How the 1% Surcharge Works

The mechanics are straightforward. If your California taxable income (the number on Form 540, after all deductions and adjustments) exceeds $1,000,000, you owe an extra 1% on the amount above that threshold. Earn $1,200,000? You pay the standard tax on the full amount using California’s regular brackets, then add 1% of $200,000 ($2,000) on top.

The 1% only applies to the excess. Someone earning $1,000,001 owes exactly one extra penny from this tax. There’s no cliff where crossing $1M suddenly taxes your entire income at a higher rate. That said, the marginal impact is real: every additional dollar above $1M faces a combined 13.3% California rate (12.3% bracket + 1% MHST), and that’s before federal taxes.

It Applies to ALL Income Types

This is the part that catches people. The Mental Health Services Tax doesn’t discriminate by income category. Wages, salaries, and bonuses? Taxed. Business income from Schedule C or pass-through K-1s? Taxed. Rental income? Taxed. And the big one: capital gains? Taxed at the same rate as everything else.

Remember, California already doesn’t offer a preferential capital gains rate. Long-term gains get taxed as ordinary income per Cal. Rev. & Tax. Code Section 17041. So when those gains push you past $1M, they face the 1% surcharge on top of the 12.3% bracket rate. A tech employee who exercises stock options and realizes a $2,000,000 gain doesn’t just owe the federal 20% plus 3.8% NIIT. They owe California 13.3% on the portion above $1M. That’s a combined federal-plus-state rate that can approach 40% on the excess. For a deeper look at how this affects investment income, see our California capital gains tax guide.

The $1M Threshold: No Inflation Adjustment, No Doubling for MFJ

Two things about the $1,000,000 threshold that most filers get wrong:

First, it’s not indexed for inflation. The brackets in California’s regular rate schedule get adjusted every year based on the CCPI per RTC Section 17041(h). The Mental Health Services Tax threshold doesn’t. It’s been $1,000,000 since 2004. In inflation-adjusted terms, that $1M is worth considerably less than it was twenty years ago. More taxpayers cross it every year, which is exactly what the state’s revenue projections depend on.

Second, the threshold doesn’t double for married filing jointly. If you’re filing MFJ, the surcharge kicks in at $1,000,000 of combined taxable income. A couple where each spouse earns $600,000 is well past the threshold. This is one of the few places in California tax law where MFJ filers get no bracket relief relative to single filers. It’s a marriage penalty in everything but name.

One-Time Events That Push You Over

Most of the people who pay this tax aren’t consistently earning $1M+ every year. They’re people who had one big year. We see it constantly in our practice:

• Stock option exercises or RSU vesting — A startup employee whose company goes public can realize millions in a single tax year
• Business sales — Selling a small business you built over 20 years can produce a one-time gain that dwarfs your normal income
• Real estate transactions — Selling a Los Angeles or Bay Area property with $1M+ in appreciation triggers the surcharge even if your regular salary is $150,000
• Large Roth conversions — Converting a $2M traditional IRA creates taxable income that year, even though you’re just reshuffling your own retirement savings. See our Roth conversion guide for planning strategies.
• Lawsuit settlements and judgments — Taxable portions of settlements can spike income in a single year

The cruel arithmetic here is that these are often once-in-a-lifetime events for the taxpayer, but California taxes them as if they represent your annual earning power. There’s no income averaging provision that would let you spread the gain across multiple years.

Revenue and Where It Goes

The Mental Health Services Tax generates roughly $2 billion to $3 billion per year for the state, though the amount swings wildly because it’s so dependent on capital gains realizations and high-income volatility. In boom years — when the stock market surges and IPOs flood the market — MHST collections spike. In downturns, they plummet. The revenue funds county mental health programs under the Mental Health Services Act, and the volatility creates planning headaches for the agencies that depend on it.

From a tax planning perspective, the MHST is one more reason California high-income filers should think seriously about the timing of income recognition, pass-through entity elections, charitable remainder trusts, and installment sales that spread gain recognition across years. If you can keep your taxable income below $1M in any given year, you avoid the surcharge entirely. That’s not always possible, but it’s worth modeling.

Where It Shows Up on Form 540

The Mental Health Services Tax is calculated on Form 540 itself, per the FTB Form 540 instructions. After computing your regular tax using the tax table or Schedule X, you add the 1% surcharge on the excess over $1,000,000. It’s not a separate form or schedule — it’s built right into the return. The FTB’s instructions walk through the computation, but the math is simple: (taxable income minus $1,000,000) times 1%. If your taxable income is $1,000,000 or less, the calculation is zero and you move on.

Sources & References

• FTB Form 540 Instructions (2024 Tax Year)
• Cal. Rev. & Tax. Code Section 17043 — Mental Health Services Tax
• Cal. Rev. & Tax. Code Section 17041 — Income Tax Rates
• California DHCS — Mental Health Services Act (Proposition 63)
• IRS — Net Investment Income Tax (NIIT)
• FTB — Mental Health Services Tax Information