Wealthy Californians Can Use Existing Strategies to Reduce Taxes

A California bill to tax residents with more than $50 million in global income may have died in committee, but the ultrawealthy should still watch for potential wealth taxes. The state is likely to reintroduce a wealth tax due to a looming budget shortfall.

Any new bill would face significant costs and logistical hurdles, as setting up a program to implement and enforce would probably require California to create a new division within their Department of Revenue to receive and process these returns and verify compliance. This would include hiring and training of staff and most likely getting outside experts (such as valuation experts).

It would also require new forms and system changes. Rather than focusing on uncertainty, high-net-worth individuals looking to reduce their tax burdens in California may want to consider their existing options: moving themselves or assets out of state, using irrevocable trusts, or exploring charitable tax reduction strategies.

While leaving the state may seem drastic, it may also not create the hoped-for results. State taxation can be tricky to navigate. Issues of nexus and domicile require attention to detail to complete the severance and officially detach oneself from the state’s ability to tax.

The Franchise Tax Board determines if the taxpayer is a resident of California or if the taxpayer has income that is taxable by California. The definition of a resident of California looks to more than 10 factors to determine the strength of the taxpayer’s ties to the state.

Any individual who was at one point a resident of California will continue to be a resident until that taxpayer can prove otherwise. For non-residents, California taxes California source income, which includes income from a business or profession carried on in California. Additionally, a trust’s entire taxable income is subject to tax in California if the fiduciary or beneficiary is a resident of the state.

Another option may be to do nothing and wait until some kind of similar law is close to passage before pulling up stakes and heading somewhere with lower taxes. As of now, given the political and logistical hurdles, it’s unlikely a wealth tax is anywhere close to being passed and implemented.

For example, the now-dead AB 259 specifically excluded directly held tangible personal property from taxpayers’ global net worth—think expensive art or jewelry—that was kept in another state. Moving that art or jewelry could help reduce the tax burden in the event of a new wealth tax.

HNWIs who don’t want to just follow a wait-and-see approach should consider working with their advisers to explore the tools and planning strategies permitted under current tax laws—particularly those that build in flexibility to allow for adjustments in the future.

Irrevocable trusts are one umbrella strategy that encompasses several different bells and whistles that may be used depending on the individual’s goals. The Tax Cuts and Jobs Act doubled the existing estate and gift tax exemption amounts—but it’s set to expire at the end of 2025, so individuals and couples should use the increased exemption soon.

Another technique that has seen increased popularity for married couples is the spousal lifetime access trust, an irrevocable trust created by a grantor for the benefit of a beneficiary spouse. This type of trust can transfer value out of the grantor spouse’s estate for estate tax purposes while maintaining some limited access to the wealth for the beneficiary spouse’s benefit.

California residents who are comfortable making completed gifts with less control could consider making an irrevocable, completed gift to a non-California trustee with no trust administration in California and contingent beneficiaries. A completed gift means the donor has given up full ownership and control over the asset.

This would presumably defer California income taxation until income is distributed to California beneficiaries. This scenario could lend itself to complete mitigation of any potential future wealth tax on the value of this trust, as it would have presumably successfully removed the wealth from the state before any wealth tax implementation.

Finally, California taxpayers who are philanthropically inclined can assess a variety of tax-advantaged charitable strategies, including the use of private foundations, donor-advised funds, or charitable trusts that can benefit charities and select beneficiaries.

Charitable trusts, such as charitable lead trusts and charitable remainder trusts, are considered split interest trusts in that they have both charitable and non-charitable beneficiaries. For example, a donor may decide to create a charitable lead annuity trust, in which the annual annuity payments go to a charity (either as a fixed dollar or fixed percentage of the fair market value of the assets). After the trust term, the remainder passes onto non-charitable beneficiaries, which is usually the donor’s family.

Whatever their objectives, California HNWIs should work with tax advisers to determine the best planning techniques for their circumstances.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Marguerite Weese is chief operating officer of Wilmington Trust Emerald Family Office & Advisory.

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