Navigating the California Exit Tax: What You Need to Know Before Leaving the Golden State

California, renowned for its scenic beauty and vibrant economy, also carries the reputation of imposing high taxes on its residents. For those contemplating a departure from the Golden State, there’s an additional financial consideration that might catch them off guard: the California exit tax. 

What exactly is the California Exit Tax?

The California exit tax is a levy imposed on individuals and businesses who opt to move out of California. It forms a part of the broader California wealth tax strategy, aimed at taxing the wealth of state residents. Individuals with annual incomes exceeding $30 million could find themselves subject to this tax for a duration of up to ten years post their California departure. This tax encompasses various assets such as property holdings, stocks, and other investments.

How much are you expected to pay?

The exit tax rate stands at 0.4% on the net worth exceeding $30 million within a tax year. For married taxpayers filing separately, the threshold is reduced to $15 million. It’s worth noting that while certain real estate holdings within California may be exempt from the exit tax, they are still subject to state taxes.

Both individuals and businesses exiting California fall under the purview of the exit tax. This includes businesses shifting their operations out of state and individuals relocating to other states. It’s crucial to understand that the tax is specifically tailored for those moving out of California, not for those merely relocating within the state.

What’s the rationale behind the exit tax?

The inception of the exit tax aimed at plugging a loophole in capital gains tax regulations. Previously, individuals could sidestep capital gains taxes by relocating out of California before selling assets like stocks. The introduction of the exit tax ensures that these gains are subject to taxation, irrespective of the individual’s relocation status. Moreover, it serves as a mechanism for California to recoup investments made in businesses and individuals through tax incentives and other fiscal initiatives.

Let’s Add An Example: 

Let’s say John, a resident of California, has been living and working in the state for the past 15 years. During this time, he has accumulated significant wealth through various investments, real estate holdings, and business ventures. However, John decides that he wants to move to a different state with a lower cost of living and better tax environment for his business.

Upon deciding to leave California, John learns about the California Exit Tax, which is imposed on certain residents who choose to leave the state. This tax is primarily targeted at individuals with high net worth or significant unrealized capital gains.

Before leaving, John consults with a tax advisor to understand the implications of the California Exit Tax. The advisor informs him that California imposes a tax on any unrealized capital gains accrued during the time John was a resident of the state. This means that John will have to pay taxes on the appreciated value of his assets, even though he hasn’t sold them yet.

To calculate the exit tax, John and his tax advisor assess the current market value of all his assets, including stocks, bonds, real estate properties, and business interests. They then determine the difference between the current value and the original purchase price or fair market value at the time John became a California resident.

After crunching the numbers, they find that John has accrued substantial unrealized capital gains on his assets. As a result, he will owe a significant amount in exit taxes to the state of California.

John realizes that the California Exit Tax will eat into a considerable portion of his wealth, but he decides to proceed with his move anyway, considering the long-term benefits of living in a state with lower taxes.

Upon officially moving out of California, John must file a final tax return with the state, including payment for the exit tax owed. This ensures that he fulfills his tax obligations before establishing residency elsewhere.

In conclusion, the California exit tax holds significant implications for high earners and businesses contemplating an exit from the state. Its ability to exert financial repercussions for up to a decade following relocation underscores the importance of grasping its intricacies. 

If you have questions, contact Paragon today.