California is well-known for its highest progressive taxes in the US. As a result, residents are hoping to avoid taxes and relocate to a tax-free state. However, the state government imposes a “California Exit Tax” on individuals with high net worth, which they are legally bound to pay even after departure.
So, if you want to escape from additional taxes on your income, read this article to explore various strategies. Here, I’ve put together all the detailed information on the Cal exit tax, how to minimize it, and the benefits and drawbacks of it.
The California exit tax is a one-time wealth tax levied on individuals and businesses relocating from the state.
If you earn $30 million per year from your California-based business and investments, you are required to pay taxes at the rate of 0.4%. However, if married taxpayers choose to file separately, they will be required to pay taxes on $15 million.
Meanwhile, it is important to consider that California doesn’t have any official wealth tax. The “California exit tax” was part of the Assembly Bill 259 and died in early 2024.
But according to some resources, some lawmakers requested another wealth tax for ultrarich residents and business executives.This proposed model may be similar to how additional paid-in capital impacts equity calculations in corporate structures
Disclaimer:
The California exit tax is only a proposal and has never been signed into law. So, there is no official exit law in the state. However, the state still imposes other wealth taxes on high-net-worth individuals after relocating— similar to how debt financing can impact a company’s financial obligations.
California is one of the highest tax collectors in America, with top earners paying 13.3% taxes. If this exit tax is implemented in the state, it targets two broad categories: high-net-worth individuals and long-term residents.
Here, I’ve mentioned a detailed breakdown of individuals who could be affected by the exit tax California.
Wealthy Individuals: Residents with a net worth of more than $30 million globally are required to pay tax.
Long-Term Residents: Individuals who live up to 10 years in California and earn significant income will be legally bound to pay taxes.
California Sourced Income: Business owners who relocate but still have property, investments, and earn enough money will be obliged to pay taxes.
If you fit any of these categories, you have to pay the California exit tax. However, it is crucial to note that such tax policies would not impact middle-class residents and small business owners. Still, it’s useful to understand tax concepts like semi-monthly pay and salary vs hourly structures when evaluating impact.
The California exit tax isn’t an official standalone tax law, but the Franchise Tax Board (FTB) applied it in the state to prevent tax avoidance.
With taxes ranging from 1% to 13.3%, California has a progressive personal tax system. Therefore, individuals relocate to other states in the US before selling their assets to avoid high taxes. This situation creates a loophole in the collection of capital gain taxes.
That’s why the inception of the Cal exit tax comes into existence to capture unrealized capital gains even after relocation. As a result, the government allows FTB to impose tax on income earned after individuals leave.
Let’s understand with an example:
If you built a house in California and sold it after moving to Texas. The California law still claims a portion of the taxes from the property sale because you made it while you were a resident.This situation is not unlike evaluating fixed cost structures when determining long-term profitability.
What Strategies California Expats Should Focus on?
When you are planning to leave California, it’s a wise decision to reduce tax liability before relocation. But it requires careful planning and a tax professional to implement these strategies.
Here, I’ve jotted down targeted strategies to minimize exit tax for your guidance.
Non-residency and Asset Management Strategies:
Consider relocating to a tax-free state before leaving California.
Transfer your business and investments to another state of residence before changing your citizenship.
Either close or transfer your California bank accounts and financial relationships.
Evaluate the tax implications of your assets and do not sell them right away after moving— the same way you’d cautiously approach retro pay or cash flow statements for compliance.
Cancel your California voter registration and driver’s license, or transfer them to a new state.
Structure your business accordingly in order to reduce California-sourced income. This is helpful for you to prevent the exit tax.
Schedule Time for Planning:
You should begin preparations 12–18 months before departure to a new state.
Document your resident address in another state.
You have to spend more time outside California and maintain a detailed record of it.
Arrange all your important financial transactions when you are leaving the state— similar to best practices followed in outsourced accounting.
Essentially, you should consider contacting tax experts to manage documents and assets.
On the whole, when you follow these recommendations, it highlights that your ties with another state are higher than California. In this case, FTB will not consider you a California resident, and you are lawfully moving to a tax-free state without tax obligations. These strategies are crucial whether you’re an individual or running accounting for startups.
What are the Benefits and Drawbacks of the California Exit Tax?
The California exit tax is designed to plug a loophole in the capital gains tax and to maintain state revenue. Meanwhile, it discourages high-net-worth individuals to reside and invest in the state.
As a result, the Ca Exit Tax has both benefits and drawbacks for both residents and the government. So, have a look at the subsequent section to learn more about the pros and cons of this tax implication.
Benefits of California Exit Tax
The exit tax can be beneficial for the government to maintain the budget and improve public services. Here is the breakdown of Cal exit tax advantages:
Maintain State Revenue: It helps the government to generate revenue and cover budget downfalls in the state, even after rich residents and business owners relocate.
Support Critical Services: The tax collected from the high-net-worth individuals could be used for public welfare, developing infrastructure, and improving health services.
Promote Economic Equality: Some economist claims that wealth tax (including exit tax) has the potential to achieve economic equality in California and helps in reducing the wealth gap.
Prevent Capital Gain Avoidance: It prevents capital gain avoidance, where individuals could evade paying taxes on the sale of assets after moving to a new state. These goals parallel the intended outcomes of systems like reverse charge VAT in global tax compliance.
Drawbacks of California Exit Tax
On the other hand, residents claim that the Cal exit tax can be frustrating for them and discourages them from investing in the state. So, take a look to learn in great detail about the drawbacks of the exit tax California.
Brain Drain or Discouragement: The high-net-worth individuals and business owners may leave the state due to high taxes. It discourages rich residents from living and relocating to California.
Double Taxation Concerns: Many individuals have concerns regarding double taxation. They might pay exit tax and other wealth tax to the government on their net worth.
Law Complexity: The Cal exit tax adds complexity to state tax regulations. Implementing and regulating this law requires a robust valuation process and legal documents.
Constitutional Challenges: Many opponents claim that it may potentially violate the freedom of travel and constitutional rights. These tax policies could become as controversial as the implications around T accounts or tax reference numbers in regulated jurisdictions.
While there’s no official California exit tax, the government still imposes a wealth tax on individuals who leave the state. This Ca exit tax is designed to prevent capital gains tax avoidance and to maintain the budget shortfall.
However, it adds complexity to the state regulations and “brain drains” rich people from investing in California. So, if you also fit in the exit tax category, you should carefully read the above-mentioned strategies to prevent additional taxes after leaving the state.
In addition, you should contact professional tax experts to manage all legal procedures and documents accurately and on schedule. Understanding basic concepts like bookkeeping, accounts receivable, and payslips can also make exit planning much smoother.
Frequently Asked Questions
Ans: No, there’s no official California exit pass, and it was suspended in early 2024. But you may still be forced to pay taxes on California-sourced income after relocating.
Ans: High-net-worth individuals and long-term rich residents have to pay the Cal exit tax or wealth tax on their income.
Ans: Yes, you should reduce your California-sourced income and change your domicile to minimize the exit tax after moving to a new state.
Ans: If you sell your property after departure, the California law still imposes capital gain tax on the sale profits.
Ans: The California exit tax will not go into effect because it is a proposal and has not been enacted.
