Is the California Exit Tax Unconstitutional?

California’s proposed exit tax has sparked debate over whether it infringes on constitutional rights. The measure would impose taxes on certain high-net-worth individuals even after they leave the state, raising concerns about its legality and enforceability. Critics argue it could violate protections against extraterritorial taxation and restrict the right to move freely between states.

Key Points of Proposed Legislation

The proposed tax targets individuals with a net worth exceeding $30 million who relocate out of California. It would apply to unrealized capital gains, meaning individuals could owe taxes on the appreciated value of assets such as stocks, real estate, or business holdings even if they have not been sold. The tax rate would align with California’s existing capital gains tax, which reaches up to 13.3% for high earners.

To enforce this, the legislation includes a provision allowing California to track and tax former residents for up to ten years. The tax liability would be based on the value of assets at the time of departure, with adjustments for later gains or losses. While the federal government imposes an expatriation tax on individuals renouncing U.S. citizenship, no state has implemented a similar tax on former residents.

Constitutional Clauses Relevant to the Proposal

Several provisions of the U.S. Constitution could determine whether California’s exit tax is legally enforceable.

The Commerce Clause grants Congress the power to regulate interstate commerce and has been interpreted by courts as limiting states’ ability to impose taxes that burden economic activity across state lines. If California’s tax is seen as discouraging residents from relocating or interfering with business decisions, it could be challenged as an unconstitutional restriction on interstate commerce.

The Due Process Clause of the Fourteenth Amendment requires a clear connection between a taxpayer and the taxing state. In Quill Corp. v. North Dakota (1992) and South Dakota v. Wayfair, Inc. (2018), the Supreme Court ruled that a state must establish a sufficient nexus before imposing tax obligations. While these cases dealt with sales tax collection, the same principle could apply to whether California has the authority to tax individuals who no longer reside in the state.

The Privileges and Immunities Clause of Article IV prevents states from treating nonresidents unfairly compared to residents. If former Californians are subjected to tax obligations that do not apply to those still living in the state, it could be argued that the law creates an unconstitutional disparity. Courts have previously ruled against state policies that impose excessive burdens on individuals based solely on residency status.

Jurisdiction over Former Residents

California’s ability to tax individuals who no longer live in the state depends on whether it retains legal authority over their financial affairs. Typically, states tax individuals based on residency or income sourced within the state. Once someone moves, their tax obligations generally end unless they still earn income from California-based sources, such as rental properties or businesses operating in the state.

The proposed exit tax extends beyond this framework by asserting continued jurisdiction over an individual’s wealth, even if it is no longer tied to any in-state economic activity. California’s Franchise Tax Board (FTB) already conducts residency audits to determine whether individuals who claim to have left the state have actually severed ties. These audits examine factors such as property ownership, business interests, and time spent in California. If the exit tax becomes law, similar scrutiny could be applied to those who relocate, with the FTB monitoring asset appreciation and demanding payment on unrealized gains.

Enforcing collection outside California presents challenges, as the state lacks direct authority over assets held elsewhere. States cannot unilaterally enforce tax debts across borders, so California would need to rely on cooperation from other states or legal mechanisms such as the Multistate Tax Commission (MTC). While some states honor tax enforcement requests through reciprocity agreements, many do not. If a former resident refuses to pay, California may attempt to pursue claims through civil litigation, but this would require legal action in the taxpayer’s new state of residence, adding layers of complexity.

Legal Precedents That Could Shape the Discussion

Courts have historically scrutinized state tax policies that impose financial obligations beyond their borders, particularly when they affect individuals who have severed residency ties.

In Shaffer v. Heitner (1977), the Supreme Court ruled that a state cannot assert jurisdiction over someone merely because they once held property there. This decision established limits on a state’s ability to reach beyond its territory for tax or legal claims, which could weaken California’s argument that it retains authority over former residents’ assets.

In Cook v. Tait (1924), the Supreme Court upheld the federal government’s right to tax U.S. citizens on worldwide income regardless of residency. However, this ruling applies to federal authority rather than state powers. No state has successfully imposed a similar extraterritorial tax, and courts have generally resisted allowing states to regulate individuals who have fully relocated elsewhere.

In Franchise Tax Board of California v. Hyatt (2019), the Supreme Court ruled that one state cannot be sued in another state’s courts without consent. This could complicate California’s ability to enforce an exit tax, as other states may not cooperate with collection efforts. Without a federal mandate requiring compliance, enforcement mechanisms could face significant legal obstacles.