The California Exit Tax: What Future Expats Should Know

Americans living abroad after moving away from California.

In this article, we discuss the current status of the California exit tax, a mechanism through which the state aims to close a loophole in its capital gains tax regulations while simultaneously applying a broader wealth tax initiative on qualifying individuals and entities.

While many articles focus on the exodus of Americans leaving the state for low-tax jurisdictions elsewhere in the U.S., such as Florida and Texas, we contextualize this information for those considering or already planning a move to Europe.

As we note, discussions around exit and wealth taxes in California position high-net-worth California residents well to grasp and navigate the complexities of moving abroad.

Finally, while the implications of the exit tax as noted in the legislation introduced in early January 2023 are largely existential at this point, we remind readers that California residency is challenging to break, making careful consideration and planning paramount when planning to leave.

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What Is the California Exit Tax?

The California exit tax is primarily aimed at individuals with a high net worth or significant unrealized capital gains. The tax is part of a broader strategy of taxing the wealth of the Golden State’s residents via legislative bill AB-259 Wealth Tax: False Claims Act. (1)

The proposed exit tax rate for California residents who leave the state is 0.4% on a net worth exceeding $30 million within a tax year. For married taxpayers filing separately, the threshold is reduced to $15 million. This tax may exclude real estate holdings, however state taxes still apply.

Did California exit tax pass?

Legislative bill AB-259 Wealth Tax is currently still with the legislative assembly after facing significant political headwinds after its initial introduction. (2)

Why was AB-259 introduced?

A key aim of AB-259 was to mitigate the state’s increasing deficit via the creation of a progressive wealth tax for individuals and taxpayers married filing separately, beginning at 1% for those with net worths in excess of 50 million dollars or 25 million dollars, respectively.

Had this bill been passed and signed into law, it would have gone into effect from January 1, 2024. The “exit tax” as it has been dubbed, refers to the application of the wealth tax even to those who leave the state, phasing out over four years from their departure. However, AB-259 has not been passed, and Governor Gavin Newsom has signaled that he is strongly opposed to the creation of a wealth tax in California. (3)

When does the California exit tax go into effect?

At present, the fate of the California exit tax associated with AB-259 is uncertain.

When we support clients who are California residents with the cross-border financial planning element of leaving California to move abroad, we focus on the possibility and implications of breaking California state residency. (4)

Current tax considerations when moving away from California

While there is no official exit tax to leave California, the general sentiment is that the state does make it exceedingly difficult to break state residency, potentially resulting in full or partial state tax liability.

This liability applies to individuals who move out of the state but still have financial ties to California. This includes but is not necessarily limited to taxes on:

capital gains from California property
income from California-based sources, and
business revenues.

It’s also worth noting that state tax audits have increased by more than double since 2018, (5) and that increase in audits correlates with an existing increase in population moving away from California.

Moving abroad and navigating the exit tax in California

Prior to moving abroad, we emphasize the importance of managing unresolved or correcting tax situations. Given the Franchise Tax Board’s zealousness for pursuing taxpayers from whom tax is owed, we do not recommend risking having to navigate these interactions from abroad.

Moreover, initiating a proactive review of your tax situation and finances prior to moving abroad is an investment in your financial well-being for years to come. Doing so can result in a tax-efficient plan to move abroad and a plan to optimize your ongoing tax responsibilities once you’re a U.S. expat. There are a multitude of reasons why it’s important to ensure that your tax situation is in order prior to moving abroad:

Given the complexity of California state taxes, it’s possible that you may need to continue filing a state tax return even after you move abroad
U.S. citizens, permanent residents, and other U.S.-connected people are also obligated to file an annual federal tax return, further complicating the paperwork associated with maintaining U.S. tax compliance.
The most tax-efficient set up for you and your family will depend a great deal on where you’re moving. While the U.S. has tax treaties with dozens of countries, the terms of each agreement as they relate to things such as the recognition of U.S. retirement account distributions and the treatment of capital gains tax varies by country.

Is California going to have a wealth tax?

Right now, the bill proposing to initiate a wealth tax in California, AB-259, is still with the assembly. We do not anticipate California to pass a wealth tax in the near future, however, we vigilantly follow updates related to the topic and encourage those who stand to be implicated by the proposed tax to do so too.

Preparing to navigate wealth taxes in Europe

Detractors of the idea of a California wealth tax often point to their long-term inefficacy in sourcing tax money from the world’s richest. One of the first things Emmanuel Macron did when he took office was repeal France’s wealth tax, noting that many of the people and businesses to whom it applied were simply leaving France and depriving the state of their tax dollars altogether.

Today, only two countries in the EU have a net wealth tax: Spain and Norway.

However, many other taxes remain to be mindful of when designing an international estate plan

For example, despite no longer having a wealth tax, French inheritance law is rife with tax tripwires and complex rules. There are also many rules around gifting and property ownership and transfers are notoriously challenging to navigate, particularly for expat families.

Finally, the threshold for being considered “high net worth” or “ultra-high net worth” is significantly lower in Europe compared to the U.S. (6)

We encourage Americans considering moving outside the U.S. to connect with us for a realistic understanding of what can be done to mitigate their tax liabilities, particularly if the intent is to move abroad permanently.

The California Exit Tax: What Future Expats Should Know - FAQ

Is the California exit tax illegal?

Technically, no, but it is considered something of a political hot potato, which is reflected in Governor Gavin Newsom’s declaration that he would not sign AB-259 even if it were passed and came to his desk.

References

Disclaimer

This material is purely intended to be general and educational in nature, and should not be construed as specifically-tailored investment, financial planning, tax, legal, or other professional advice. Information and data contained herein is as-of the date of publication, and may be subject to change in the future without notice. Any investment performance referenced is purely past performance, which is no guarantee of any future performance. Nothing contained herein should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation of any security or other financial product or investment strategy. All investment, tax, and financial planning strategies involve risk that you should be prepared to bear. You are highly encouraged to consult with professionals of your choosing before taking any action based on this material.