When Are You Exempt from California Exit Tax?

The topic of California Exit Tax has recently gained a lot of attention, and for the controversy around exit tax law in the United States. It is considered by many to be a significant deterrent for businesses and individuals who want to move out of the state. This article will take a closer look at the California Exit Tax, how it works, and why it has become such a hotly debated topic.

What is the California Exit Tax?

The California Exit Tax is a tax imposed on individuals who have lived in California for a certain period and then moved out of the state. The tax is imposed on any capital gains that the individual has earned while living in California, even if they were only realized after the individual left the state.

The California Exit Tax applies to individuals who have been residents of California for at least two of the past five years and who have a net worth of $2 million or more or an average annual net income tax liability of $200,000 or more for the five years before leaving the state.

How is the California Exit Tax calculated?

The California Exit Tax applies only to assets appreciated. It is computed by taking the fair market value of the individual’s assets on the date they leave California and subtracting the adjusted basis of the property (which is essentially the cost of the acquisition plus any improvements made). The resulting amount is the individual’s capital gain, subject to California state tax.

When is a taxpayer exempt from California Exit Tax?

A taxpayer may be exempt from the California Exit Tax in certain situations. Here are some of the common exemptions:

1. If you maintain non-resident status in California. If you move out of California, establish tax residency in another state, and meet certain non-resident status requirements, you may be exempt from the California Exit Tax. To qualify, you must spend less than six months in California during the year and not have a permanent home in California.
2. You may be exempt from the California Exit Tax if you are a covered expatriate under federal tax law. A covered expatriate is generally a U.S. citizen or resident who renounces their citizenship or terminates their residency and meets certain other criteria. However, it is essential to note that the federal exit tax may still apply.
3. If you are a resident of a state with which  California has tax treaties that provide exemptions from the California Exit Tax. These treaties generally provide that residents who move between California and one of these states are exempt from the California Exit Tax. Read below for more on these tax treaties.
4. If you moved to a Low-tax state such as Nevada or Texas, you might be exempt from the California Exit Tax. However, it is essential to note that the California Franchise Tax Board may closely scrutinize moves to these states to ensure that they are legitimate and not tax-motivated.

Which states have a tax treaty with California?

The California Exit Tax may not apply if the individual moves to a state with a tax treaty with California, and they may be able to avoid the tax altogether. Here is a list of the states that have a tax treaty with California:

1. Arizona
2. Indiana
3. Oregon
4. Virginia

Under these tax treaties, double taxation of the same income of residents who move between California and one of these states may be avoided by providing credit for taxes paid in another state. 

For example, if you are a California resident and earn income in Oregon, you may be subject to income tax in both states. However, under the tax treaty between California and Oregon, you may be able to claim a credit on your California tax return for the tax you paid to Oregon on that income. 

What are the assets that are exempt from California Exit Tax?

It is important to note that not all assets are subject to the California Exit Tax. Here are some of the assets that are exempt from the tax:

1. Retirement accounts: Assets held in qualified retirement accounts, such as 401(k)s, IRAs, and pensions, are generally exempt from the California Exit Tax.
2. Primary residence: The first $1 million gain from a primary home’s sale is usually exempt from the California Exit Tax.
3. Small business stock: Certain small business stock held for more than five years may be exempt from the California Exit Tax.
4. Personal property: Personal property, such as furniture, clothing, and jewelry, is generally exempt from the California Exit Tax.

10 Steps to Non-Taxing Exit from California 

If you are a resident of California and are planning to move out of the state, there are several steps you can take to become a non-resident for tax purposes. Here are some of the critical actions you should take to become a non-resident of California:

1. Establish residency in another state: The first step in becoming a non-resident of California is to establish residence in another state.
2. You must spend more time in your new state than in California and have a physical presence in the new state. 
3. You should also register to vote in the new state. 
4. Get a driver’s license in the new state and cancel the California situated club membership.
5. You should change your mailing address with your banks, credit cards, and other financial institutions to your new address in the new state.
6. Sell or rent out your California home. This will help establish that you are no longer a California resident and have moved to another state.
7. You should cancel or transfer your California utilities, such as your electricity, gas, and water, to the new address in the new state.
8. Close your California bank accounts and open new ones in your new state.
9. Change your health insurance to an available plan in your new state.
10. Notify the California Franchise Tax Board on Form 540 that you are no longer a resident of California and provide them with your new address. File a final California tax return to ensure that you are not subject to any taxes in California after you have moved.

It is important to note that many other factors can impact the application of the California Exit Tax, and the rules are complex. It is recommended that you consult with a tax attorney who can help you navigate the tax laws compliance.