When the IRS applies a certain tax treatment to a transaction, California taxpayers tend to believe that the same tax treatment will automatically be applied to the transaction in California. This assumption may cost you a lot of money. California has its own tax code, and several important facets such as capital gains, research and development, and cryptocurrency transactions can result in a vastly different outcome at the state level than at the federal level.
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Long-Term Capital Gains (LTCG) are exempt from any special tax rate in California
The federal Internal Revenue Code provides preferential tax rates on qualifying long-term capital gains, depending on taxable income. There is no long-term capital gains rate preferred in California. Look for a professional (similar to a tax audit lawyer in San Diego) for some necessary assistance.
Rather, California typically treats capital gains as taxable income, and uses its regular individual income-tax rates.
For investors who sell, this is important:
- Share prices and mutual fund holdings
- Cryptocurrency
- Investment real estate
- Business interests
- Other capital assets
A transaction that is treated favorably at the federal level in terms of long-term capital gains can thus have a very different tax impact in California.
Tip: If you have a very valued asset to sell, estimate federal and CA tax impacts independently, and not based on the federal capital-gain estimate.
When the Federal R&D Rules Don’t Match California
Research and development is also one of the areas that shows a significant difference.
The federal research credit is available to federal taxpayers if their activities and expenses meet the requirements of IRC section 41. California has its own rules for research and development deductions, and there are some federal research and development provisions that do not automatically conform to California.
California has its own eligibility and calculation rules, as well as rules for some federal rules for R&D expense deductions.
The bottom line for business is clear:
Avoid Using the Federal R&D Calculation as Is on The California Return
Maintain documentation showing:
- Qualified research activities
- Employee involvement
- Qualified research expenses
- Project development records
- Contractor costs
- California-specific calculations
Crypto Raises Some Special Record-Keeping Challenges
The IRS considers cryptocurrency and other types of digital assets to be property for federal income-tax purposes. For most uses, California follows the federal characterization, but the state calculations may differ as California does not necessarily meet all the federal provisions.
One of the more significant misconceptions is that of wash sales.
Traditionally, IRC Section 1091 applies to stock and securities sold by a federal person, such as a company, that is a wash sale. IRC Section 1091 is traditionally treated as stock and securities. Historically, cryptocurrency was treated differently because digital assets are generally considered to be property, and not stock or securities. Get in touch with a professional (similar to an EDD audit lawyer in Los Angeles) who can help you plan your future taxes.
Taxpayers should not assume that it gives them the green light to claim all crypto losses for California purposes.
The tax treatment can vary between California and federal tax law, and new or proposed legislation can alter the situation. Traders should consider the rules that will apply to the specific tax year and not internet tips regarding “crypto wash-sale loopholes.”
Capital Losses Must Be Planned Separately from Other Losses
Capital-loss treatment for federal and California returns may also differ due to the differences in tax rates, deductions, carryforwards, and California conformity rules.
California investors should keep a separate state tax worksheet, which includes details of:
- Capital gains
- Capital losses
- Carryforwards
- Crypto transactions
- Stock sales
- Business-asset transactions
Tax Tips for Smart California
- Look at Federal and California Taxable Income before significant transactions.
- Keep separate California tax workpapers.
- Federal deductions are not necessarily applied in California.
- Conform to California rules once a year.
- Maintain detailed crypto transaction records.
- Create project and employee document R&D records.
- Model the California impact prior to making significant capital gains or losses.
California tax planning is more than a copy of the federal tax return. The state’s tax policies for capital gains, research and development incentives, deductions, and digital-asset deals can have a substantial impact.
The best way to think about federal and California tax calculations for investors and business owners is that they’re sort of kindred but different. Those differences can be found if they are not costly surprises with advance planning.
READ ALSO: Tax Preparation and Accounting: What Every Small Business Should Know
