Is California Pension Income Taxable Outside California?

Individuals who spent their working years in California may decide to spend their retirement years in other states. Reduced income during retirement may not cover expenses in California, which has the fourth highest cost-of-living of the 50 states. Any liability for taxation of pensions by California is material to retirement security--only three states have higher maximum tax rates than California.

As early as 1991 opposition existed to California’s taxation of pensions received by non-residents. Only 12 states imposed such taxes on non-residents. Effective January 1, 1995, the U.S. Congress eliminated the practice with passage of Public Law 104–95. The Act eliminated taxation of non-residents for pension and retirement income, including monthly pensions, deferred compensation plans, IRAs and annuities, or certain other qualified employer payment arrangements created upon retirement.

Prior to passage of Public Law 104-95, pensions earned while working in California were considered “California Source Income” and were taxable income for non-residents. Some California source income is still taxable for non-residents. Rental income that a non-resident receives from California real estate --such as a time-share on a condominium--in excess of $1,500 in a calendar year is subject to California income tax. A non-resident partner who receives income from a California-based partnership, non-resident shareholders in certain California-based corporations and trust or estate beneficiaries may also be liable for California taxes. California also charges income taxes on wages of non-residents who work in California, such as a resident of Arizona who crosses the Arizona-California border to work.

In the reverse situation, a California resident receives a pension or a distribution from a pension fund based on work done in another state--all the pension is taxable in California. For example, if a California resident withdraws pension funds in a lump sum after retirement, the pension funds would all be taxable if the individual received the funds after becoming a permanent resident of California. The fact that the funds were earned while residing in another state is not controlling.

Non-residents of California who become aware of the McCauley Act may mistakenly believe the Act was enacted and a law exists to tax non-residents for California-source pension income. The McCauley Act was a proposed initiative for the November 2010 California election. The Act would have imposed an excise tax on pensions paid to non-residents if the pensions were based on work done in California. The excise tax would have been steep--50 percent on any pension amount above $40,000 annually. The measure did not make it to the ballot and never became law.