Tax strategies for high-income earners in California start with a hard number: the combined top marginal rate on wage income exceeds 50% once you stack California’s 13.3% rate (12.3% plus the 1% Mental Health Services Act surcharge) on top of the 37% federal bracket for 2026.1Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Add the 3.8% net investment income tax that applies to most high earners, and the effective marginal rate on investment income climbs toward 54%. Cutting that bill meaningfully requires using every retirement shelter available, running the pass-through entity elective tax if you have business income, giving appreciated property instead of cash, holding California-issued municipal bonds, and avoiding the state’s non-conformity traps that can quietly reverse a federal win.
Max Out Retirement Accounts First
Retirement contributions are the most reliable lever for lowering adjusted gross income. The 2026 elective deferral limit for a 401(k) is $24,500, with an $8,000 catch-up if you are 50 or older.2Internal Revenue Service. Retirement Topics – 401(k) and Profit-Sharing Plan Contribution Limits Under SECURE 2.0, participants between ages 60 and 63 get a larger $11,250 catch-up. One wrinkle hits high earners directly: if your prior-year FICA wages exceeded $150,000, catch-up contributions must go into a Roth account on an after-tax basis rather than reducing current taxable income.3Internal Revenue Service. COLA Increases for Dollar Limitations on Benefits and Contributions
Defined Benefit Plans for Business Owners
If you own a business or earn substantial consulting income, a defined benefit plan can produce deductions well beyond what any 401(k) allows. Contributions are set by an actuary based on the amount needed to fund a target retirement benefit, and the maximum annual benefit in 2026 is the lesser of 100% of average compensation over your highest three consecutive years or $290,000.4Internal Revenue Service. Retirement Topics – Defined Benefit Plan Benefit Limits A 55-year-old with high compensation can contribute well over $200,000 in a single year, deductible as an ordinary business expense under IRC Section 404.5Office of the Law Revision Counsel. 26 U.S. Code 404 – Deduction for Contributions of an Employer to an Employees Trust or Annuity Plan
Timing matters. Most employer-sponsored plans must be established by December 31 of the tax year for which you want the deduction. A sole proprietor with no employees has slightly more room: since 2023, a solo 401(k) can be adopted by the tax filing deadline, though elective deferrals still must be made by that same deadline.6Internal Revenue Service. Publication 560 – Retirement Plans for Small Business A SEP-IRA is more flexible still and can be both established and funded as late as the extended filing deadline, which makes it a workable last-minute shelter in March for the prior year.
Solo 401(k) for Self-Employed Earners
Self-employed professionals without full-time employees can open a solo 401(k) and contribute in two capacities: as the employee, up to $24,500 in elective deferrals, and as the employer, up to 25% of net self-employment income. The combined ceiling for 2026 is $72,000 under age 50, $80,000 for ages 50 through 59, and $83,250 between ages 60 and 63.7Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500 The $24,500 employee deferral is a single limit across all 401(k) plans you participate in, so if you also contribute through a W-2 employer, the solo plan deferral has to be reduced accordingly.
Backdoor and Mega Backdoor Roth
Direct Roth IRA contributions phase out once modified adjusted gross income reaches $168,000 for single filers or $252,000 for married filing jointly in 2026.7Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500 The workaround is a nondeductible traditional IRA contribution (up to $7,500, or $8,600 at age 50 or older) followed by a conversion to Roth. Because the contribution was already after-tax, the conversion is largely tax-free.
The pro-rata rule is the catch. If you hold any pre-tax balances in traditional IRAs, SEP-IRAs, or SIMPLE IRAs, the IRS treats them as one pool when calculating how much of your conversion is taxable. Someone with $93,000 in pre-tax IRA balances converting a $7,500 nondeductible contribution would owe tax on roughly 92% of the converted amount. The clean fix is rolling pre-tax IRA balances into a 401(k) before converting.
If your employer plan permits after-tax contributions, the mega backdoor Roth extends the idea. After maxing pre-tax or Roth deferrals, you make after-tax contributions up to the overall plan limit ($72,000 under 50) and convert them in-plan to a Roth account. Plan documents vary; many employers do not allow after-tax contributions at all, so verify before counting on this.
Elect the Pass-Through Entity Tax
California’s pass-through entity elective tax remains the most effective workaround to the federal $10,000 cap on state and local tax deductions. S-corporations, partnerships, and qualifying LLCs can elect to pay a 9.3% tax on their qualified net income at the entity level.8California Legislative Information. California Revenue and Taxation Code 17052.10 That entity-level payment is deductible on the federal return, so a business with $1 million in qualifying income generates a $93,000 federal deduction that would otherwise be lost to the SALT cap. Owners then claim a nonrefundable California credit for the tax paid on their behalf, with unused credits carrying forward up to five years.
The program was originally scheduled to sunset after 2025, but SB 132 extended it through 2031. One procedural trap deserves attention: the entity must make an initial payment by June 15 of the tax year equal to $1,000 or 50% of the prior year’s elective tax, whichever is greater. Under the old rules, missing that payment killed the election. Starting in 2026, a missed or short June 15 payment no longer disqualifies the election, but it triggers a 12.5% reduction in each owner’s PTE credit based on their share of the unpaid amount.9Franchise Tax Board. Pass-Through Entity (PTE) Elective Tax Treat the June 15 date as mandatory.
Give Appreciated Assets, Not Cash
Donating appreciated securities or real estate directly to a 501(c)(3) is one of the most efficient philanthropic moves available in a high-rate state. Instead of selling the asset, paying capital gains tax, and donating the net, you transfer the asset itself. You deduct the full fair market value and never recognize the gain. The asset must have been held for more than one year.10Internal Revenue Service. Publication 526 – Charitable Contributions This matters more in California than in most states because the state taxes capital gains as ordinary income at rates up to 13.3%.11Franchise Tax Board. Capital Gains and Losses
Deduction caps limit how much you can use in a single year. Cash contributions to public charities are capped at 60% of AGI; donated capital gain property is capped at 30%.10Internal Revenue Service. Publication 526 – Charitable Contributions A taxpayer with $3 million in AGI donating $1.2 million in appreciated stock deducts $900,000 that year and carries the excess forward up to five years. Noncash donations over $5,000 require a qualified appraisal and Form 8283,12Internal Revenue Service. Charitable Organizations – Substantiating Noncash Contributions and the receiving charity must issue a written acknowledgment describing the property.13Internal Revenue Service. Charitable Contributions – Written Acknowledgments
Starting in 2026, the One Big Beautiful Bill Act introduced a floor: only charitable contributions exceeding 0.5% of AGI are deductible, and the floor applies to carryforward amounts from prior years. For someone earning $2 million, the first $10,000 of giving produces no deduction. Donor-advised funds remain a common tool for bunching several years of planned giving into one tax year to clear the floor, though the new above-the-line deduction for non-itemizers specifically excludes contributions to donor-advised fund sponsors.
Hold California Municipal Bonds for Double-Exempt Income
Interest from bonds issued by California state and local agencies is exempt from both federal and state income tax.14Internal Revenue Service. Topic No. 403 – Interest Received For a taxpayer in a combined marginal bracket above 50%, that double exemption can make a nominally lower-yielding California bond deliver more after-tax income than a higher-yielding taxable alternative. Bonds from other states remain exempt federally but are fully taxed by California at your state rate, which means a portfolio tilted toward California general obligation bonds, school district bonds, and state infrastructure bonds captures the full benefit.
Use an HSA Despite the California Addback
If you are enrolled in a high-deductible health plan, a health savings account produces a federal deduction for contributions. The 2026 limits are $4,400 for self-only coverage and $8,750 for families.15Internal Revenue Service. Rev. Proc. 2025-19 At a 37% federal rate, a family contribution saves roughly $3,238 federally. Funds grow tax-free and come out tax-free for qualified medical expenses.
California does not conform. Under Revenue and Taxation Code Section 17131.4, contributions are fully taxable at the state level, and interest or investment gains inside the account are taxed each year.16California Legislative Information. California Revenue and Taxation Code 17131.4 You claim the federal deduction on Form 8889 and add it back on California’s Schedule CA.17Franchise Tax Board. Schedule CA (540) – California Adjustments Residents The extra recordkeeping is annoying, but the federal savings justify the account. After age 65, HSA funds can be withdrawn for any purpose without penalty, though non-medical withdrawals are taxed as ordinary income federally and in California.
Account for the 3.8% Net Investment Income Tax
The 3.8% net investment income tax applies to interest, dividends, capital gains, rental income, and passive business income once modified AGI exceeds $200,000 for single filers or $250,000 for married filing jointly.18Office of the Law Revision Counsel. 26 U.S. Code 1411 – Imposition of Tax Those thresholds are not indexed to inflation. For a California high earner holding substantial investments, the combined marginal rate on long-term capital gains runs 20% federal plus 3.8% NIIT plus up to 13.3% California, totaling 37.1%. That is close to the federal ordinary income rate on its own. Strategies that reduce or defer investment income (municipal bonds, charitable gifts of appreciated property, installment sales) carry extra weight because they also sidestep NIIT. Material participation in a trade or business can keep that income out of the NIIT’s reach, since the tax targets passive activity income and trading businesses rather than active ones.
Watch California’s Non-Conformity Traps
California tracks the Internal Revenue Code in broad strokes but diverges in places that matter a great deal to high earners. These gaps can create unexpected state tax bills even when a federal strategy works cleanly.
No QSBS Exclusion
IRC Section 1202 allows founders and early investors to exclude up to 100% of the gain on qualified small business stock held at least five years. California does not conform. Under Revenue and Taxation Code Section 18152, the state taxes the full QSBS gain as ordinary income at rates up to 13.3%. A founder sitting on a $10 million QSBS gain who owes zero federal tax will still owe California roughly $1.33 million.
1031 Exchange Clawback for Out-of-State Property
Federal Section 1031 lets you defer capital gains tax when swapping investment real estate for replacement property, and California honors the deferral. The twist: if you exchange California property for property located in another state, the Franchise Tax Board tracks the deferred California-sourced gain indefinitely. You must file FTB Form 3840 in the year of the exchange and every year afterward until the gain is recognized.19Franchise Tax Board. Reporting Like-Kind Exchanges When you eventually sell the out-of-state replacement property without another exchange, the original California gain becomes taxable. Missing the annual FTB 3840 can trigger a Notice of Proposed Assessment for the entire deferred gain plus penalties and interest. If a 1031 exchange is part of a plan to eventually leave California, understand that the state’s claim follows the gain, not the property.
If You’re Thinking About Leaving
The Franchise Tax Board actively audits departing residents with high incomes. Residency turns on the strength, number, and nature of your connections to California compared with your claimed new state: where you spend your time, where your spouse and children live, which state issued your driver’s license, where your vehicles are registered, where you vote, and where your bank, medical, and professional relationships sit.20Franchise Tax Board. Guidelines for Determining Resident Status Buying a house in Nevada or Texas while keeping a home in California is exactly the pattern that invites an audit. Maintaining a marital home in California weighs heavily against a claim that you have actually moved. A clean break generally means changing driver’s license, voter registration, professional memberships, doctors, and accountants while cutting your California days substantially.
A limited safe harbor exists for individuals who leave under an employment-related contract. You must stay outside California for at least 546 consecutive days, and return visits cannot exceed 45 days in any tax year.20Franchise Tax Board. Guidelines for Determining Resident Status The safe harbor disappears if intangible income exceeds $200,000 in any year the contract is in effect, or if the FTB determines the primary purpose of leaving was state tax avoidance. For most high earners, that $200,000 intangible income threshold puts the safe harbor out of reach. Someone who moves mid-year files Form 540NR as a part-year resident and pays California tax on all income earned through the date of departure, plus any California-sourced income earned afterward.