Year: 2023

By Dr. James M. Dahle, WCI Founder

I’ve written elsewhere about all of the possible ways to deal with wealth inequality and its problems. I put a wealth tax pretty far down that list. Nevertheless, it is becoming a more and more popular idea. In 2023, legislatures in eight states (California, Connecticut, Hawaii, Illinois, Maryland, Minnesota, New York, and Washington) have introduced wealth tax bills. One of the biggest problems with a wealth tax is that it will be difficult and expensive to administer and to comply with fairly. It also feels punitive and makes you wonder whether the goal is to fund the government and improve everyone’s standard of living or just to punish the wealthy. While greed is not pretty, neither is envy. Frankly, given the number of tax cheats out there, hiring a lot more tax auditors is probably a better way to raise money for additional government functions. I certainly hate tax cheats (at every economic level) more than wealthy people.

However, today’s post isn’t about changing tax policy or giving advice to legislatures. Today, we’re going to give advice to those who might be affected by wealth taxes.

 

Who Will Be Affected by a Wealth Tax?

While there is no wealth tax currently in place (other than the federal and state estate taxes present in some states and exit taxes such as that in California), proposals seem to be aimed at those with a net worth of $25 million-$1 billion or more. Whether those figures will be indexed to inflation, nobody knows. I kind of doubt it, so the effect over time will be similar to the old Alternative Minimum Tax (AMT), where more and more Americans found that the tax that was not originally designed to tax them suddenly did apply to them. It also reminds me of the old Martin Niemöller quote:

“First they came for the [billionaires], and I did not speak out—because I was not a [billionaire.]

Then they came for the [multidecamillionaires], and I did not speak out—because I was not a [multidecamillionaire].

Then they came for the [millionaires], and I did not speak out—because I was not a [millionaires].

Then they came for me—and there was no one left to speak for me.”

A little dramatic perhaps, and I agree that it’s probably unlikely that this tax would ever apply to someone with a net worth under $1 million. But I don’t find it all that far-fetched to see a scenario where it affects most white coat investors at some point in the future.

More information here:

How Do Rich People Avoid Taxes?

 

What Might a Wealth Tax Look Like?

One of the best parts of living in the US is that we have 50 states trying all kinds of things all the time. Lots of those things don’t work out very well, and other states get to learn from the error committed in a single state. In other aspects of government, like 529s, states compete with one another resulting in benefits for everyone. This is a good thing. There is no current serious proposal for a federal wealth tax, but we can look at the state proposals. California’s proposal has received the most press. Here are the details:

• 1.5{c024931d10daf6b71b41321fa9ba9cd89123fb34a4039ac9f079a256e3c1e6e8} annual tax on “worldwide net worth” of $500 million ($1 billion married) or more
• 1{c024931d10daf6b71b41321fa9ba9cd89123fb34a4039ac9f079a256e3c1e6e8} annual tax on “worldwide net worth” of $25 million ($50 million married) or more
• Tax applies to all trusts of any value
• Trust assets will be applied to the worldwide net worth of the grantor(s) to the extent permitted by the US and California Constitutions
• Some sort of provision will be in place for “liquidity-constrained” taxpayers that allows them to pay when assets are sold
• “Liquidity-constrained” is defined as 80{c024931d10daf6b71b41321fa9ba9cd89123fb34a4039ac9f079a256e3c1e6e8}+ of net worth in illiquid assets
• If you leave California, you pay an exit tax for up to 10 years
• Worldwide assets are defined as:

1. 1. Stock in public and private C Corps
   2. Stock in S Corps
   3. Interest in partnerships
   4. Interest in private equity and hedge funds
   5. Interests in non-corporate businesses
   6. Bonds and interest-bearing savings accounts
   7. Cash and deposits
   8. Farm assets
   9. Mutual funds
   10. Put and call options
   11. Futures contracts
   12. Arts and collectibles
   13. Financial assets held offshore
   14. Pension funds
   15. “Other assets” except real estate
   16. Debt except those associated with real estate

• Real estate and its associated debt would be considered in a separate category and NOT taxed UNLESS it is held in a corporation, partnership, LLC, or trust
• Personal property outside of the state would not be taxed
• Net worth calculated according to rules associated with the federal estate tax
• Any transaction with the primary purpose of reducing worldwide net worth shall be disregarded
• Dependents’ assets of greater than $50,000 are considered the taxpayer’s assets
• The book value of all business entities must be reported each year. If that is not available to the taxpayer, the taxpayer must provide a certified appraisal of their interest
• Business interests worth less than $50,000 need not be reported
• Businesses to be valued at 7.5X profits unless the taxpayer can show that should not be the case

I find it fascinating that California’s current exit tax and proposed wealth tax do NOT include real estate, especially given California’s very unique property tax law. Yet another good tax reason to be a real estate investor, I guess. I couldn’t find anything about how losses might benefit you either, but it’s a long bill. Imagine you build an $80 million business and pay wealth taxes on it for a few years. Then, the business implodes, and you lose $80 million in wealth. Do you get any of those taxes back? I don’t think you do, but you probably get some kind of credit against future taxes. Maybe someday we’ll be doing “wealth tax-loss harvesting” in addition to “income tax-loss harvesting.”

More information here:

10 Best Tax-Free Investment Options to Consider

 

10 Steps You Can Take to Dodge a State Wealth Tax

Let’s get into the nitty-gritty. Let’s say you live in a state that actually passes a wealth tax that looks something like this. What should you do about it?

 

#1 Learn About Your Law

Step 1 is to learn about the law. Will you have a wealth tax problem either now or later? What assets count? What assets do not count? What happens if you leave? What happens if you give an asset away to charity, to your heirs, or to a trust?

 

#2 Do Nothing

You may choose to simply do nothing. Perhaps you’ve realized that you have enough money. Maybe paying a wealth tax will not have a material change in how you live your financial life. Perhaps you don’t even agree with Judge Learned Hand when he said:

“Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”

Pay your taxes and move on. Certainly, many people will choose this pathway, and there’s nothing wrong with doing so.

 

#3 Move

It is great to see states competing with each other, but they do so on many levels. They compete for residents and for businesses. States already have differing levels of income tax, property tax, sales tax, and more. If you feel exactly the same about living in Las Vegas as Orange County, well, pack up and leave. Take your business and employees with you. Millions of previous California residents now live in Arizona, Nevada, Idaho, Utah, and Texas. New York residents often move to Florida. They reduce their cost of living and their tax bill.

Yes, you will likely get nailed with an exit tax as you leave (it may last up to 10 years), but that will probably be less onerous than paying that wealth tax every year for the rest of your life. Paying a 1{c024931d10daf6b71b41321fa9ba9cd89123fb34a4039ac9f079a256e3c1e6e8} wealth tax has exactly the same effect as paying an extra 1{c024931d10daf6b71b41321fa9ba9cd89123fb34a4039ac9f079a256e3c1e6e8} in AUM fees. Over 30 years, your $25 million only grows to $190 million (7{c024931d10daf6b71b41321fa9ba9cd89123fb34a4039ac9f079a256e3c1e6e8}) instead of $252 million (8{c024931d10daf6b71b41321fa9ba9cd89123fb34a4039ac9f079a256e3c1e6e8}). If that exit tax costs you less than $62 million in the long run, you’ll come out ahead. Plus, any additional wealth you build in the new state won’t be taxed by California.

 

#4 Give Stuff Away

One great way to get around the estate tax has always been to give assets away until your estate is below the estate tax exemption amount. It would be no different with the wealth tax. You can give an unlimited amount to charity at any time. Your deduction may be limited, but you may wish to give above and beyond that deductible amount to reduce your wealth tax. Both you and your spouse can give away up to $17,000 [2023] per year to anyone you like without filling out a gift tax return and using up some of your exemption. California won’t let your dependents have more than $50,000 before it still counts as your asset for the wealth tax, but your kids won’t be dependents forever and you have plenty of family and friends that are not your dependents now. Maybe you’d prefer your friends get 100{c024931d10daf6b71b41321fa9ba9cd89123fb34a4039ac9f079a256e3c1e6e8} of that money instead of California getting 1{c024931d10daf6b71b41321fa9ba9cd89123fb34a4039ac9f079a256e3c1e6e8} of it.

 

#5 Buy Personal Property Outside the State

Want a second home with a dock, boat, jet skis, snowmobiles, and an airplane up in Idaho? Now you have another great reason to buy them.

 

#6 Invest Directly in Real Estate

I have no idea why California is not including real estate in the “worldwide net worth” calculation. But it’s potentially a massive, massive loophole. So, go invest in real estate, at least once you have $25 million in other assets. You’ll have to own it in your name (which introduces serious asset protection concerns), but it does get you out of the tax.

 

#7 Use Irrevocable Trusts

Yes, California is trying to make trust assets still count toward your wealth. But I think the state can only do that to a limited extent due to constitutional law. I don’t think assets in a true irrevocable trust are going to count, although an intentionally defective grantor trust like ours might not avoid a wealth tax. You’ve got $25 million+. Go talk to a lawyer that knows for sure.

 

#8 Life Insurance?

Whole life insurance cash value is not specifically listed in the worldwide net worth, but there is a category for “other assets”—and the bill does say it will use the federal estate tax method of calculating net worth (which does include the life insurance death benefit in the estate unless it is owned by an irrevocable trust). There might be a loophole here, though, promoting the sale of cash-value life insurance policies. Obviously, wait until the final bill is passed before going down this road, and even then, you might be better off getting higher returns and paying the tax than getting a big whole life insurance policy.

 

#9 Qualify as a Liquidity-Constrained Investor

The rules for this seem to be set at 80{c024931d10daf6b71b41321fa9ba9cd89123fb34a4039ac9f079a256e3c1e6e8}+ of assets being illiquid, but if you qualify, you could delay/defer paying your wealth tax on at least some of your assets. A deferred tax is still a tax, but there is value to paying taxes later. So, put more of your money into illiquid assets.

 

#10 Donate to Politicians Who Oppose Wealth Taxes

If your annual wealth tax is $1 million and it costs you another $100,000 a year to comply with the law with tax prep and appraisal fees, how much should you be willing to spend to prevent it from becoming law or being repealed if it has become law? I would argue at least that much. Sounds icky and nobody wants to know how the sausage is made, but let’s not kid ourselves about what is going on. It takes money to get elected, and if you don’t like how your state is being run, you have three choices:

1. Vote
2. Campaign
3. Donate

I suggest you do all three.

 

#10.5 Hide and Undervalue Assets

I put this one in partly in jest. There are both tax avoidance (legal) and tax evasion (illegal) methods in this category. Any asset that isn’t specifically listed would be included in this method. Maybe you put a big chunk of your money into pillows in a warehouse in Nevada. It’s a personal item and it’s out of state, right? But you could later sell 0ff those pillows. Nobody can really value many businesses accurately, especially illiquid ones. Having had businesses appraised several times, I’m amazed at how different the values can be and just how big the illiquidity discount can be (30{c024931d10daf6b71b41321fa9ba9cd89123fb34a4039ac9f079a256e3c1e6e8} is not unusual).

As you move out of the gray areas and into the black, isn’t this exactly what cryptocurrency is for? To protect you against confiscation, one of Bernstein’s Four Deep Risks? Cryptocurrency regulators are so far behind the technology that there is an awful lot of opportunity here for the unscrupulous. It’s much easier to hide from a wealth tax than an income tax.

 

There are better ways to deal with wealth inequality and to fund the government than a wealth tax. But should a wealth tax be implemented in your state, consider the above methods to deal with it.

 

If you need help with tax preparation or you’re looking for tips on the best tax strategies, hire a WCI-vetted professional to help you figure it out.

 

What do you think? What will you do if a wealth tax is passed in your state that applies to you or will eventually apply to you? Comment below!