Beginning in 2024, California employees may face payroll tax increases on two separate fronts. But in both cases, there may be ways taxpayers can reduce or even eliminate these taxes.

Thank you for reading this post, don't forget to subscribe!

California State Disability Insurance (SDI) Tax

In 2023, California residents incurred a State Disability Insurance (SDI) tax that was 0.9% on wages up to $153,164 in annual income, resulting in a maximum individual contribution of $1,378 for the year. The $153,164 cap meant that all wages above that amount did not incur the tax. Under Senate Bill 951, which was enacted in 2022 and becomes effective January 1, 2024, that wage cap will be removed and the tax percentage will increase. After January 1, 2024, all wages will be taxed at 1.1%; this will have a much greater impact on higher earning employees.

Employers do have the ability to implement their own internal plan that would exclude their employees from the state program. This is referred to as an employer-sponsored voluntary disability insurance (VDI) plan, and it must adhere to the following state guidelines:

  • ▪ Offer the same benefits to employees as the SDI
  • ▪ Provide at least one benefit that is better than those in the SDI
  • ▪ Not cost employees more than the SDI
  • ▪ Be able to match any increase in benefits to the SDI program resulting from future legislation.

Although operating an internal VDI plan does require additional administration, the overall objective for employers is straightforward—simply set aside sufficient internal funds to match the costs of the state required employee benefits.

Funding for the company VDI plan would likely come from internal payroll deductions on employee income. In addition to the payroll deductions, a cap or income limit could also be included to maintain an optimal level. For example, company analysis might show that a 1.1% payroll deduction from all employees up to a $190,000 cap will generate the correct amount of money to cover the necessary program benefits. Using this same example, another option might be to reduce the payroll deduction percentage to 0.8% while increasing the cap to a higher level (say, $300,000) and achieve the same results.

The main takeaway is that employer-sponsored VDI plans can yield considerable tax savings for higher-income taxpayers in California.

California State-Run Long-Term Care (LTC) Program

States across the country are currently facing a difficult situation due to the increasing Medicaid costs associated with long-term care (LTC). In California, spending on Medicaid has expanded considerably over the last decade, and is out-pacing revenue growth. Currently, Medi-Cal (the California Medicaid program) accounts for the second-largest budget outlay in the state, right behind K-14 education. The current demographic situation will likely add additional pressure to Medicaid spending in the coming years.

Washington was the first state to take action to curb rising Medicaid costs by introducing a state-run LTC program (WA Cares) that is funded by a .58% payroll tax. Following Washington’s lead, other states are now exploring similar ways to reduce their Medicaid spending on extended care.

In 2022, California commissioned a two-year task force to analyze different options for a state-run LTC program. The task force presented its final recommendations to the state in December 2023 that consisted of five distinct plans designs offering a broad range of LTC benefits. As expected, with greater benefits comes higher taxes. The tax amounts range from 0.6% to 3%. The plans also currently split the tax obligation between employer and employee rather than all on the employee as was done in Washington.

Now that the task force recommendations have been released, the responsibility has shifted to the state legislators. It will be upon them to decide on the merits of sponsoring a bill during the 2024 legislative session. At this point, no one has any idea when (and even if) LTC legislation will be introduced in California.

Of interest, all five task force plan recommendations allow for an optout of the state program to those who already own LTC insurance. The rationale is that those who have planned responsibly and purchased insurance to offset future LTC needs should not be forced to incur the additional income tax associated with the state-run plan. In Washington, residents were given a specific future date that private coverage needed to be in place in order to opt out, but this turned into a rush to secure coverage and resulted in many of the LTC carriers in Washington discontinuing their insurance offerings.

Other states, including California, learned from Washington and will likely require existing coverage be in place prior to a bill being enacted. For example, as New York Senate Bill 959 reads, “existing LTC coverage must be in place prior to Jan. 1 of the calendar year of the bill’s effective date.” Using a retroactive or backdating approach for allowing opt-outs makes sense from a state’s perspective because it is still in their best interest to maximize the tax base funding the program.

In addition to California and New York, several other states—including Pennsylvania, Minnesota, Massachusetts, and Colorado—have begun exploring the concept of a state-run LTC program. The list currently includes Pennsylvania, Minnesota, Massachusetts, and Colorado.

For residents of California or one of the other states considering legislation, now is a good time to examine the costs of private LTC coverage versus the tax liability under a state-run plan. The progressive nature of the proposed taxes means that mid- to high-income taxpayers will face a greater impact and may benefit considerably from opting out of a potential state-run LTC program.

Jason Chalmers is a director at Cohn Financial Group, Phoenix, Ariz.