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% annual tax on “worldwide net worth” of $500 million ($1 billion married) or more
- 1% 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%+ 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:
-
- Stock in public and private C Corps
- Stock in S Corps
- Interest in partnerships
- Interest in private equity and hedge funds
- Interests in non-corporate businesses
- Bonds and interest-bearing savings accounts
- Cash and deposits
- Farm assets
- Mutual funds
- Put and call options
- Futures contracts
- Arts and collectibles
- Financial assets held offshore
- Pension funds
- “Other assets” except real estate
- 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% wealth tax has exactly the same effect as paying an extra 1% in AUM fees. Over 30 years, your $25 million only grows to $190 million (7%) instead of $252 million (8%). 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% of that money instead of California getting 1% 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%+ 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:
- Vote
- Campaign
- 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% 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!
The exit tax is a particularly nasty idea
Another cynical zero sum world view policy. Interesting how state endorsed “equity” is always based on the elimination of equality.
A wealth tax…I should be so fortunate.
But seriously, this is a bad policy idea.
An exit tax? That was a new one for me.
I think you should be able to vote with your feet.
The AUM analogy was funny.
If I did win a multi-billion dollar lottery, it looks like I’d need a small army of money and legal people to keep it.
On a serious note, wealth taxes produce an exodus. Maybe that’s where the exit tax idea came in. I could see more states trying to float that one. “You made your money here, you must pay to leave.”
Your “gutsy” use of the Martin Niemöller quote is interesting but lacking in historical perspective.
We got to this terrible place because of 50 years of significantly lower taxes on the very wealthy, who then astutely took that wealth and lobbied congress to expand, even more, their stunning wealth. To create never-before-seen levels of corruption and graft.
The difference between a person making $30,000,000 a YEAR (average of the 0.01%ers) and a working doctor with a family is significant, both in actual wealth and in their ability to pay taxes.
It has gotten extremely dangerous for democracy around the world to let these “30 million a year” folks run things. It is not sustainable.
The average physician (and I realize their are exceptions, such as this author) has a lot more in common with the lowest paid laborers than the 30 million a year person.
I don’t disagree with you that there is a problem. I just don’t think a wealth tax is one of the better ways to solve it. This article isn’t about the problem and how to solve it though. It’s about what to do if a wealth tax is passed. The article about how to solve the problem you’re concerned about can be found here:
https://www.whitecoatinvestor.com/tax-policy-reform/
That one hasn’t been “hard-published” on the blog, but it is the first link in the article.
Bear in mind you don’t have to be making $30M a year for this wealth tax to apply. You can just have $25M. It wouldn’t be unusual for someone with an income of just $1-2M to acquire that level of assets.
And I’m not the first nor the last to “abuse” that Niemoller quote. I actually it applies pretty well here even if the original application was a lot more sinister.
I think most agree more equality in this regard is required. Just finished listening to The Psychology of Money and he mentions how the gaps in wealth have significantly diverged over the past several decades and that should be addressed. I just feel like if there’s a wrong way to go about fixing the problem, our politicians will find it.
I think there are some better ways and worse ways to do it. I think an annual wealth tax is one of the worse ways.
You might want to check that “50 years” reference.
The top 0.5% have been sticking it to the bottom 99.5% since before the Egyptians. The method changed from religion to capitalism. Same game otherwise.
“During the Gilded Age—the decades between the end of the Civil War in 1865 and the turn of the century—the explosive growth of factories, steel mills and railroads driven by the Second Industrial Revolution made a small, elite class of businessmen incredibly rich. By 1890, the wealthiest 1 percent of American families controlled 51 percent of the nation’s real and personal property. Among the richest of the rich were the so-called robber barons, whose extreme avarice drove them to use unethical business practices and exploit workers to create lucrative monopolies, and in the process amass fortunes that would amount to billions of dollars in today’s money.”
Interesting, though, that it’s not the same group of people for very long who are on top. The old saw goes shirtsleeves to shirtsleeves in three generations? I’m speculating here, but I’d hazard a guess that enormous wealth like that is more likely to vanish due to mismanagement or profligacy than persist for more than a couple generations. What’s probably a better way to tax the insanely wealthy is to zero in on options as payment for executives, carried interest for private equity managers, and rules regarding golden parachutes and executive buyouts.
I think you’d like this article:
https://www.whitecoatinvestor.com/generational-wealth/
Again, on wealth inequality being a special issue of “50 years of significantly lower taxes on the very wealthy”…I refer you to this article about this worldwide phenomenon that has been a part of the human experience for millennia:
https://www.vox.com/platform/amp/world/2017/1/23/14323760/inequality-europe-chart
One’s view of one’s own financial situation can be quite self-referential and most would like the increase in taxes to start just above their income level.
So White Coat Investors (who likely make from $100,000 to say…$1,000,000) generally think that they are just another working person. I’ve always just considered myself a highly paid employee…
It is offensive, not merely “a little dramatic,” to analogize taxing the uber-wealthy a few percentage points on their massive wealth with taking all of the assets from, beating, imprisoning, terrorizing, and systematically humiliating and murdering people of different political ideologies or ethnic groups (i.e. the meaning of Martin Niemöller’s “they came for”).
Sorry to offend you. Not my intent.
Although I’m not sure that comment is what you really found offensive about this article. You seem more bothered by the idea of wealthy people using legal means to decrease their tax bill.
Thanks for the reply!
It really isn’t people lowering their tax bills that I was responding to – I love finding ways to save and am a big fan of your website and emails for this very reason! (Thanks for all of the education and useful tips!)
It was the use of our memory, fear, and outrage against the Holocaust as a rhetorical tool in a place that has no relevance or comparison of scale to the Holocaust that I was responding to. Better writers than myself have written about the ways it minimizes the history, the disrespect it shows to the people who lived through it, and the related harms this can cause (e.g. https://www.ushmm.org/information/press/press-releases/why-holocaust-analogies-are-dangerous).
Well, I’ll ask our content manager at his kids’ Bar Mitzvah this weekend why he didn’t pull that out when he edited the post if it is so offensive and harmful.
In the meantime, f you know a quote that makes the point just as well, send it my way and I’ll start using that instead.
Hey Jonathan, I appreciate you writing in and giving us something to think about. I edited this post. I’m Jewish, and I had family members die in the Holocaust. When I edited this piece, I wasn’t offended by what was written, and Jim knows full well that if I get an inkling that something doesn’t belong in a post, I don’t keep my mouth shut about it. In fact, looking back on it, I didn’t even consider that some would take offense at that passage. But now that you’ve said it, I can understand why others could be offended by the quote. We always strive to be better at WCI, so we’ll take your POV and your comments to heart moving forward. Thanks again for saying it.
Thank you Jonathan. I also cringed when I read the quote, from a perspective of cultural appropriation. My Jewish ancestors fled Latvia and Lithuania. Jim, to me your reply came off a bit terse and defensive, perhaps you could be a little more receptive to feedback?
What culture do you think I’m appropriating it from? I’m very curious. Niemoller was not Jewish (nor a trade unionist, nor a socialist.) In fact, he was initially an antisemitic preacher. He changed a lot of his views later and spent time in a concentration camp.
At any rate, the quote (as modified) precisely indicates my thoughts on people’s attitudes toward a wealth tax. “It doesn’t affect me, so why should I care about it?” Well, it may affect you later! As someone said above, everyone thinks a wealth tax is a good idea so long as it starts at a level just above their level of wealth!
My use of the modified quote has nothing to do with being pro or anti Holocaust, Nazi, or Jew. Only the fact that laws that initially don’t affect you later may. It feels like people are trying to find offense where none is intended. I mean, if it wasn’t offensive to my editor, whose has family members who were killed in the holocaust, why are you being offended on his behalf?
Alas, it’s hard to control what offends oneself so I guess I shouldn’t blame you. But it is exceptionally hard to write in such a way that nobody ever finds anything you write offensive, yet people are still interested in reading.
The end of the Weinmar republic has plenty of allegories to the US today that are unrelated to the genocide that took place after the economic crash and fall of private property rights. The scapegoating and fear used to centralize power is nearly identical.
Demonizing American citizens who are wealthier than you(nor jews) will not solve ANY problems.
Growing wealth gap has been caused by many things. But none of them are related to the tax system not being progressive enough. Does anyone have to be reminded we have one of the most progressive tax systems on the planet where the top 10% fund 90% of all federal tax receipts alone.
Instead of juvenile neo-Marxist class warfare and abstracting the rich into a cohort to scapegoat how about we look at the generations of bad policy..
Fed induced inflation targets that punish savers, rewards investors and incentivize consumption. All of which disproportionately hurt the middle and lower classes by no fault of the “wealthy”.
IRS tax breaks on Cadillac employer sponsored health plans that that replaced wage increases with over-coverage.
A complicated and ever expanding tax code(tax break code) that allows only the savvy to navigate.
Just to name a few…
Wealth tax is a clumsy axe. There are different paths to billionaire status.
Oprah via entertainment.
Rihanna and K. Kardashian via entertainment and product marketing.
Bill Gates via software.
Ken Griffith via rapid trading strategies.
Hedge funders via carried interest rules.
Real estate moguls via 1031s.
Should all routes be treated the same? or change the rules for some routes.?
More discussion here: https://www.whitecoatinvestor.com/tax-policy-reform/
But before formulating policy, you have to consider your goals. Are you trying to fund the government? Are you trying to get rid of rich people? Are you trying to decrease the spread between the rich and poor? Which of those is most important? These are value/political judgments, not economic ones.
I don’t think WCI meant any offense, but I also found the use of the Niemoller quote to be tasteless. It’s not a good idea to compare any financial issue with the Nazis. About a decade ago, Stephen Schwarzman (founder of Blackstone) got widely criticized for comparing higher tax rates to Germany invading Poland. Just not a good idea.
I found the analysis in the article itself intriguing. I think a wealth tax won’t happen because it’s too tricky to implement and value various assets. Of course, it could happen anyway. In my mind, the simpler polices would be eliminating self-directed IRAs (retirement accounts would only be for publicly traded securities) and equalizing capital gains and income tax.
Getting rid of the unduly favorable tax treatment seems like lower hanging fruit than treating long term capital gains as ordinary income.
Unduly favorable tax treatment is a pretty vague term. Care to be more specific?
That would remove one of the major reasons for taking a risk investing your money. If you’re taxed on your capital just as much as on your labor, what’s a point of taking an investment risk in a first place?
And demonizing “the rich” comes from a long and glorious tradition of a zero-sum economical theory, which invariably leads to economic and societal ruin. Take it from someone who grew up behind the Iron Curtain
While I agree lower qualified dividend/LTCG rates encourage investment, there is still good reason to invest even without those improved tax rates. Unearned income is unearned income. I invest in lots of investments that don’t pay qualified dividend rates.
Sorry, getting rid of the tax treatment for “carried interest” would make sense. It wasn’t your capital to begin with, it was your clients’. Compensation for managing someone else’s money shouldn’t be treated the way we currently treat carried interest.
The CA wealth tax bill’s inclusion of trusts with a $0 trigger of the wealth tax could negatively impact many middle class households who have modest amounts of savings and use living trusts for a variety of reasons, including bypassing probate. It seems the bill as currently written could negatively impact a significant subgroup of Californians who are not wealthy in the sense of the thresholds used for individuals.
Am I reading the bill correctly that there’s an offsetting tax credit for real estate (property) taxes? Perhaps one reason why real estate is exempted is the high cost of coastal real estate in CA – if real estate weren’t exempted, primary residences’ valuations could be counted in the wealth tax assessment (though it seems an exception for primary residences could be included easily enough).
I am a well compensated professional, a physician. I worked hard and made extra income since I was a resident through side gigs and moonlighting. I maxed out my tax deferred accounts and my taxable accounts with a high savings rate since I was young. I also started a practice that became very successful. The result of all of my saving, investing, and optimizing is an 8-figure net worth.
Now that I am older, the magic of compounding continues to increase our wealth. There have been many years where I paid a 7-figure income tax bill. I think a wealth tax is a terrible idea in that it is costly, hard to administer, and hard to comply with. I would rather give all of my wealth to charity rather than take the pain of complying with government required appraisals of difficult to value assets to then pay a wealth tax. I would also consider retiring to a state without a wealth tax. This wealth tax idea discourages investment, discourages work, and discourages wealth building. What would happen to the 200+ employees who work for the business that I created if I simply decided it just isn’t worth it any more?
The Niemoller quote is in use all over. I expect highly educated people (the readers of this blog) to understand the use of an analogy. It is to demonstrate the similarity of the relationship between A and B to that between C and D. It makes no difference what A and B are, and what C and D are.
I grind my teeth when I see this in opinion columns and letters to the editor. My calming thoughts are ‘of course, not everyone is sophisticated enough to understand analogies’ but honestly, I think the offense taken is ridiculous.
The TCJA expires in 2025. This gives Congress multiple opportunities to mess with the tax code. Maybe better, maybe worse. Always opportunities. Don’t waste energy on trying to predict the Tax Code. Who knows how the political winds will blow next year or 10 years from now.
I just want to chime in to say that I appreciated the apt analogy. A lot of these topics are naturally very dry, and I always appreciate the attempt to make them more interesting. I assume I’m part of the (mostly silent) majority, and I really hope the extremely sensitive minority who are decrying this analogy don’t cause writers to tamp down future attempts at injecting color into these pieces.
I might add a few eclectic ideas:
– Strategic Divorce. You have now halved your wealth and it may get you below a threshold. Other tax and financial consequences need to be evaluated
– Gift to children. Tax consequences exist and use of an irrevocable trust might be a way to further enhance this
– Hard to value assets, while mentioned, isn’t necessarily to be thought of in jest. What is value if something hasn’t been sold? It is an unknown and subject to debate. This reality should be used to your advantage