California’s “Exit Tax” Explained

California is in the midst of a significant overhaul of its tax code, and there’s one bill in particular that has lots of people talking. Assembly Bill 2088 (AB 2088), which was introduced in Sacramento in August of 2020, would impose the state’s first wealth tax. And more controversially, it proposes to levy a wealth tax on Californians for a period of up to 10 years, even after they’ve left the state, a California exit tax.

So how does all of this work? And what can you do to reduce your California state tax obligation? Let’s look first at how California determines who owes state tax.

How Does California Determine Residency?

California’s Franchise Tax Board (FTB) sets the requirements that determine who is (and who is not) a California resident for the purpose of tax assessment. To make this determination, the FTB examines a list of 19 factors using what they call the “closest connection” test. This test examines your community and economic relationships to determine your residency status. Factors include:

  • The location of your largest residential property
  • Where your spouse and children reside
  • Where your children go to school
  • Residence listed on your credit card account statements
  • Where you claim your homeowner’s property tax exemption
  • The number of days you spend annually in California
  • Residency as listed on your Federal and local tax returns

The FTB also looks at a number of personal factors, such as where you vote, where you register your vehicles, and where you see a doctor or dentist. The FTB assigns weighted values to each of the 19 factors and uses them to determine your residency status.

The AB 1253 Wealth Tax

Assembly Bill 1253 (AB 1253), passed in May of this year, proposes increased taxes on the state’s wealthiest residents. Under AB 1253, the state’s new highest tax rate would be 16.8%, which is a 26.3% increase from the state’s current top rate. There are significant concerns that this bill will negatively affect small to medium-sized businesses already suffering due to COVID-19 and the attendant economic slowdown.

Is AB 2088 a California Exit Tax?

Technically, no. That is, you are not taxed simply for leaving, nor are you prevented from leaving without paying the tax due. What AB 2088 does do is propose to assess taxes on former California residents for up to a decade after they’ve left the state.
This aspect of the Bill has sparked more than its share of controversy, and there remains a significant question as to whether the Bill can survive the almost certain court challenges that will follow.

How Much Would AB 2088 Raise My Taxes?

AB 2088 would impose a 0.4 % percent annual tax on a taxpayer’s worldwide wealth above $30 million (not counting real estate), based on market value at the end of each calendar year. Part-year residents would pay a prorated tax based on the number of days spent in California annually.

What if I’ve Already Left the State?

Under the California Revenue and Tax Code §17591, if you have left California but still have financial ties to the state, you’re still considered responsible for paying state income tax on income earned within the state. For example, if you’ve moved out of state but have an operating business or real estate within the state, you will likely still be obliged to pay state tax.
California uses something called “source income” to determine who is obliged to pay state tax. Your source income may include:

  • Income and Wages
  • Community Property (say only your spouse owns property in CA but you file jointly)
  • Business Income
  • Sale of Real Estate
  • Stocks & Bonds
  • Retirement Income

Can California Tax My Pension if I Move out of State?

Thankfully, no. A Federal law (PL 104-95) passed in 1996 supersedes the state’s tax interests and prohibits any state from taxing pension income of non-residents, even if the pension was earned within the state.

How Can I Minimize My State Tax Burden?

So, how can you pay no more than the tax you owe? Here are a few suggestions…

  • Understand the Law. Tax law is complex. By partnering with professionals who are skilled in tax law, you can avoid many potentially costly rookie mistakes. The attorneys and CPAs at Moskowitz LLP have helped thousands of clients to effectively plan, manage and minimize their tax burden.
  • Keep Documentation Current. Thinking of leaving California? Make sure your estate planning documentation is up-to-date.
  • Have an Exit Strategy. Severing economic ties with a state can be complex, and expensive. Don’t let yourself in for unexpected costs due to poor strategy. A consultant can help you develop and execute your exit plan.
  • Avoid Fees & Penalties.Why add to your existing tax bill with fees and penalties? By working with an experienced tax attorney, you can stay on top of the details and avoid penalties for late or improper filing.

At Moskowitz LLP we take your tax and accounting situation seriously. Our staff of experienced attorneys and tax professionals are here to help you navigate the often-daunting world of tax, including income tax, business tax, estate planning, property tax matter. Don’t depart from California without contacting us first before you leave and get your California Exit Tax plan. Reach out to us today; we’re waiting to hear from you.

Contact Moskowitz LLP today