California Exit Tax on High-Net-Worth Individuals

With high taxes, restrictive regulations, and costly labor, energy, and utility costs in
California, many wealthy residents have considered leaving. But before making such
a drastic decision, they may want to reconsider.
This bill would tax former residents for up to 10 years after leaving California on any
wealth they accumulated during that period, violating federal due process and
interstate commerce laws by taxing wealth beyond California’s borders.

What is the exit tax?

This proposal, part of California’s wealth tax initiative, would target high-net-worth
individuals who leave California. An exit tax would comprise of 0.4% one-time
payment on assets exceeding $30 million for individuals filing separately; married
taxpayers filing jointly are exempted.
The proposed exit tax has many high-net-worth residents and businesses
reconsidering their relocation plans, due to potential financial implications that could
extend over a decade. Therefore, proper relocation planning is imperative.
To withstand constitutional scrutiny, wealth exit taxes must be carefully tailored.
They must not interfere with people’s freedom to travel and should instead be
grounded on objective fact rather than subjective assumptions that those leaving
may not contribute as much to the economy or community as those remaining
behind.
Additionally, wealth exit taxes cannot discriminate against interstate commerce. A
state must not charge more when products cross state lines and must ensure that its
taxes collected are equitable and fair. A wealth exit tax fails these tests by
discriminating against people leaving the state while failing to generate enough
funds for its needs.

Who is subject to the tax?

The proposed California Wealth Tax will target residents whose net worth exceeds
$30 Million (if married filing separately), or $15 Million if married filing separately. It
is not an income tax but instead acts as an exit fee on all assets except California
real estate – home, business, stocks, inherited assets as well as portion of retirement
accounts are considered assets in this calculation.
California claims that this policy serves to recoup their investments made in these
residents and businesses – whether through tax breaks, financial incentives or
infrastructure support – in making them successful; they feel entitled to receive
some form of return for that success.
But this may violate both the Commerce and Due Process Clauses of the U.S.
Constitution. According to the Commerce Clause, states may not place greater
burdens on interstate commerce than on intrastate commerce; additionally, under
Due Process clause rules states cannot discriminate against people making voluntary
choices to leave for political motives.
As California is home to many high-net-worth individuals with assets held in
corporations, partnerships, limited liability companies or trusts – it may be
challenging to establish that there is no contact. Therefore, tax professionals with
experience are crucial in helping avoid an exit fee by structuring assets properly,
timing sales of certain assets appropriately or creating trusts.

How much does the exit tax cost?

Wealth exit taxes aim to close an important loophole that enables individuals to
evade California taxes by liquidating assets elsewhere, thus leading to lost revenues
for California as well as social unrest due to people leaving its borders.
The California wealth tax seeks to recoup some of its investments made in
individuals and businesses through tax breaks, financial incentives and
infrastructure support. Furthermore, this measure encourages residents to remain
within California while investing more.
To promote fairness, the wealth tax applies a uniform rate across all assets except
California real estate which is exempt from exit tax. Individuals with diverse asset
portfolios should seek advice from their tax advisor regarding specific provisions and
considerations that apply. Stock options and inherited assets may be treated
differently under this wealth tax due to vesting schedules or exercise dates that
differ.
The wealth tax is likely to pass constitutional review as it meets its “narrowly
tailored” objective, though it could face challenges on First Amendment grounds
since it restricts travel freedoms; alternative measures could achieve similar results
without violating Constitutional rights to freedom of movement between
jurisdictions.

How do I avoid the exit tax?

There are multiple strategies available to you for avoiding California’s exit tax. First,
ensure your relocation is for legitimate business or family reasons. California’s
Franchise Tax Board also considers various factors when assessing whether you
reside within its borders such as frequent visits and length of stays within its
borders; relationships between friends and family members; as well as strength of
ties to a new community within California.

If your relocation can be documented through any of these factors, the FTB may
decide that you are no longer considered a California resident for tax purposes and
you can avoid being subject to the wealth exit tax and other state levies targeting
ultrawealthy residents who leave California. This could save money when filing taxes
as you’ll avoid wealth exit taxes targeted at ultrawealthy individuals leaving.
Though California has attempted to impose an exit tax in the past, these efforts
failed due to insufficient nexus with nonresidents and constitutional scrutiny due to
any attempt at restricting travel rights. Therefore, wealthy individuals should keep
an ear open for any new legislation that might impact their decision to move out of
state, especially since a California wealth exit tax or similar proposal could become
reality in future legislation.