Bloomberg Tax
March 17, 2023, 8:45 AM

California Wealth and Exit Tax Shows a Window Into the Future

Michael Nathanson
Michael Nathanson
Colony Group

The recently introduced California wealth tax proposal essentially contains three components. The first, a wealth tax of 1% on household wealth over $50 million and 1.5% on wealth over $1 billion, would apply starting in 2024 and to those with over $50 million starting in 2026. It would be based on worldwide net worth, with some exceptions, and would apply to full-time, part-year, and temporary residents, subject to apportionment.

The second component is an exit-tax structure that allows the wealth tax to be applied for several years after a taxpayer leaves California. Also included are provisions that enable certain taxpayers to defer payment by contracting to pay the tax in the future, even if they leave. The third component is an enabling amendment to the California constitution.

While the California proposal is unlikely to pass, thanks in part to Gov. Gavin Newsom’s opposition, ultrawealthy taxpayers should be wary of what it portends. The California proposal doesn’t stand alone. Proposed legislation in Hawaii would impose a tax of 1% on state net worth exceeding $20 million, and proposed legislation in Washington would impose a tax of 1% on taxable worldwide wealth over $250 million.

Other states, including New York, have taken steps toward taxing the ultrawealthy, though primarily through higher taxes on capital gain and other income. Late last year, Massachusetts imposed a surtax of 4% on income over $1 million through a ballot initiative—and this example is perhaps telling. The “Massachusetts millionaires’ tax” had been introduced and defeated multiple times before finally becoming law.

The most recent wealth-tax proposals may not pass this year but, as in Massachusetts, it’s not the first time such proposals have been considered. They, too, may be part of a trend in which voters and politicians gradually become more comfortable with a targeted new tax.

Adding to the pressure, some state budget deficits are growing, forcing them to make difficult decisions. In California, the projected deficit of $22.5 billion roughly coincides with the projected $21.6 billion of revenue offered by the wealth tax proposal.

Then there’s the national rhetoric surrounding wealth inequality, with several politicians unsuccessfully calling for a national wealth tax. The political hurdles for a national wealth tax, however, are greater than they are in progressive states, making these states a natural testing ground.

As for the potential for exit taxation, fears of losing revenue from wealthy taxpayers moving to lower-tax jurisdictions aren’t unfounded. They’re the main reason why the eight states mentioned above acted in concert. According to the US Census Bureau, such migration already has been occurring.

If the trend favors future state wealth and exit taxes, how will they look? Let’s consider several provisions of the US Constitution.

First among those provisions are the Privileges and/or Immunities Clauses. The Supreme Court has held that these clauses guarantee the right to travel and preclude the states from unduly restraining interstate mobility.

We can therefore expect any future wealth or exit tax won’t impose a heavy burden on a taxpayer’s decision to move. The California proposal arguably could fail this test, not only because of the magnitude of the exit tax but also because it would apply to illiquid and hard-to-value assets, making the decision to move expensive and administratively burdensome. While the California proposal does offer a limited debt option to pay the tax in the future, the courts may require more.

Also relevant is the Commerce Clause, which reserves to Congress (not the states) the power to regulate commerce. The Supreme Court has established various tests to ensure that a state tax doesn’t violate this clause and other clauses such as the Due Process Clause of the 14th Amendment.

To satisfy them, a state likely would need to ensure that a wealth or exit tax is applied to wealth accumulated while in the state, by people who have been living there, and offer some sort of credit for wealth sourced elsewhere. Therefore, the California proposal’s scope may be too broad, and its application after a taxpayer leaves the state is likely an overreach. Post-exit taxation may ultimately be limited to paying tax liabilities accrued prior to departure.

For now, ultrawealthy taxpayers seeking to avoid wealth and exit taxes must be vigilant for when they might be enacted. When that happens, the most obvious solution will be to move—before the taxes become effective.

A less extreme strategy would be to remain a part-time resident, presumably triggering apportionment or proration to mitigate the tax. Other strategies would include reducing taxable wealth by investing in exempt or excluded property; accelerating charitable contributions; and making family gifts, including through entities (accounting for any federal tax implications).

Legislators in eight states have recently introduced proposals to raise more money from their wealthiest taxpayers, but the wealth tax and accompanying exit tax proposed for California are especially worthy of consideration. Predictions that these new taxes will be imposed in their current form are overstated for now but should be seen as a harbinger of things to come—and a call to action for those who want to avoid them.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Michael Nathanson is chair and CEO of the Colony Group, a national wealth and business management company. He also hosts the “Seeking the Extraordinary” podcast.

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