What about 1% California Mental Health Service Tax?

The extra 1% Mental Health Services Tax in California for many years appeared to be a tax that would only affect the very wealthy. However, with professionals having high salaries, investment income, or what looks like a significant amount of cash coming in all at once, they can surpass the $1 million mark surprisingly fast today.

There is also a California surtax on income over $1,000,000 at the rate of 1% on the excess. Most importantly, the $1 million index is not adjusted for inflation, which could eventually draw more taxpayers into the tax's reach due to increases in wages and asset values. Look for an experienced tax professional (like an attorney for IRS issues) for some extra benefits.

How Can You Inadvertently End Up with Over A Million Dollars?

The tax doesn't need to be triggered by a seven-figure income. There can be many different income events that could drastically affect your income taxes in one year.

Stock Compensation

Vesting of stock options, exercising of non-statutory stock options, or the sale of appreciated shares can generate significant taxable income. Generally, NSO exercises and the resulting wage income are subject to California state income taxes, and there may be an additional capital gain from the sale of the stock.

One of these professionals who makes $700,000 a year may be able to make over $1 million once they have a big equity event.

Real Estate Sales

Capital gains can be substantial when an investment property, second home, or business real estate is sold. A sale, even if it is unusual and only occurs once, may cause the sale to exceed the threshold for California taxable income.

Business Liquidations

A business owner who sells a business, partnership interest, or a substantial business asset can see big gains in one tax year. A transaction that results in a $400,000 gain may result in a seven-figure taxable-income year where the $750,000 income is the same.

There are Several Good Reasons Why the Tax Can Be Easy to Miss

The tax is on taxable income that exceeds $1 million, and not just your salary. The official calculation in California is: If the earnings exceed $1 million, just subtract $1 million and then tax the remainder at 1%.

For instance, if your California taxable income is $1.2 million, an extra $2,000 in Behavioral Health Services Tax would be added to your taxes.

Since the threshold does not change with inflation, taxpayers whose earnings and investment gains grow as years pass could find themselves in it earlier. Get a tax professional (similar to a personal tax attorney) for help.

Listed Below Are Strategies That May Help

If you foresee crossing this line, use this as an opportunity to plan ahead by December 31:

·         Capital gains might be offset by investment losses realized from the sale of suitable investments at a loss (as per tax rules).

·         Follow up on stock transactions: Don't do separate follow-ups for each transaction, but instead coordinate transactions by vesting, exercising options, and selling.

·         Take the time to think about giving back: Giving of qualified charitable contributions may be a way to lower taxable income, but the rules and limits for deductible giving in California vary from the federal rules.

·         Discuss real estate and business transactions across tax years: Understand whether real estate or business transactions can be structured across tax years, when commercially and legally feasible.

·         For high-income earners, there may be other estimated-tax issues to watch for; estimated taxes should be figured based on the liability for the year, rather than waiting until tax filing season.

The 1% tax is not necessarily a tax on the entire $1 million. It's for amounts of California taxable income above that level. However, a large stock sale, stock redemption, or other business transaction may place an otherwise comfortable high-income earner in the additional tax bracket.

Planning year-round is the better course of defense. Consider consulting a qualified tax professional before using options, selling property with an appreciation, closing a business, or cashing in on significant charitable gifts if you are concerned about the possible California tax liability. When a single event can alter your entire tax position, the benefits of a few months of planning can make a huge difference.