Picking up from last year’s failed wealth tax bill (AB 2088), California legislators have introduced a new and seemingly more ambitious wealth tax measure in AB 310 and ACA 8. Predictably, the proposal has garnered popular support among progressives and fervent objection from conservatives.
But what would the “California Tax on Extreme Wealth” actually entail—and would passage be any likelier this year than the last?
The basic rules. If passed, the proposed wealth tax would impose an annual 1 percent tax on “worldwide wealth” in excess of $50 million per household ($25 million for married persons filing separately) and an annual 1.5 percent tax on wealth in excess of $1 billion per household ($500 million for married persons filing separately).
Only California residents would be subject to the tax. Temporary residents, as defined, are taxed in proportion to the percentage of days present in-state. Similarly, taxpayers who move in and/or out of state are taxed each year in proportion to their residency over the preceding 4 years.
The tax applies to “worldwide net worth,” which broadly includes practically any asset of value owned by the taxpayer wherever held, save for constitutional exclusions for out-of-state personal property, directly held real property, or liabilities related to such directly held real property. Real and personal property are subject to the tax, however, if held through a trust or business entity. (But a credit is available for individuals who own real property via a trust or business entity based on the proportion of property taxes paid.)
Special gift and other estate planning issues. Estate planners may be particularly interested in the measure’s gift and trust taxation provisions.
Under the tax, “wealth” further includes any asset transferred by a taxpayer to a relative, as well as any asset transferred to any party where the transferor retains control or directly benefits from the transferee’s use of the asset. The amount includible is reduced by consideration paid by the transferee. Consideration in excess of fair market value, however, is included in the transferor’s wealth. A trust that has a potential beneficiary related to the taxpayer, moreover, is itself considered a relative under the proposed rules.
These relative-transfer limitations notwithstanding, an individual may nonetheless divide their wealth at death among any number of heirs to circumvent or otherwise reduce liability among those heirs. See Galle, et al. “The California Tax on Extreme Wealth: Revenue, Economic, and Constitutional Analysis.”
Additionally, assets held in trust would be taxable to one of the trust, the beneficiaries, or the grantor. Any trust may elect to be taxed as if it were an individual. Otherwise, trust assets are taxable to any beneficiary with a present right to receive those assets. Contingent beneficiaries, on the other hand, are taxed when and to the extent trust assets are distributable. However, a throwback tax may apply to contingent beneficiaries whose interests vest, in which the beneficiary is liable for previously unpaid taxes on an asset as if they had owned the asset in prior years (unless the grantor elects to be taxed). If neither the trust nor a beneficiary is taxed, then the grantor is liable.
Because beneficiaries and grantors can be taxed only if they’re California residents, however, there are many scenarios in which multi-state families can use trusts to avoid the wealth tax. See, e.g., Galle, et al. “The California Tax on Extreme Wealth: Revenue, Economic, and Constitutional Analysis” (out-of-state settlor creates trust for benefit of California heir, who moves out-of-state for 4 years before receiving any distributions).
So you’re saying there’s a chance? Despite AB 2088’s shortcoming last year, proponents of the new measure remain hopeful, pointing to the fact it affects an even smaller proportion of taxpayers (0.07 percent of the state’s wealthiest residents) while raising significantly more revenue (over $22 billion per year). To contrast, AB 2088 had proposed a 0.4 percent tax on wealth in excess of $30 million and would’ve taxed the top 0.15 percent while raising $7.5 billion per year. In addition, the idea of a wealth tax has continued to gain traction both at the national and state level, fueling local optimism.
Conversely, critics warn of an exodus of elites, emphasize the cost and impracticability of valuation and enforcement mechanisms, and lament the apparent inadequacy of relief measures. Additionally, the bills face opposition not only from conservatives but also moderate Democrats in both houses.
Were it to pass the Legislature, moreover, the measure would still face a few steep challenges.
First, because the California Constitution currently caps any tax on net worth at 0.4 percent, the measure would require a constitutional amendment. Accordingly, ACA 8 was introduced as a resolution to amend the state constitution. If passed, the proposal must then be approved by the voters in the subsequent election. (On the other hand, if ACA 8 doesn’t pass the Legislature, it could still be enacted via the ballot initiative process.)
Second, even if passed, the legislation may well be vetoed by Gov. Gavin Newsom, who has previously indicated skepticism and may ill afford to support such a controversial measure ahead of a likely recall election this November.
Given the recent momentum of serious wealth tax proposals both in California and across the country, however, this is a development to watch closely, regardless of the particular and perhaps ill-fated outcomes of ACA 8 and AB 310 this year. Stay tuned.
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