Military MSRRA / VTBA and Married Filing Separately Questions

[TaxG6]

Hi, I am a military spouse and I just wanted to ask a few questions because these specific tax issues are uncommon. My spouse is active duty military with a SLR of FL  and currently stationed in CA. We live together and work in CA. We filed as FL residents under the provisions of the VTBA/MSRRA and did not pay CA taxes in 2022. Last year we filed as "married filing jointly," but we could benefit from changing our filing status to "married filing separately" this year. 

1) If we switch to "married filing separately" this year, can I still file taxes as a FL resident under the provisions of the VTBA/MSRRA as a military spouse? Are there any changes that have to be noted on the return to ensure that this is done correctly?

2) My spouse (military) started earning 1099 income for a side hustle in 2023. My understanding is that CA state taxes will be owed on that 1099 income this year (but NOT on the military W2 income). Is that correct?

3) If we open a solo 401K, can my spouse shelter some of that 1099 income from CA taxes with pre-tax contributions?

4) Are capital gains/dividends/interest subject to CA state taxes in our situation?

Thank you for your help.

[NCperson]

@TaxG6 - why do you want to file Separately (I am assuming you mean at the Federal level).  I have yet to come across a situation where that makes financial sense.  Congress passes tax laws that protect the sanctimoney of marriage and that is why 96% of married couples file "joint".  

[TaxG6]

We have no children, no property, and the math actually works out for us this year in terms of lower projected federal taxes owed (according to multiple MFJ vs MFS calculators). Also - student loans are entering repayment next month, so filing separately will minimize monthly IDR payments according to loan calculators.

[NCperson]

@TaxG6 - I didn't put it in the original post because it's an indirect function of taxes; the ONLY way I've a benefit of filing Separate relates to repayment of Student debt where the lower earning spouse is on a income based repayment plan and being able to report a lower income gets the payments reduced.  

So filing Separate should create higher taxes, but the student loan payment reduction off sets that.

suggest you have someone else check your MFS vs. MFJ calcuations and how you input the information.  It would be unlikley that MFS is better, esp. if the spouse's incomes are far apart.  Remember, both must report the standard deduction or both must itemize; one can't take standard while the other itemizes.  

Suggest rerunning your assumptions through this calculator which is set up for 2023.

https://www.dinkytown.net/java/1040-tax-calculator.html

[TomD8]

1)  Yes.  The VBTA does not require the spouses to file a joint return in order to take advantage of its provisions.

2)  That is correct.  An active duty service member who is a non-resident of CA is exempt from CA income tax only on his/her military pay.

3)  Pre-tax 401K contributions are exempt from CA state income tax.

4)  Non-residents of CA are taxed only on CA-source income.  Interest and dividends have a source in California if the account or security is used in a trade or business or pledged as security for a loan, the proceeds of which are used in a trade or business in California.  Capital gains from the sale of stocks and bonds are sourced to the resident state of the taxpayer at the time of the sale.  See "Income Taxable by California" on page 6 of the CA tax publication:

https://www.ftb.ca.gov/forms/2022/2022-1031-publication.pdf

[TaxG6]

Thank you for the helpful responses.

Here's a question that isn't really addressed in the FTB bulletin:

If I (military spouse) start earning 1099 income, would I be exempt from CA taxes on gross profits earned as a sole proprietor? And how does state taxation apply in terms of distributions and salary received from S-corporations with regards to the MSRRA?

[TomD8]

This CA tax publication should answer your questions:

2022 FTB Publication 1032 Tax Information for Military Personnel

[samueldinmore14]

Why not just answer the questions?