Tax Planning for High-Income Californians

California's High-Income Tax Burden

California's top marginal income tax rate is 13.3% — the highest state income tax rate in the nation. Combined with the 37% federal rate, California high-income earners face a combined marginal rate of up to 50.3% on ordinary income. For capital gains, the combined rate can reach 36.8% (23.8% federal + 13.3% California, with no California preference for long-term gains). KDA's tax planning for high-income Californians focuses on legally reducing this burden through a combination of entity structuring, retirement planning, deduction optimization, and income timing.

Pass-Through Entity Tax (PTET)

California's Pass-Through Entity Tax (PTET) is one of the most valuable planning tools for high-income California business owners. S corporations and partnerships can elect to pay California income tax at the entity level — the entity deducts the PTET payment as a business expense on the federal return, effectively circumventing the $40,000 SALT cap (raised by the OBBBA from $10,000). For a California S corp owner with $500,000 in pass-through income, the PTET election can save $30,000–$50,000 in federal income tax annually. KDA files the PTET election and manages the quarterly PTET payments for every eligible client.

Retirement Plan Strategies

Retirement plans are one of the most powerful tax deferral tools available. KDA's retirement plan strategies for high-income Californians: (1) Defined Benefit Plan — allows contributions of $100,000–$300,000+ per year for high-income business owners over 50; contributions are fully deductible. (2) Solo 401(k) — allows contributions up to $70,000 per year (2025) for self-employed individuals. (3) Cash Balance Plan + 401(k) — combining a cash balance plan with a 401(k) can allow $200,000–$400,000 in annual deductible contributions for high-income owners over 50. (4) Backdoor Roth IRA — allows high-income earners who exceed the Roth IRA income limits to contribute indirectly.

Above-the-Line Deductions

Above-the-line deductions reduce adjusted gross income (AGI) and are available regardless of whether you itemize. Key above-the-line deductions for high-income Californians: (1) Self-employed health insurance — 100% deductible for self-employed individuals. (2) Self-employed retirement contributions — SEP-IRA, Solo 401(k), and defined benefit plan contributions. (3) Health Savings Account (HSA) — $4,300 individual / $8,550 family (2025); triple tax benefit (deductible contribution, tax-free growth, tax-free withdrawals for medical expenses). (4) Student loan interest — up to $2,500 (phases out at higher incomes). (5) Alimony — deductible for divorces finalized before 2019.

Income Timing Strategies

High-income Californians can reduce their tax burden by timing the recognition of income and deductions: (1) Defer income — if you expect to be in a lower tax bracket next year, defer income to the following year (e.g., delay billing, defer bonus). (2) Accelerate deductions — if you expect to be in a higher tax bracket this year, accelerate deductible expenses into the current year. (3) Installment sales — spread the gain from a business or real estate sale over multiple years to avoid pushing into higher brackets. (4) Qualified Opportunity Zone investments — defer capital gains by investing in a QOZ fund within 180 days of the sale.

Investment Tax Strategies

KDA's investment tax strategies for high-income Californians: (1) Tax-loss harvesting — systematically realize capital losses to offset gains; losses can offset gains dollar-for-dollar and up to $3,000 of ordinary income. (2) Asset location — hold tax-inefficient assets (bonds, REITs) in tax-deferred accounts and tax-efficient assets (index funds, growth stocks) in taxable accounts. (3) Qualified dividends — prefer investments that generate qualified dividends (taxed at 15–20% federally) over ordinary dividends (taxed at up to 37%). (4) Municipal bonds — interest on California municipal bonds is exempt from both federal and California income tax — particularly valuable at California's 13.3% top rate.