The Highest Tax in the English-Speaking World is in this U.S. State
If you are an investor, taxes matter. Uncle Sam & California’s Uncle Roger (named after the verb) want your investment income.
- When you graduate to investing money held outside of your IRA/401(k), it’s a whole new ball game — especially in California.
- Taxes matter: you can build wealth faster and with less risk by being tax-smart.
- Californians give up, in taxes, as much as 1/3 to 1/2 of each year’s interest, realized stock and bond gains, etc.
- The top combined net tax rate is 52.2% on short-term investment income for California residents.
- The big-ticket items — selling long-term investments, with years of accumulated growth — face lower federal capital gains taxes, bringing the high-income net tax rates to 33%.
- Of the 35 OECD nations, only France and Denmark have higher long-term capital gains than California’s 33% (top-20 are listed below).
- When selling investment property, taxes will be even higher due to the higher tax on depreciation recapture.
- New fractional 1031 exchange options exist to defer capital gains taxes for investors selling investment property.
- Know your tax rate; make better financial decisions: go to FreeTaxCalc.com to estimate your 2016 and 2017 marginal tax rates.
- Modern Investing is wealth management optimized for superior risk-adjusted after-tax returns, as opposed to performance in a world without taxes, or on basic metrics like cost-minimization.
- Respond below or contact me with any questions if you would like to learn more.
Skip this article if:
- You hold your assets offshore
- You have not started saving for retirement outside of your IRA/401(k)
- You are an academic —e.g. a finance professor — free to assume-away taxes. Academic research on portfolio management generally ignores the effects of complex and ever-changing national, state and local tax codes.
After Uncle Sam’s share, of the 41 states taxing investment income, California claims the most from you.
For investors, it’s the tax on the big ticket items that can sting the most in a given year in term of absolute dollars. Assets with years of appreciation are taxed as capital gains when they are sold without help and/or regard for tax efficiency.
Combining state and federal taxes on long-term capital gains, high-income Californians face a
33% tax rate — the highest in the English-speaking world.
According to the Tax Foundation’s Kyle Pomerleau, there are only two OECD countries with a higher tax rate on long-term capital gains than California: France and Denmark. (see Top 20 list below by OECD Nation and U.S. State)
→ see below below for more on long-term capital gains ←
The taxes on short-term investment income in California can exceed 52%!
Combined tax rates for California residents max-out at 52%+ on short term investment income:
- bank interest: CDs, money market, etc.
- corporate bond coupon payments, REIT income
- short term trading of securities: capital gains held one year or less
- ‘flipping’ your IPO shares in Snap(Chat) Inc.
- short-term (non-qualified) stock dividends
- most stock option trades
- short-sales, including many hedge fund investments
Specific examples of the tax hit on short term investment income:
- A married couple in California with $290,000 in salary + bonus can say goodbye to 48% of the interest earned in their taxable bank and money market accounts this year.
The math on long-term capital gains taxes: 33%
Uncle Sam’s capital gains tax rate generally applies when, for example:
- selling your house or investment property
- company shares you own get acquired for cash (e.g LinkedIn:Microsoft)
- you sell securities in your investment portfolio held for over a year
- you receive qualified stock dividends
- you receive certain mutual fund distributions
The top IRS long-term capital gains tax rate is 20%.
The 20% long-term federal capital gains tax rate applies where a single taxpayer’s income exceeds $400,000 or a married couple’s income exceeds $450,000.
High income tax payers face an additional net investment income tax (NIIT) of 3.8%.
The 3.8% rate applies where a single taxpayer’s income exceeds $200,000 or a married couple’s income exceeds $250,000.
The NIIT went into effect on 1/1/2013 to help pay for the Affordable Care Act (PPACA) or “Obamacare”. It is safe to say that in 2017 we will be hearing more about the longevity of this additional tax.
In states like California, ordinary income tax rates apply, which max-out at 13.3%.
There is no distinction between long-term and short-term capital gains/ordinary income in many states.
Simply adding them together, 20% + 3.8% + 13.3% = 37.1%. However state taxes can be deductible on federal income calculations. Factoring those deductions, net of the adjustments for alternative minimum tax (AMT) gets us to a 33% long-term capital gains tax rate in California.
Taxes on investment property gains can be even higher.
Investment property will tend to have years of accumulated depreciation. Instead of applying your long-term capital gain tax rate, the IRS applies a 25% rate on depreciation recapture.
This is reasonable, considering the investor benefited by more than the 25% rate when taking the depreciation expense to reduce ordinary income. That tax shelter is a special aspect of real estate investing.
Exception: Fractional 1031 exchange alternatives for investment property
Most real estate investors are familiar with the ability to defer capital gains on sale when they do a 1031 exchange.
Very few are aware of the additional option to getting out of active property management and exchange the sales proceeds in a Fractional 1031 exchange alternative: the Delaware Statutory Trust (DST).
This 1031 alternative is only available to accredited real estate investors with the help of a financial advisor with DST expertise. If you and your CPA and/or real estate attorney would like to learn more about this option, just let me know.
The Top-20 L.T. Cap Gain Tax rates among the OECD:
Top Marginal Tax Rate on L.T. Capital Gains, by OECD Nation and U.S. State
Rank: Country/State: Rate:
1. Denmark 42.0%
2. France 34.4%
3. California 33.0%
4. Finland 33.0%
4. Ireland 33.0%
6. New York 31.5%
7. Oregon 31.0%
8. Minnesota 30.9%
9. New Jersey 30.4%
10. Vermont 30.4%
10. D.C. 30.4%
12. Maryland 30.3%
13. Sweden 30.0%
14. Maine 29.8%
15. Iowa 29.6%
16. Idaho 29.4%
17. Hawaii 29.4%
18. Nebraska 29.1%
19. Connecticut 29.0%
20. Delaware 29.0%
Income Tax-Free States:
Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming have no income tax. Residents of New Hampshire and Tennessee pay tax on dividends and investment income but not on earned income. (source)
About the Author
Jason R. Escamilla, CFA is CEO of ImpactAdvisor LLC, a boutique Registered Investment Advisor based in San Francisco, serving individuals and corporate clients with advanced wealth management needs: high tax-bracket, custom-tailored portfolios, alternative investments, etc.
ImpactAdvisor LLC specializes in Modern Investing: Tax Smart + Socially-Selective℠
Our average client has over $1M in investment assets. We have a waiting list for smaller accounts, but with the help of modern custom software, data and design, we will work quickly through the backlog.
Our Mission is to make Modern Investing available to everyone.
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