Key Takeaways

• A California resident in the top brackets often pays a combined marginal rate above 50% on the last dollar of ordinary income once federal, state, and Medicare-related taxes stack together.
• Most of that rate is fixed. The deductions that work for ordinary employees — retirement contributions, itemized deductions — make only a small dent at this income level.
• The federal SALT deduction cap was temporarily raised to $40,000 for 2025 through 2029, but it phases out for higher earners and is scheduled to return to $10,000 in 2030. For most households above roughly $500,000 of income, the relief is limited.
• The levers that can meaningfully change the picture are different in kind: business ownership, real estate depreciation, entity structure, and exit planning.
• This is the introduction to a series on one of those levers — turning a recurring federal W-2 tax bill into family real estate equity — written from a California legal-structure perspective.

Why California’s Top Earners Face One of the Heaviest Tax Burdens in the Country

The short answer

If you earn a high W-2 or professional income and live in California, the combined marginal tax rate on your top dollar of ordinary income frequently lands above 50% once you add federal tax, California state tax, and the Medicare-related surtaxes that apply at higher incomes. Much of that burden is structural and cannot be planned away through ordinary deductions. A meaningful slice of it, however, responds to a different set of tools — and that is what this series is about.

Four taxes, stacked on top of each other

The reason high earners in California feel squeezed is that several separate taxes apply to the same income, each layered on the last.

Federal income tax. The top federal marginal rate is 37%. Under the 2025 tax legislation commonly called the One Big Beautiful Bill Act, the individual rate structure from the 2017 Tax Cuts and Jobs Act was made permanent, so that top rate is not currently scheduled to sunset. For 2026, it applies to taxable income above roughly $609,000 for a single filer and roughly $731,000 for a married couple filing jointly — though those thresholds are adjusted annually, so treat any specific figure as illustrative and confirm the current year’s brackets with your CPA.

California income tax. California’s top marginal rate is 13.3%, frequently described as the highest state income tax rate in the country. That figure is built from a 12.3% top bracket plus an additional 1% Mental Health Services Tax that applies to taxable income over $1 million, enacted by Proposition 63 and codified at Revenue and Taxation Code section 17043. Two features of that $1 million threshold catch people off guard: it is not indexed for inflation, and it does not double for married couples filing jointly. It stays at $1 million regardless of filing status.

The Additional Medicare Tax. A 0.9% surtax applies to wages and self-employment income above $200,000 for single filers and $250,000 for married couples filing jointly. For a high-earning professional, this applies to a large share of earned income.

The Net Investment Income Tax. A separate 3.8% tax applies to net investment income — including most passive rental income, capital gains, interest, and dividends — once modified adjusted gross income crosses the same $200,000 / $250,000 thresholds.
Put the ordinary-income layers together and the combined marginal rate on income over $1 million reaches roughly 51% for wage income. On certain investment income, the stack can climb toward the mid-50s. These are illustrative composite figures, not your actual rate, which depends on your full return — but the order of magnitude is what matters: more than half of the next dollar.

Why the usual deductions don’t move the needle

When a high earner asks how to lower the bill, the common answers — maximize the 401(k), bunch charitable deductions, harvest some losses, are all worth doing, but at this income level they trim around the edges rather than change the shape of the problem.

A few California-specific reasons why:

The SALT cap, even after its temporary increase. For years, the federal deduction for state and local taxes was capped at $10,000 — a particularly painful limit in a high-tax state, because it meant most of your California income tax was not deductible federally. The 2025 federal legislation temporarily raised that cap to $40,000 for tax years 2025 through 2029. That sounds like relief, and for some households it is. But the increased cap phases down for higher incomes, beginning around $500,000 of modified adjusted gross income, and is scheduled to revert to $10,000 in 2030. For the households this series is written for, much of the benefit is reduced or phased out — and all of it is temporary. Treat the specific figures as current-as-of-drafting and confirm them with your tax advisor, because this is one of the fastest-changing areas of the code.

The Alternative Minimum Tax. The AMT continues to limit the value of certain deductions for higher earners, and California imposes its own parallel AMT.

The phase-outs. Many deductions and credits phase out entirely well below the income levels this series addresses. High earners often find themselves outside the reach of the very provisions designed to reduce taxable income.
The result is a household earning $700,000, $1 million, or more, paying an effective rate that feels immovable — because, through ordinary planning, much of it is.

What actually can move the picture

The tools that meaningfully change a high earner’s tax position are categorically different from deductions. They generally involve owning something that the tax code treats favorably and structuring that ownership correctly. The main categories:

• Business ownership — operating income taxed and structured differently from wages, including the pass-through entity elective tax that California extended through 2030 as a workaround to the SALT cap (the subject of a dedicated article in this series).
• Real estate depreciation — the ability, under specific conditions, to generate paper losses that offset other income, accelerated through cost segregation and bonus depreciation.
• Entity structure — how the operating business and the real estate are held, which affects both tax treatment and liability exposure.
• Exit planning — like-kind exchanges and the step-up in basis at death, which determine how much of the deferred tax is ever actually paid.

Each of these is a legal-structure question as much as a tax question. That distinction matters, and it is the reason a law firm — not only an accountant, belongs in the conversation.

Where this series goes

This article is the entry point to a series built around a single idea: for the right household, a recurring six-figure federal tax bill can be redirected into an appreciating, amortizing real estate asset — turning tax drag into family equity. The strategy is well established. It is also widely misunderstood, frequently executed badly, and heavily scrutinized by the IRS when done without discipline.

The series walks through the framework, the linchpin requirement that determines whether the strategy works at all (Real Estate Professional Status and its alternatives), the California-specific traps that national tax commentary tends to ignore, how these acquisitions are financed, how the strategy is eventually exited, and how the entity structure that drives the tax benefit also protects the assets you build. Each piece is written for a California resident, because California’s rules — its non-conformity to federal depreciation, its clawback on out-of-state exchanges, its restrictions on professional entities, change the analysis at almost every step.

None of it is a do-it-yourself project. The households who get this right build the legal architecture before the first deal closes, with tax counsel and a CPA working together. The households who get it wrong tend to learn the rules from an audit notice.

A note for readers earning $400,000–$500,000

If your household income sits somewhat below the levels emphasized here, the same framework applies — and reading it now, before you are deeper into the top brackets, is the right time. Several of these structures take years to build correctly, and the planning is far easier to do in advance than to retrofit.

Work with Bay Legal

If your household earns well into the six or seven figures and your tax planning still consists mainly of maximizing retirement contributions, there are layers of the code you may not have explored — and structuring them correctly is a legal question, not only an accounting one. To talk through your situation with a California attorney, call Bay Legal at (650) 668-8000 or reach us through baylegal.com/contact.

The strategies in this series are built on legal structure — the right entity, the right ownership, the right documentation, put in place before a transaction closes. That is the work we do. If you are considering real estate as a way to address a heavy California tax burden, the time to involve counsel is early, while the architecture can still be designed rather than repaired. Call (650) 668-8000 to start the conversation.

Because every household’s facts differ, the right next step is a conversation about yours. Reach a California attorney at Bay Legal through baylegal.com/contact or (650) 668-8000.

Frequently Asked Questions

What is the top tax rate in California?

California’s top marginal state income tax rate is 13.3%, which applies to taxable income over $1 million. That figure combines a 12.3% top bracket with a 1% Mental Health Services Tax on income above $1 million. It is frequently cited as the highest state income tax rate in the nation. Your actual rate depends on your full return.

What is the combined marginal tax rate for high earners in California?

Once federal income tax (up to 37%), California income tax (up to 13.3%), the 0.9% Additional Medicare Tax, and the 3.8% Net Investment Income Tax are stacked, the combined marginal rate on top-bracket ordinary income frequently exceeds 50%, and on certain investment income can approach the mid-50s. These are illustrative composite figures rather than any individual’s actual rate.

Did the SALT deduction cap change?

Yes. The 2025 federal tax legislation temporarily raised the state and local tax (SALT) deduction cap from $10,000 to $40,000 for tax years 2025 through 2029. However, the increased cap phases down for higher-income households beginning around $500,000 of modified adjusted gross income, and it is scheduled to return to $10,000 in 2030. The specifics change quickly, so confirm current figures with your tax advisor.

How can high-income earners in California reduce their taxes?
At high income levels, ordinary deductions make only a small difference. The tools that can meaningfully change the picture generally involve favorably taxed ownership — business income, real estate depreciation, entity structure, and exit planning, combined with correct legal structuring. These strategies are fact-specific and require qualified tax and legal advice.

Is real estate a way to lower W-2 taxes in California?

Under specific conditions, real estate depreciation can generate losses that offset other income, including wages — but only if certain requirements in the passive activity loss rules are met, and California’s non-conformity to federal depreciation changes the state-level result. It is a legitimate but heavily regulated strategy that should not be attempted without qualified counsel.

This article is general legal information, not legal, tax, or financial advice. Reading this article and contacting Bay Legal, PC do not create an attorney-client relationship; that relationship is formed only by a signed engagement agreement. This article addresses California law and is written for California residents; other states differ. The law changes, and the figures and rules described here are current only as of drafting and may have changed since publication.