Tax Considerations for California’s Proposition 30

Brandon R. Amaral, CFP®, EA
Brandon R. Amaral, CFP®, EA

Founder & Financial Planner, Amaral Financial Planning

As we enter the holiday season, it’s also time to start voting in our local elections. While there are many important initiatives on the ballot this year, one I want to highlight is California’s Proposition 30.

While this post is not politically charged, nor does it go into the pros and cons of the initiative, I want to look at the tax consequences if passed and strategies that could help reduce your tax bill.

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Here are tax considerations for Prop 30:

What is Proposition 30?

Proposition 30 is an initiative that provides funding for programs to reduce air pollution and prevent wildfires by increasing taxes on personal income over $2 Million. If passed, this would impose an additional 1.75% in taxes on income over $2 Million starting January 2023.

The purpose of this tax is to provide funding to taxpayers and businesses to purchase zero-emission vehicles (ZEVs) and install more charging stations. A portion of the tax would also go towards wildfire response and prevention activities.

How can this affect you?

Everyone knows that California has one of the highest state income taxes in the country. In addition to the top tax bracket being 12.3%, California imposes a 1% Mental Health Services tax on all income OVER $1 Million. If this proposition passes, you will also owe an additional 1.75% in taxes on all income OVER $2 Million (2.75% combined).

Sounds like a first-world, 1% problem? Not necessarily. Here are a few examples of how this can affect you:

  • The Bay Area homeowner that purchased their home in the 70s for $30,000 is now worth $2.5 Million. They plan to downsize and live off the proceeds.
  • The tech employee that has been underpaid for 10 years and was receiving stock options. The 100,000 options they received for $0.20/ share are now worth $5 Million.
  • The partner who built their firm from the ground up is looking to retire. They have the opportunity to sell their partnership interest for $3 Million.

In each of the scenarios, the individuals have lived modest lives and have been working hard for this potential windfall. Depending on the type of income (ordinary or capital gains), they can expect to pay anywhere from 39% – 53% in total income taxes.

How can you avoid this tax?

Depending on your situation, there are a few different strategies you can take advantage of to reduce your tax bill:

Perform a 1031 Exchange

While complex, this strategy can save you tens of thousands of dollars in taxes. To start, you will need to move out of your home and start renting it out. Once you have 2-3 years of rental activity, you will be able to sell the home and complete a 1031 exchange. This allows you to defer the taxable gain and invest in other real estate investments. Although you may eventually still owe taxes to California later, you are able to avoid some of the high-income surtaxes.

Spread sales over multiple years

For holders of stock options, you typically have more control over when tax is triggered (i.e., exercising or selling your options). Since your taxable income and tax rates are based on the calendar year, you are able to spread your exercises/ sales over multiple years. For example, you could sell enough shares to stay under certain income thresholds in December, and then later sell more in January. Although you may have placed the trades a few days apart, you can spread the gains over multiple tax years.

File as Married Filing Separately

While some strategies require long-term planning, this strategy is utilized after the tax year has ended. California’s surtaxes (Mental Health Tax and the potential Prop 30 tax) are assessed on a per-tax return basis. This means that a married couple that files as Married Filing Jointly with $4 Million of income can expect to pay $65,000 in surtaxes (1% of $3 Million and 1.75% of $2 Million). However, if the couple opts to file as Married Filing Separately, they can reduce their surtaxes to only $20,000 (1% of $1 Million x 2), effectively saving $45,000 in taxes. It is important to consider the pros and cons of changing your filing status to Married Filing Separately when in a high-income year.

Understanding the tax implications of ballot measures is essential to saving you money and reducing your tax bill. If you would like to work with a financial planner to walk you through your options, I would love to help you!

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Disclaimer: This blog is for informational purposes only, and should not be considered advice or recommendations. All opinions expressed herein are solely those of Amaral Financial Planning, LLC, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made to another parties’ informational accuracy or completeness. You should consult your financial advisor, tax professional or legal counsel prior to implementation.