California's Deduction Policy For Investment Management Expenses

California's treatment of investment management expenses for tax purposes has been a subject of discussion in recent years, with some changes taking place due to the Tax Cuts and Jobs Act (TCJA). While the TCJA eliminated various deductions, including those for investment management fees, California has not conformed to all these changes. This means that California still allows deductions for investment management expenses, even though they are no longer deductible for federal tax purposes. This difference between federal and state tax laws can be advantageous for taxpayers in California, as they can continue to claim these expenses and potentially reduce their taxable income. However, it is important for individuals to carefully review the specific guidelines and consult with tax professionals to ensure accurate reporting and compliance with the latest regulations.

Investment fees are deductible in California

California has a unique set of rules and regulations when it comes to tax returns, and understanding these can help you minimise your tax liability. One of the key differences between federal and California tax law is the treatment of investment fees and expenses.

To claim these deductions, you will need to itemize your deductions. This means that you will need to keep accurate records of all your investment-related expenses. It is important to note that California does not conform to all federal itemized deductions, so you should ensure you are aware of the specific rules for California. For example, gambling losses are deductible up to the extent of gambling winnings.

To claim your investment fees as deductions on your California tax return, you can follow these steps:

• Log into your tax return account.
• Select 'State' in the left navigational pane and choose California if it is not already selected.
• Navigate through the questions until you reach a screen that says, 'Here's the income that California handles differently'.
• Go to 'Investments > Investment Income Expenses'.
• Enter your investment fees as a negative figure for non-taxable income expense in the adjustment to income section.

By following these steps, you can ensure that your investment fees are deducted from your California tax return, reducing your taxable income for the year. It is always recommended to seek professional advice or refer to the official government websites for the most up-to-date and accurate information.

How to claim investment fees in California

If you are filing your tax return in California and want to claim for investment fees, there are a few things you need to do. Firstly, it's important to note that while federal tax law no longer allows for the deduction of investment advisory fees as of 2018, California state law does still allow this as a miscellaneous itemized deduction.

To claim these fees, you will need to itemize your deductions on your California state tax return. This means you will not take the standard deduction and will instead list out your individual deductions, including any advisory fees that are allowed.

• Log into your Turbo Tax return.
• Select the state in the left navigational pane in your program. If California is not selected, add it and choose it from the list.
• Navigate through the questions until you reach a screen that says, "Here's the income that California handles differently".
• Go to Investments > Investment Income Expenses.
• Enter the amount you paid in adviser fees.
• If you need to calculate the fees, you may need to contact your portfolio manager to determine what portion of the investment fees applied to US government bonds.
• If you are unable to get an exact answer, you can try using a formula based on the percentage of taxable versus non-taxable bonds.
• Your investment expenses should appear on line 21 of your Schedule CA form.

Please note that it is always recommended to consult with a tax professional familiar with California tax law to ensure you are following the latest rules and regulations.

California's standard deduction

The standard deduction is the amount that reduces your taxable income, and it can be claimed by all filing statuses unless someone else claims you as a dependent on their tax return. In California, you can claim the standard deduction if you are not claimed as a dependent by someone else on their tax return.

The standard deduction amounts for 2023 were slightly lower, at $5,363 for single or married/RDP filing separately, and $10,726 for married/RDP filing jointly, head of household, or qualifying widow(er).

California has nine state income tax rates, ranging from 1% to 12.3%. The state income tax is levied on your income each year and is often withheld from your paycheck. The tax rates for the 2024 tax year remain the same as the previous year, but the income brackets have shifted slightly across all filing statuses.

California's non-conformity to federal itemized deductions

California's tax laws generally conform to the Internal Revenue Code (IRC) with some modifications. However, California does not conform to all federal itemized deductions. For instance, California does not conform to the federal change regarding divorce or separation agreements executed after 31 December 2018. In such cases, a Schedule CA adjustment is required.

For divorce or separation agreements executed before 1 January 2019, California conforms to federal law. Alimony payments are deducted by the payer and included in the income of the recipient.

Regarding investment expenses, such as investment advisor fees, these are deductible in California. To claim these deductions, you need to log into your TurboTax return and select California as your state. As you navigate through the questions, you will reach a screen titled "Here's the income that California handles differently." From there, you can select "Investments > Investment Income Expenses" to claim your investment fees.

It is important to note that the new tax law eliminated investment expenses as an itemized deduction at the federal level, but it should transfer over to your California state return. These investment expenses will appear on line 21 of your Schedule CA form.

California's non-conformity to the SALT deduction limitation

California has taken steps to allow its residents to mitigate the effects of the $10,000 federal limit on the SALT (state and local taxes) deduction, implemented under the Tax Cuts and Jobs Act (TCJA). This limit is set to expire on December 31, 2025.

In July 2021, Governor Gavin Newsom signed Assembly Bill 150 (AB-150) into law, creating a workaround for the SALT deduction limitation. This law allows certain pass-through entities, including partnerships, multi-member limited liability companies, and S corporations, to elect to pay California income tax on behalf of their individual, estate, and trust owners, with their consent. By doing so, the entity can take the deduction for state tax paid without limit, reducing the federal taxable income passed through to the owners. The owners then receive a California income tax credit for the tax paid by the entity, avoiding double taxation.

This workaround is beneficial for pass-through entity owners, especially those in high-income brackets. However, it is important to note that a pass-through entity with even one ineligible owner is disqualified. Additionally, the law does not prevent a qualified entity from electing to pay the entity-level tax, even if one or more owners do not consent. Non-consenting owners are simply excluded from the calculation, and their share of the entity's income is not subject to the entity-level tax.

The timing and payment process for the elective tax is different for tax years beginning in 2021 and 2022. For tax years starting in 2021, the qualified entity has until the original return due date, excluding extensions, to pay the entire entity-level tax. For tax years beginning in 2022, the entity must pay a first installment by June 15 of the applicable tax year, with the second installment due by the original return due date, excluding extensions.

The new law provides an incentive for C-corporations to make an S-election, as long as all shareholders join in the election to maintain S-corporation status. It also offers an opportunity for sole proprietors to form an LLC or incorporate their business and elect S-corporation status. However, there is a requirement for S-corporations to pay reasonable compensation to their shareholders, which would reduce the entity's net income subject to the elective tax.

While AB-150 provides a mechanism for residents to mitigate the SALT deduction limitation, it is important to carefully consider the details and eligibility requirements before electing to take advantage of this workaround.

Frequently asked questions