California does not honor US tax treaties. Income a treaty keeps off the federal return is still taxed by California. The Franchise Tax Board says so in its own instructions, and the fix is an addition on Schedule CA.
This catches careful preparers. The federal return is correct and the software is internally consistent. The California return is short by exactly the amount the treaty excluded.
What the rule is
A tax treaty is an agreement between the United States and one other country. It decides which country taxes which income. Most treaty articles reduce or remove federal tax on certain income of a resident of the other country.
The IRS is plain that this stops at the state line. Its treaties page says: “Some states honor the provisions of U.S. tax treaties and some states do not.” California is in the second group.
The FTB states the rule in Publication 1001. Treaty-exempt income “may be excluded for California only if the treaty specifically excludes the income for state purposes.” If the treaty is silent about state tax, California requires the income to be reported.
Where the statute puts it
California’s Revenue and Taxation Code defines income by pointing at federal law. Section 17071 says Section 61 of the Internal Revenue Code “shall apply, except as otherwise provided.”
Section 61 is the full federal definition of income, before any treaty article is applied. A treaty is an agreement between the federal government and another country. California is not a party to it, and its instructions treat the excluded income as taxable.
How it shows up on Schedule CA
Schedule CA is California’s adjustment schedule. Residents file Schedule CA (540); part-year residents and nonresidents file Schedule CA (540NR). Column A copies the federal figures, column B subtracts, and column C adds.
The 2025 instructions for Schedule CA (540) and Schedule CA (540NR) carry the same wage line. Treaty-exempt income excluded on the federal return: “enter the excluded amount on applicable line 1a through line 1h, column C.” The only exception is income “specifically exempted for state purposes.”
A treaty claim made on federal Schedule 1 goes on line 8z, column C, “as a positive number.” Publication 1001 points to the same places.
For nonresident aliens, the 540NR instructions go further. Use columns B and C “to adjust federal AGI to include income from all sources,” reportable federally or not. (AGI is adjusted gross income.)
California has “no special rules” limiting a nonresident alien’s AGI to US-source or effectively connected income. (Effectively connected income is income from a US trade or business.) So the federal Form 1040-NR limits do not carry over either.
Who it bites
The pattern is a client who is a California resident for state purposes and a treaty claimant for federal purposes. The FTB treats anyone here for other than “a temporary or transitory purpose” as a resident. Residents are taxed “on all income regardless of source.”
Students and trainees. The IRS treaty tables list China’s Article 20(c): up to $5,000 a year of pay during training, no time limit. India’s Article 21(1) covers payments from abroad for study.
Teachers and researchers. China’s Article 19 exempts three years of teaching at a US educational or research institute. India’s Article 22 gives two years at a US educational institution, and the J-1 postdoc is the classic case.
Pension articles. Publication 1001’s example is the RRSP, a Canadian retirement savings plan. Its treaty deferral of earnings “does not apply for California income tax purposes.”
Any other treaty-based pension position needs the same question asked: does the treaty mention state tax?
The F-1 who became an H-1B. An engineer from India or China often arrived as a student, and the treaty years were the early ones. If California was missed then, the exposure already sits in prior years, waiting for a notice.
How firms miss it
The federal return is built to keep treaty income off the income lines. The Form 1040-NR instructions say exempt wages “should not be reported on line 1a.” They go on line 1k and on Schedule OI, item L, the return’s information schedule.
Often the employer already left them off the W-2 and reported them on Form 1042-S, the foreign-person income statement. So the wage figure the software imports is already net of the treaty.
Schedule CA column A copies federal lines 1a through 7a, not line 1k. So the exempt amount never enters column A, and nothing prompts a column C entry. The software is doing exactly what the instructions say.
The California addition is a manual entry. Nobody types it unless someone knows the rule and reads the Form 1042-S. In a firm that sees three of these returns a year, that someone is usually the partner.
A resident-alien client on a Form 1040 fails a different way. The treaty claim sits as a negative figure on Schedule 1, and the software carries it into column A. The line 8z, column C add-back is still manual.
What the FTB notice looks like
It is a Notice of Proposed Assessment. The FTB mails one when the client owes additional tax, penalties or interest. It says plainly: “This notice is not a bill.”
The client has 60 days to protest. After that the assessment becomes final and the FTB bills it. Interest runs “from the original due date of the tax return,” according to FTB 7275.
An accuracy-related penalty of 20 percent of the underpayment can apply. Paying within 15 days of the notice date stops further interest.
For a student the amount is small and the notice is a surprise. For a researcher with three years of exempt salary, it is three years of tax and interest arriving at once.
What this means for the firm
This is not a hard rule. It is an easy rule to forget, because everything upstream tells you the income is gone. The fix is one line on Schedule CA and one sentence in the workpapers saying why.
Foreign-income returns are the ones The Desk is built for, and the state side is part of the job. One enrolled agent prepares the return and a second reviews it, state against federal. A Form 1042-S or a Schedule OI in the file is the flag for this rule.
Your firm stays preparer of record; we never sign a return or e-file. What comes back is a worksheet with the Schedule CA addition shown and the reason written down. Our article on what comes back from the desk explains the format.
If your California pile has treaty returns in it, start with five returns. The federal decisions upstream are in our foreign-income article, and the residency side is in our state tax guide. How firms work with us and what it costs are on their own pages.
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