If you don’t live in California, you will want to read about this new tax in preparation of it spreading to your home state. A lot of Californians are transplanting to states like Colorado, Arizona, and Texas to flee high taxes. The sunshine state makes history with the country’s first proposed wealth tax.
In fact, California comes in at number one for the country’s highest income tax - 13.3 percent.1 And if you’re a high earner, you could be subject to an even bigger tax hit soon.
What Is a Wealth Tax?
With income tax, the individual is taxed on how much they made during the previous year in taxable income (such as a salary, retirement account withdrawals, interest, etc.).
Wealth tax, on the other hand, is an annual tax that is applied toward an individual’s actual net worth - as opposed to the income earned over that year.
Would California’s Wealth Tax Impact Everyone?
No, it would not. The currently proposed wealth tax would impact around 30,400 Californians, or those with a net worth above $30 million (for single or joint filers, $15 million each for married individuals filing separately).2 It would apply a 0.4 percent tax rate on an individual or couple’s net worth above the $30 million threshold.
How Is Net Worth Calculated?
Now that’s the million dollar question (no pun intended). Trying to determine the net worth of the ultra wealthy is not always something that can be easily calculated or defined. As of now, the tax would take into account all globally accumulated assets and liabilities held by an individual or couple. Many are predicting, however, that the state may run into trouble when it comes to determining the value of illiquid assets, as well as attempting to tax assets not held within the state of California.2 Not to mention savvy investors often use Limited Liability Company’s to own investments.
But Wait… Startup Entrepreneurs May Catch a Break
California - and the Bay Area in particular - has been the home of startup visionaries for years. From Mark Zuckerberg to Steve Jobs, Silicon Valley has become the breeding ground for successful startups.
While this wealth tax is meant to earn additional revenue for the state, lawmakers likely don’t want to alienate or discourage entrepreneurs from bringing their endeavors to the Golden State (how likely is that?) In the proposed bill, taxpayers with entities such as startups or other hard-to-value assets may “elect for an unliquidated and deferred tax liability to be attached to those assets.”2
If an individual would choose to go this route, they’d need to sign a contract with the state of California determining when the value of these assets (such as a start-up) would become subject to the proposed wealth tax.
Thinking of Leaving the State? Consider This First
If the wealth tax is likely to impact you directly, your first instinct may be to call your real estate broker and start packing. The problem is, just because you move out of California doesn’t mean you wouldn’t be subject to California’s proposed wealth tax. If you would have been eligible for the wealth tax (i.e. your net worth was greater than $30 million) sometime within the last 10 years before moving, you are still subject to the tax even after leaving the state. For the next ten years, you could be paying the wealth tax, albeit at a rate that lowers gradually every year - 90 percent the first year, 80 percent the second, etc.
If you’re worried about this proposed wealth tax and its potential impact on your financial future, get in touch with your financial advisor or accountant immediately. He or she may have more information on this bill or offer clarity and insight to your biggest questions surrounding these potential tax changes.
Why this matters to the rest of the USA?
Following the American Revolution, the newly established government was understandably cautious when it came to taxation as direct taxation was prohibited by the Constitution for all practical purposes. The 16th Amendment was introduced in 1913 to pave the way to an income tax by removing the proportional to population clause, thus saving the poor souls at the IRS from the unemployment line. It was quickly followed by an income tax on people with an annual income of over $3,000. This tax touched less than 1% of Americans. 3
There is an old saying about not letting the camel get their nose under the tent. Why? Because then the whole camel gets in the tent. It won’t surprise me to see this new wealth tax expand first to the high net worth individuals and then expand to all the rest of us.
However, there are only so many bites you can take out of an apple before there’s no apple left. America was formed by entrepreneurs escaping repressive regulations and taxes of their home country. At what point does the tax code motivate entrepreneurs to seek other countries that promote liberty just like we once did? Then who will we tax when we need to repay the $4 Trillion dollars we’ve printed this year fighting COVID-19? Food (or should I say apples) for thought.
This isn't the first tax increase due to COVID, Nashville Tennessee approved a 34% property tax increase. This tax increase is coming from the governments decrease in revenue due to the economy because of COVID-19.4 Not only has this affected home owners, but COVID has also affected small business owners due to unemployment claims, which employers have to pay a certain amount of. This is can be detrimental to a small business that not only had to pay more for unemployment taxes, but couldn't operate at its potential for months. Nothing is free, we will paying the consequences of this virus for many years to come.
To your freedom,
Certified Tax Specialist™
P.S. If you’d like a complimentary analysis of your future tax risk on your IRAs/401k, use my calendar link to schedule a virtual meeting.
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.