 16.8 percent for the highest earners. This represents an increase of 26.8 percent. The current rate has been in effect since 2012, and federal tax changes in 2018 (limiting the amount of non-deductible state tax to $10,000) have already created higher taxes. If you’re not a millionaire, you may not think this will affect you, but the reality is that many small business owners pay personal income tax on their business profits, and this could hit them hard.
The higher tax rate isn’t the only issue. If passed, AB 1253 would take effect not immediately, as one might expect, but retroactively, all the way back to January 2020. This could create a hardship for small companies already negatively impacted in 2020 by losses due to shutdowns and economic downturns during the pandemic, as well as property damage and loss from protestors rioting. Paying taxes on an additional 8-12 months of earnings (depending on when the bill passes) could be the proverbial “final straw” for small business owners.
Moving your business to a different state with lower tax rates (or possibly a state with no income tax, such as Washington, Texas or South Dakota) may sound like a viable alternative, but unfortunately it may not help. California has the right to continue to tax business owners even after they’ve left the state. According to Forbes contributor Robert W. Wood, “A California resident is anyone in the state for other than a temporary or transitory purpose. It also includes anyone domiciled in California who is outside the state for a temporary or transitory purpose.”
While buying a home in Texas sounds like a simple solution, California tax authorities will look at more than a residence. Where you own and operate your business matters, as does the amount of time you spend in that location. And, according to Wood, the state will look not only at your business locale and home address, but also your voter registration, vehicle registration, and driver’s licenses, in addition to your bank accounts and any organizations to which you belong. California’s auditing reach is extensive, in both time and space, especially for those who do not file yearly returns.
The regular session of the California legislature ended in August without any action on AB 1253. For those still living in California, you may get the chance to vote on the bill before it is enacted into law. For those who conducted business in California in 2020 but have since left the state, Wood advises considering filing a non-resident tax return on your California income, just to be on the safe side.