A possible wealth tax in California is a controversial topic that has lessons not just for the wider world. Debates about reducing inequality of income and wealth on one hand, and the dangers of the impact on economies on the other, continue. 

The battle over California’s proposed “Billionaire Tax Act” is heating up, prompting wealth advisors to begin preparing mitigation strategies for “ultra-ultra”-high net worth clients.

Under the proposed ballot measure, state residents with a net worth over $1 billion would be required to pay a 5 per cent tax on their total wealth, not just income, over a five-year period.

The healthcare union that’s backing the plan needs to collect 875,000 valid signatures by April 17 to place the tax initiative on the November 3 ballot. Bernie Sanders, the firebrand independent senator from Vermont and a democratic socialist, kicked off the pro-wealth tax campaign last week [February 18] at a packed rally in Los Angeles where the crowd chanted “tax the rich.”

Calling out well-known billionaires including Elon Musk, Mark Zuckerberg, Larry Ellison and Sergey Brin, Sanders said “We’ve got some bad news for them. Starting right here in California, these billionaires are going to learn that we are still living in a democratic society where the people have some power.”

Opposition
But the wealth tax proposal faces intense – and well-financed – opposition. As expected, the venerable California Business Roundtable is attacking the initiative, aided by a $3 million donation from conservative businessman Peter Thiel.

Other opposition groups are also forming, including Golden State Promise, funded in part by cryptocurrency executive Chris Larsen, as well as efforts financed by Silicon Valley investors such as Ron Conway and Daniel Tierney. Google co-founder Sergey Brin contributed $20 million to Building a Better California, a political action committee backed by other tech titans that’s supporting three ballot measures designed to undercut the wealth tax.

What’s more, California governor Gavin Newsom, a liberal Democrat eyeing a presidential bid, is actively hostile toward the wealth tax initiative. And tellingly, no elected California politician showed up for the Sanders-led “Tax the Billionaires” rally in Los Angeles.

(Editor's note: As the home of Silicon Valley and other industries that can drive immense wealth, California – often a bellwether of certain political trends – has already wrestled with how to raise revenue on wealthier citizens. For example, legislators in Sacramento have sought to crack down on the use of trusts in other US states as a way of stemming revenue outflow.)

Strategies
Nonetheless, California wealth managers, lawyers and accountants are taking no chances. A conference organized by the Society of Trust and Estate Practitioners (STEP) of Orange County, for example, recently drew several hundred wealth advisors to discuss a variety of mitigation strategies.

Addressing the conference, first reported in the New York Times, Andrew Katzenstein, a partner with the Holthouse Carlin Van Trigt accounting firm, jokingly said a wealthy couple worth slightly more than $1 billion could avoid the wealth tax by getting divorced, since if they split up, they would have to divide their assets.

In a more serious vein, Katzenstein, who is also an attorney, described other mitigation strategies in an interview with Family Wealth Report. When planning for the wealth tax, individuals shouldn’t take steps that wouldn’t make sense otherwise in case the tax doesn’t become law, he said. 

“For example, real property owned directly by a person is excluded from the net worth calculation under the proposed Billionaire’s Tax Act, so no tax is due on that home,” Katzenstein said. “However, the assets of a grantor trust are part of the grantor’s net worth calculation under the BTA and are subject to the tax if it’s in the grantor trust on December 31, 2026.” 

If the individual buys the house out of the grantor trust for cash, he’ll now own the home directly and it won’t be part of the net worth calculation under the wealth tax, Katzenstein said. “Because the person owns the house at death,” he added, “their heirs can inherit the house with a 'stepped-up’ basis so that when they sell it, they won’t pay capital gains tax.”

California residents who oppose the Billionaire Tax Act can also become directly involved in the political process by donating money to groups  sponsoring competing ballot measures, noted attorney Christopher Karachale, partner at the Hanson Bridgett law firm in San Francisco.

Personal property exemptions
Those taxpayers who believe the wealth tax will become law can buy other homes or properties in or out of state to reduce their taxable wealth, since the tax wouldn’t apply to personal real estate. Art works are another form of personal property that wouldn’t be subject to the tax. Wealthy clients may consider moving valuable art work to homes in other states by April 3, Katzenstein said, because personal property won’t count toward net worth  if it is outside California for at least 270 days this year.

Reducing insurance valuation on items like fine jewelry because under the wealth tax assets cannot be valued for less than they are insured is another mitigation strategy. “You’re also saving on insurance premiums,” Katzenstein said. “It’s another example of something clients should be doing anyway.”

“Don’t let the tax tail wag the dog”
Any actions taken in anticipation of a potential wealth tax should keep a broader perspective in mind, agreed Jim Bertles, co-head of US wealth planning at AlTi Tiedemann Global. “Don’t let the tax tail wag the dog,” Bertles said.

“We are advising those clients with philanthropic interests, if it fits with their personal goals and timing, to accelerate their contributions to charity by funding their private foundations and/or donor advised funds and thereby remove assets that would otherwise be subject to the Billionaire's Tax,” Bertles said. “The tax advantages, in addition to removing assets from the Billionaire's Tax, are compelling.”

Regarding trusts, moving and modifying or decanting existing irrevocable non-grantor trusts “is more of a state income tax avoidance strategy,” Bertles explained. “The strategy to remove assets from the Billionaire's Tax is to create new trusts that are completed gifts, non-grantor trusts, and outside of the client's estate.”

California residents considering a major liquidity event like selling a business and subsequently relocating out of state “should start relocation discussions at least a year before liquidity event discussions,” said Karin Christenson, senior wealth planner at Wilmington Trust.

If a billionaire’s wealth is concentrated in illiquid assets, such as private company shares, “consider strategies to improve liquidity, such as exploring secondary market sales or lines of credit,” said Terrance Hutchins, managing director of tax and business planning for Stevens Capital Partners.

Roth accounts and deferred compensation offer other potential planning opportunities to lower a client’s calculated net worth, Christenson said. But, she warned, “the ability to eliminate the tax will be narrow.”

Review and update
Ownership structures including trusts and business interests should be carefully reviewed to identify any potential exposure, said Hutchins. “Early planning is key, as last-minute transfers may be subject to anti-avoidance rules,” he warned.

For complex or closely held assets, wealth managers should make sure clients have up-to-date, defensible appraisals and documentation to support valuations, Hutchins added. Similarly, estate and marital arrangements should be reviewed to understand how the proposed tax could impact aggregated assets, especially for married couples.

State residency is also a major consideration that will come under strict scrutiny and require detailed documentation, though anyone living in the state since January 1 of this year is obligated to pay the wealth tax if it becomes law.

Heading off collapse?
Whether the measure ever will take effect is an open question. 

The sponsor, Service Employees International Union-United Healthcare Workers West, hopes voters respond to its campaign emphasizing that 90 per cent of the tax revenues are mandated for spending on healthcare that the union says is needed to make up for the deep cuts the Trump administration made into federal healthcare programs. The remaining proceeds will be directed to food assistance and education.

California will lose approximately $100 billion from federal healthcare funds over the next five years, pushing the state “toward a healthcare collapse,” the union says. As a result, insurance premiums will skyrocket, millions of state residents will lose coverage, hospitals will close and around 145,000 healthcare jobs will be eliminated, according to pro-tax publicity.

The estimated 200 to 250 billionaires who live in California can easily help prevent this apocalyptic scenario, the union contends. Citing a statistic that the average rate of growth for the wealth of billionaires in the United States of 7.5 per cent annually, the union says billionaires would “barely notice” paying one per cent of their total wealth a year for five years. “This tax would be less than that amount, so even if billionaires pay it all in one year, their wealth would still increase,” the union argues.

Harmful consequences?
Opponents counter that a wealth tax would drive away wealthy taxpayers who fund state services and entrepreneurs who create new business and jobs. If passed, the tax “will devastate California’s innovation economy [and] ultimately destabilize our tax revenue even further, ” Rob Lapsley, president of the California Business Roundtable told the Times.

Opponents are expected to spend around $75 million to fight the wealth tax initiative, including ads featuring Governor Newsom and other Democratic officials such as San Francisco Mayor Daniel Lurie. Competing  tax-related proposals on the ballot may confuse voters. Wealth tax sponsor Service Employees union hasn’t gotten support from many other major politically influential unions in the state. And even if the wealth tax measure passes, it’s expected to immediately face a number of legal challenges. 

More to come
Nonetheless, the wealth tax concept, fueled by concerns over lagging tax revenue and income inequality, is unlikely to fade away. The mood was perhaps best captured in the recent headline “Billionaires’ Low Taxes Are Becoming a Problem for the Economy” from a quite unexpected source – The Wall Street Journal.

Aided by a group called Patriotic Millionaires, a number of states are considering raising taxes on their wealthiest residents, including Pennsylvania, which has its own “Tax Billionaires, Fund PA” plan, Virginia, which is debating creating new top tax brackets and Illinois, where a proposed constitutional amendment would impose a 3 per cent tax on income over $1 million.

Even for clients not impacted by a wealth tax at present, the California proposal “is a case study for how future wealth taxes may be posed and what exclusions and planning opportunities exist,” said Wilmington Trust’s Christenson.

Residency, liquidity and legal issues were addressed in a January story on the California Billionaire Tax Act.

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