California's income tax system differs from federal tax law in many ways. Unfortunately, this means that many of your federal deductions may be limited or disallowed in California. But the Golden State does have some of its own deductions and many credits that you may benefit from.
Income Exempt from California Income Tax
Certain types of income are exempt from income tax in California (some of which are taxed on your federal return). Income that is exempt in California includes:
- Social security and railroad retirement benefits (however, all other private, state, local, and federal pensions are fully taxed)
- Interest earned on federal bonds
- State income tax refunds
- Distributions from an health savings account (HSA)
- Unemployment compensation
- Paid family/maternity leave (which is taxed on your federal return)
- California state lottery winnings
- Through the end of 2012: California will allow you to exclude up to $250,000 ($500,000 if married/RDP filing jointly) of cancelled debt in connection with a home sale (this usually happens in foreclosure or short sale situations).
Income Taxed in California That Is Not Taxed Federally
There are also types of income that you will have to pay taxes on in California that are not taxed on your federal return, such as:
- Your Cash for Clunkers rebate: if your rebate was greater than the cost of the vehicle you will have a capital gain in California
- Foreign-earned income that you may have excluded on your federal return
- Interest earned on municipal (state and local) bonds from outside of California is taxable
There are several federal California does not allow including deductions for: contributions to a health savings account (HSA); adoption expenses; federal estate taxes; expenses of teachers, principals, etc.; qualified higher education expenses; and state, local, or foreign income taxes paid. Also, the amount of other federal deductions such as IRA contributions and charitable giving are limited in California.
If you take the standard deduction, you cannot increase your California standard deduction for property taxes, taxes on the purchase of a new car, or disaster losses as you may have done on your federal return.
But there is some light at the end of the tunnel. California has a few additional deductions of their own:
- Interest on loans from utility companies: a deduction for interest paid or incurred on a public utility company financed loan that is used to purchase and install energy efficient equipment or products
- If you qualified for the federal mortgage interest credit, you can take the amount of this credit as a deduction on your California tax return
- The deduction for medical expenses follows the federal deductibilty rules. You can only deduct the portion of your medical expenses that exceed 7.5% of your federal AGI. California differs from federal law in that they allow a deduction for the medical expenses of a registered domestic partner and the partner's dependents.
California income tax rates range from 1.25% to 9.55% and are levied on California residents’ income and non-residents’ income from California sources. California also charges a mental health surcharge (in addition to the regular tax rate) for residents with incomes over $1 million.
California Tax Credits
Tax credits are deducted directly from your tax due, which can sometimes make them more valuable than deductions. California's income tax credits include:
- Exemption Credit: a credit of $98 each for yourself, your spouse, and your dependents. If you are blind or over 65 you can claim an extra $98 credit
- Renters Credit: a $60 credit for single renters whose income is $34,412 or less and $120 credit married/registered domestic partner (RDP) filing jointly taxpayers whose income is $68,824 or less
- Adoption Cost Credit: 50% of the qualified costs in the year of adoption
- Child/Dependent Care Credit: a percentage of the federal credit is allowed for qualified child/dependent care expenses. This credit is refundable.
- New Home Credit (2010): a credit for those who purchased a qualifying new home between May 1, 2010 and December 31, 2010
- First-Time Buyer Credit (2010): a credit for first-time homebuyers who purchased a qualifying home between May 1, 2010 and December 31, 2010
- Joint Custody Head of Household Credit: taxpayers who are single or married/RDP filing separately who have a child may qualify for a credit of 30% of their tax liability up to $387
- Dependent Parent: for married/RDP taxpayers filing separately who also have a dependent parent
For a full list of credits see the California Franchise Tax Board (FTB) website.
Filing Your Return
Forms can be found on the California Franchise Tax Board (FTB) website and returns must be postmarked by April 15th.
The FTB lists free web-based tax preparation services on their website. Those who meet eligibility criteria can also choose to use the state’s free online return preparation tools known as ReadyReturn and CalFile. Both of these tools can be accessed on the FTB's website and are free of charge.